Let me tell you an interesting story about a professor who teaches a course in entrepreneurship.
He starts his course by reading the notes from the founding partners meeting from the original meeting of the founders (now about 70 years ago). It goes something like this:
They said that they were going to do something in the electronics field.
The key was to make a “technical contribution” and only pursue opportunities consistent with this purpose, demand people give superior performance (but otherwise largely get out of their way), contribute to the community, and have great integrity.
But the question of what exactly they were going to manufacture was postponed.
In the meeting they considered:
- medical devices
- TV Receivers
- welding equipment
- an electronic oscillator
- and even an electronic jiggle machine to help people lose weight.
He would tell his class this and ask them to rate them on a scale of 1 to 10 for entrepreneurship.
The students would give it at best a 3 – blasting these founders for lack of focus – lack of an idea – lack of a market – and lack of just about everything else.
Then the professor would mention – oh, by the way, the names of the founders were Bill Hewlett and David Packard.
The students are invariably stunned. Are you a little stunned too?
Let me ask you a question – and throw out a proposition at the same time – if you can answer this question simply and easily and positively and powerfully without a moment of hesitation I suspect that you will very likely be – or already are – successful in your real estate business. And if you can only hem and haw or burble around, I would like to not say you will fail (as that is not very nice) but I think you have an issue that needs to be addressed and maybe you are struggling in the real estate world.
The question is a simple one …..
Why are you in business?
Please take a moment to ask yourself this question. Why do you go to work every morning? Why did you start the company you work for? If you work for someone else why did they start the company? Do you know? Do you have an answer that is exciting and thrilling?
Let me dig into this….
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There is a great book by Jim Collins called Built to Last. The book is about great companies – companies that simply crush their competition – and no matter what happens they reinvent themselves and keep on cooking. Companies like Merck, like GE, like Hewlett-Packard, like Procter & Gamble, like 3M, like Nordstrom, like Boeing, like Wal-Mart.
The core point that Collins makes in his book is that these companies have something special about them that allows them to always find a way to succeed.
I think it is very simple. They have a core set of values that tells you “why” they are in business. For example:
Merck – “We are in the business of preserving and improving human life.”
Boeing – “Being on the leading edge of aviation; being pioneers.”
Walmart - “Exceed customer expectations.
Nordstrom – “Service to the customer above all else.”
These are all inspirations – these are the “why” of these great businesses. It makes you maybe want to go work there and join them. And many people of talent did exactly that. Ultimately, I think that is what propelled them to great success.
Who would you want to work for…..a plain old “aviation company” or a company that has as its mission to be on the “leading edge of innovation” and to “be pioneers.”
To inspire you about these companies all I told you just now is “why” they are in business.
To complete unfolding the mystery of why I started this article the way I started – the real contribution of HP was not the things – the widgets – that they made, but the famous “HP Way” that the founders had “invented”. This is because the widgets change over time but the HP Way is timeless.
So I think the students should not have been stunned at all. The HP Way was an incredible invention.
As Steve Jobs famously said to John Sculley in convincing him into leaving Pepsico many years ago:
“Do you want to spend the rest of your life selling sugared water or do you want a chance to change the world?”
He got Scully to join him because he did not tell Scully “what” Apple does (i.e. make computers); instead, he told him “why” Apple was in business – to change the world. And he inspired Scully to join him.
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If you are with me so far, that “why” is the critical concept, now let’s try an experiment in the real estate world.
Assume you are a real estate development company and someone asks you “Hey, Toby, what do you do?”
What would you say. Would you tell them:
“We are in the development business. We take properties that are underutilized and renovate them into more successful properties. Most of the time when we do this we create real value for ourselves and our investors. We have an excellent track record.”
Or would you tell them:
“I am in the development business to take underutilized properties and renovate them into more successful properties. This is because whenever I see a wrongly used piece of property I get this kind of burning feeling that I could make it better. I can’t help it. I immediately see things that could be done. It is a passion with me. So a few years ago I started this development company to do exactly that. Our mission is to find underdeveloped or underutilized properties and turn them from something lousy into something that we are proud of, thrilled with, and excited by. We have done pretty amazingly well – exceeding whatever I thought would happen – and I am proud of that, but the whole key to my business is finding people who share this dream and get excited about our mission.
I ask you, of the two people who answered the same question, who would you want to work for? Who would you want to do business with? Who would you want as your partner? Who would you want to invest with?
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Ultimately, in order to succeed in the real estate world – or probably any business – you have to attract talent to your organization – including both those who work for you and those who you do business with – and once you do that, you then have to retain that talent.
And in order to do that you need to be able to inspire people.
And the way to inspire people is to let them understand “why” you are in business.
It really works…..
Before I end here, I need to take a moment to give credit where it is due. Although I am The Real Estate Philosopher, often I don’t think of some my ideas. I read a lot – often about successes in other industries – and I learn from others. Today’s theme, and credit for this article, comes from a great book I read called “Start With Why” by Simon Sinek.
How the Election Will Affect the Real Estate Industry
How Will the Election Impact Taxes?
President-elect Trump promised a broad range of sweeping tax changes during his campaign, and it is not yet clear which promises he intends on, or will be capable of, delivering. However, with both houses of Congress also in Republican control, we can take an educated guess about where his administration plans to take the tax code by focusing on any areas of agreement with House Republicans. Included at the end of this note is a summary chart which shows the current law for many tax provisions, as well as the House Republican Tax Plan (“House Plan”) and the Trump Campaign Tax Plan (“Trump Plan”).
Some key similarities between the Trump Plan and House Plan are:
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Lowering both individual and corporate income tax rates
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Eliminating the alternative minimum tax
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Eliminating estate and gift taxes
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Imposing deemed repatriation of deferred foreign profits
Any plan that is ultimately adopted may not happen in one piece. A likely starting point is corporate tax rate reduction combined with a deemed repatriation, and possibly a shift to a territorial tax system (i.e., a system in which U.S. based multinational corporations pay U.S. tax only on their domestic income).
How will the election impact real estate?
Assuming that tax rates are reduced, the real estate industry can expect these effects:
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Given the prevalence of pass-through entities for real estate investments, a reduction in individual tax rates, and elimination of the AMT, will boost after-tax returns.
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If the Affordable Care Act is repealed, the 3.8% net investment income tax would also likely be eliminated. This would be a “uuuge” benefit to individual real estate fund investors and REIT shareholders who primarily earn passive investment income.
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A reduction in corporate rates will boost returns for foreign investors in U.S. real estate, since these investors often invest through leveraged corporate blockers to avoid FIRPTA. REITS will become relatively less attractive if withholding tax rates on dividends are left unchanged.
Trump has promised to close the carried interest loophole so that fund managers and others receiving carried interest pay tax at ordinary income rates. However, the Trump Plan also lets owners of pass-through entities to make the election and cap their tax rate at 15%, which brings the tax rate on carried interest back to its current level or even lower. It is also unclear how any resulting legislation would apply to existing arrangements.
How will the election impact tax reform generally?
Since Republicans hold the White House and both houses of Congress for the next two years, tax reform is certainly on the table. Importantly, while both the Trump Plan and the House Plan limit various tax breaks, neither plan contain enough revenue raisers to balance out the effects of the tax cuts. The Tax Foundation estimated that the House Plan could increase deficits by $2.4 trillion over the next decade if fully enacted, and the Brookings Institute estimated the Trump Plan would increase deficits by $6.2 trillion. The actual effects of any legislation may differ substantially from the estimates, resulting in a need for subsequent course corrections. This is precisely what happened with Reagan’s large tax cut in 1981, which was followed by several rounds of tax increase legislation in the succeeding years to fill in the newly dug revenue hole.
Although it may be hard to tell in some parts of the country, the United States has experienced a sustained recovery from the Great Recession. Triggering large deficits at this point could be inflationary and bring up interest rates. We have already seen evidence of this immediately after the election: the Treasury 20-year interest rate rose by 40 basis points in the week following the election. An interest rate hike would mean higher financing costs for investors, as well as increased cap rates that could dampen valuations of real property.
As Congress moves forward with tax reform, any lost revenue will need to be managed one way or another:
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Scale Back the Plans. The reduction in tax rates could be downsized or delayed. Or Congress could tackle business taxes quickly next year (for example, by cutting rates on companies’ overseas earnings) and postpone individual cuts. The phasing in of tax cut benefits would delay the full effects of any revenue losses.
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Live with the Humongous Deficit…for a while. Since 2009, the U.S. federal government has seen its historically high deficit (over $1.4 trillion) gradually reduce. Either plan could potentially bring the deficit right back to that level, or higher. Republicans may just live with this deficit for a time, but if the economic consequences become severe, tax increases may be needed (as in the Reagan-era).
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Add a New Revenue Source. The federal government has been studying a new potential new source of revenue in the form of a Value-Added Tax (VAT). The VAT imposes a tax on each value adding step of the entire business chain, as opposed to imposing a sales tax only on the final sale to customers. While VAT is routine in the rest of the world, it has long been considered politically toxic in the United States. It might become acceptable, however, if coupled with significant tax and trade reform.
Key Takeaways
Real estate investors could reap the benefits of across-the-board tax cuts, but huge deficits might hit the real estate sector with higher interest rates. Meanwhile, the fate of carried interest is not as doomed as it seems. Post-election tax reform is likely over the next two years in some form, but the current proposals may be cut back or delayed because of concerns about the deficit or negotiations to win some Democratic support.
The D&S Tax Practice Group is closely monitoring these developments. If you have any questions about tax reform or its impact on real estate, please reach out to a member of our Tax Practice Group.
D&S is proud to have a world-class tax group chaired by Stephen Land, who is one of the most pre-eminent tax lawyers in the United States. Stephen is a Triple Harvard (college, law school and business school), and was previously at “magic circle” firm Linklaters (where he launched, chaired and grew their US Tax Practice). He is also the current Chair of the Tax Section for the New York State Bar Association. Stephen regularly meets with government officials regarding tax rules and regulations. This is the most prestigious position a tax lawyer can hold.
The contact information for the members of our tax group are as follows:
