Last week I talked about the Grand Bargain to fix our business. If we’re fixing to fix our business now, we’ve got to talk REMIC. The Real Estate Mortgage Investment Conduit (REMIC) created as part of the Tax Reform Act of 1986 was an enormous boom to the commercial real estate industry. It facilitated the ability of the capital markets to directly fund commercial mortgage loans. It provided an important new source of liquidity for the commercial real estate industry.
For those of us who have dealt with this day and long day out for the past 39 years, it’s a frustratingly Rube Goldberg-ish complexity of rules. It makes capital markets lending work but, oh boy, the negative externalities. While eliminating double taxation, Congress encumbered that promise with numerous picky and complex rules which makes REMIC financing problematic and certainly makes the borrower experience more difficult.
One might scratch one’s head, and certainly I have been wondering why we got stuck with this hot mess. Apparently, in part, it was that the Congressional leadership and staff (okay, mostly staff) were intent on replicating the grantor trust structure and importantly many deficit hawks in the Reagan Administration were unwilling to pass legislation unless the Congressional Budget Office’s arcane modeling rules could conclude it was tax neutral. I’ve heard the arguments that Congress didn’t want to inoculate an actual operating business from taxation but a vehicle limited to holding commercial mortgage assets shouldn’t be prohibited from managing the pool for the best interests of the investors. If that includes adding new assets when others pay off, how is that inconsistent with what we think of as the functions of a trust? One can hardly confuse a REMIC trust with a gas station. They got this wrong.
We, of course, shouldn’t be surprised. This is the sort of thing we get from the mud wrestling which counts as regular order amongst our gloriously elected representatives.
Over the past 39 years, our industry has worked in a desultory sort of way to fix some of the more irrational outcomes of the REMIC rules through various and sundry patches. We’ve received a series of Rev-Procs and private letter rulings from the Service, which were helpful but, largely amounted to putting fresh paint on an ugly house. (If you want real information about how the REMIC works and the fixes we’ve developed over the years, please call my former partner Will Cejudo at Dechert LLP. I was a tax lawyer 35 years ago, but I have recovered.)
So, we have Stockholm Syndrome? Are we so captured by our regulatory estate that all that we can think about doing is nibbling around the edges for regulatory crumbs while ignoring the really compelling problems at the core of this regime? Isn’t it time we GO LARGE and try to fix REMIC and make it truly meet its initial promise of an efficient way to fund commercial real estate debt through the broadest capital market on earth? What could possibly be wrong with actually keeping that promise?
If indeed the structural gyrations of the REMIC were in some significant measure driven by a need to be tax neutral, hasn’t that goal of avoiding revenue leakage to the Treasury long gone away? It seems so 19th Century, so skirts on piano legs, so Temperance League.
Folks, we have a $37 trillion federal deficit…$37 trillion! Both left and right feel entitled to give away endless goodies to the folks in exchange for votes without really worrying about the butcher’s bill, at least the left has their very dubious Modern Monetary Theory as an intellectual fig leaf. The right? Shameless.
So, fixing the REMIC rules might result in a slight tick-up in model deficit, but, is anyone actually going to die on the hill of fiscal rectitude on changes to the REMIC? Surely not. We can, with a few modest changes to the REMIC, make capital formation easier and therefore provide more liquidity to the commercial real estate marketplaces and help the economy grow (PAC team, pay attention). It would have little impact on the fisc.
Let’s use the moment. We have a new sheriff in town. We have lots of friends on the Hill who actually understand the commercial real estate finance business who would be favorably inclined to the case that we can make. Moreover, we are in a time and place where the new Congress is thinking about one big beautiful or two slightly less adorable Reconciliation Bills. Either way, these will be chock full of miscellaneous goodies, kind of like Santa’s overflowing sack. A REMIC fix would hardly be one more thin wafer for Mr. Creosote here. This is the time. We could win here!
What’s the ask? There’s plenty here for us and we should get our heads together and figure out exactly the dimensions of that ask, but the above-the-fold are:
- Extend the reinvestment period. There’s no compelling reason these vehicles need be static. If investors want static, they will get static. But if investors want active and dynamic management and more duration, why should obscure tax rules get in the way?
- Broadly permit loan modification. Get rid of the application of the §1001 Rule. Who cares as long as the loan remains principally secured by real estate?
Beyond the core of the ask, there’s plenty of things that cry out for a fix. These include making it clear that mezzanine loans, regardless of structure as long as they are primarily secured by real estate and CPACE assets are good REMIC assets and include a clarification that a REMIC regular interest is not a loan origination asset (an ongoing problem for accessing onshore funding). We should fix that, at a minimum.
This is our moment. But time’s a wasting and those Reconciliation Bills will take form over the next few months. They ain’t waiting for us to get our act together and find our courage here. Shame on us if we at least don’t try. On to the breach, ladies and gentlemen!