Tax Cuts, Fiscal Policy, and Tenant Credit
The U.S. tax cuts passed in the closing days of 2017 offered companies an attractive opportunity to increase shareholder friendly fiscal policies including dividends and share repurchase programs. Early projections by JPMorgan suggest that large publicly traded U.S. based companies will increase buybacks by 34% in 2018 relative to 2017, with dividends expected to increase by 8%.
These trends got us thinking about how shareholder friendly fiscal policy may trickle down and impact the class A commercial and industrial tenants we see on a regular basis. Pass through entities like S-Corporations, LLPs, many LLCs have tax implications for the partners and members respectively, and thus they often engage in their own form of dividends in the form of distributions. These distributions are generally used to pay tax obligations and increase owner, partner, or member income. From a landlord’s perspective, these distributions are a negative as they limit the capital retained by the business and shrink the safety net should pass through businesses encounter trouble in successive years.
So with the tax package seemingly incentivizing large corporations to give back to their shareholders, should we expect the same thing from mid-sized companies? Maybe not given that the deductions apply to a relatively low income threshold for service companies like doctors, financial advisors, and attorneys. That means that attorneys filing joint tax returns making a combined $315 thousand or more may not see the deductions that the new tax regime allows for pass through income ($157.5 thousand if filing individually). Thus, partnerships, LLCs and S Corporations, particularly those seeking class A space, may not be as incentivized to adapt their distribution policies to the new tax structure given that the impact is likely minimal.
One exception may the venerable C Corporation. These businesses are not subject to the simple 21% tax rate. Many C corporations are likely to face a lower tax burden and thus adjust their distribution policies as a result. Some companies may choose to reinvest in their businesses, but potential shareholder pressure could pull more capital out of these businesses and weaken their credit profile.
Landlords may not notice much difference in the overall credit quality of their rent rolls today given the robust economic conditions we have enjoyed in recent years. But companies often turn to increased distributions and other shareholder friendly practices when economic confidence erodes. Thus, the tax changes, which accelerated growth in early 2018, could have the opposite impact on many smaller to medium sized businesses if conditions deteriorate.