This title may be a bit ambitious, a triumphalist embrace of hope over experience? But it’s time for the effort to be made.
With the help of my former colleagues at Dechert, notably Will Cejudo (me being the former, not him), we have proposed a new bill (need a catchy name…help, please) to amend the hoary Real Estate Mortgage Investment Conduit (REMIC) statute which has been largely untouched (with one notable failure…FASIT) for over for almost 40 years.
It’s time. The rule is burdened by limitations and restrictions that might have made some sense in the context of the tax policy debates of the mid-1980s, but are irrelevant and certainly counterproductive today.
A draft of the revised statute is attached as a redline. You will see it’s simple and the text is brief.
Essentially, we propose eliminating the requirement that collateral can only be added to the REMIC for 90 days after the startup date and permit loans to be modified, even if the modifications are material, regardless of the loan’s performance status, so long as the loan remains principally secured by real estate. Additionally, the proposal makes clear that PACE, CPACE and mezz debt, however structured (as long as principally secured by real estate) are good REMIC assets.
Easy, right?
The scattered and far from fulsome legislative history of the adoption of the REMIC in 1986 suggests that the encrustations and limitations and restrictions on the REMIC regime were designed, in part, to avoid a hit to the Treasury when double taxation on a vehicle which would receive income (debt service on the loans) and pay interest to bondholders (with an R class to soak up mismatches) was eliminated.
I’m not sure that made any sense at the time, as it seemed to be based on a counterfactual analysis of a comparison of the structure that would work (the new REMIC) against one that would never happen (a securitization vehicle subject to double taxation). Moreover, particularly in light of the fact we now have a $37 trillion deficit, no one is apparently willing to die on the hill of tax leakage, so let’s get over that faux concern and make sure we have a REMIC designed for the modern financial marketplace.
This bill will improve liquidity for the commercial real estate markets by enabling REMIC structures to better meet the needs of commercial real estate users today. These changes are modest, they’re sensible and will contribute to the economic health of our economy. What’s not to like about that, particularly in light of Mr. Trump’s laser-like focus on growth?
There’s no good policy reason that REMICs need be static and, in fact, the gymnastics and gyrations suffered by market participants endeavoring to structure transactions that make business sense while meeting the static pool rules were costly impediments to capital formation. These rules badly distorted the real reason for having a REMIC: creating a conduit for the broader capital markets to fund commercial real estate mortgages.
Apologist’s for the REMIC static regime had embraced the conceit that REMIC was designed to finance stable mortgage assets, and there were plenty of those, so the regime could be static. How silly. All commercial real estate is dynamic and to pretend otherwise is absurd. All commercial real estate requires active management, including active management of the attendant debt. This means our capital markets vehicle has to be able to modify loans to meet the needs of our borrowers, provided those changes are consistent with the best interest of the investors. That just makes good common sense. (I think I did hear President Trump talk about common sense a lot of this past week… let’s all get on board).
Since 1986 there has been enormous innovation in our marketplace. We have CRE CLOs that have been compelled to embrace inefficient REIT structures because of the absence of a REMIC alternative. We now have PACE and CPACE financing and mezz is increasingly important in our marketplace. These should all qualify as good REMIC assets and the artificial tax impediments to their use embedded in the hoary old 1986 statute must be eliminated.
Why, if these changes are so important and commonsensical, have we ignored them for the past 40 years? A little embarrassing, isn’t it? Was it hidebound fear of upsetting the occupants of the heights with a simple ask…please sir, may I have more (to only slightly misquote Dickens)? Was it a fogey-ish conviction that even though the problems were blindingly obvious, it simply wasn’t the adult thing to do to insist on change? It’s time to embrace a little courage here and try to get something done. Admittedly, it will be hard to get our gloriously elected representatives to find bandwidth to address our little problems of commercial real estate finance. The legislative sausage-making process indeed imperils almost any good idea and perhaps it’s true that during most of the past 40 years an effort, no matter how focused and broadly supported might have failed, but now it’s different; now we have an opportunity.
This is the moment to get over our Stockholm syndrome about legislative inaction.
We have a new sheriff in town. We’ve got lots of friends on the Hill who actually understand commercial real estate and would be favorably inclined to the case we can make here. We’re about to see giant Reconciliation Bill (or bills) work its way through the Congress onto the president’s desk for signature. This is the time to add our little ask to the miscellany of tax and policy legislation that will be stuffed into this bill. Sure, we’ll get pushback as lots of other good and some not so good and some entirely awful ideas compete for inclusion, but this is our moment.
So, talk to your gloriously elected representatives and tell them how important this is. CREFC has got this in hand ,but to the extent you’re members of other trade organizations, help us build momentum towards a common voice amongst the widest possible range of commercial real estate and financial trade organizations for change.
This is clearly very time sensitive. The opportunity is now, so let’s get this done.