MBT is sending investments elsewhere
First, the good news. A recent study conducted by the Anderson Economic Group in Lansing showed that Michigan is not a high tax state for businesses.
The report, released earlier this year, ranked Michigan at 22nd of the 50 states in terms of business taxes as a share of company profits. The Anderson study reported business taxes in Michigan were 14.9 percent of profits, nearly two points below the national average of 16.7 percent.
Now, the bad news. The study was done using 2006 numbers, the latest figures available to the Anderson Economic Group. Why is that bad news? Because the Single Business Tax was still the dominant levy on commerce in Michigan in 2006.
For the past 17 months, though, businesses have had to deal with the Michigan Business Tax, which replaced the much-maligned SBT in January 2008. And all but the state’s largest manufacturers have developed a deep resentment toward it, including the commercial real estate industry.
The Michigan Association of Realtors has spent the past year telling anyone who will listen that the MBT has penalized the state’s real estate sector. So has the Commercial Alliance of Realtors of West Michigan.
The MBT has three components: a gross-receipts tax of 0.8 percent, a business income tax of 4.95 percent on net income after interest and depreciation are accounted for, and a surtax of 21.99 percent on the sum of the first two.
In a column Cummings wrote for CAR, he arrived at the conclusion that a hypothetical, but not uncommon, lease could cost a landlord up to three times more in MBT taxes than with the SBT. He also showed that a normal sale of a building for $6.2 million could carry twice the state tax load under the MBT than it would have under the SBT.
“The primary issue is the Michigan Business Tax, in its current form, provides a negative effect to the after-tax, net operating income of commercial real estate. Since commercial real estate is valued on the capitalization of the income stream, assuming all other things are equal, investment real estate is worth less than investment real estate in Indiana,” Cummings told CQ.
Cummings said the glum situation is applicable not just to investors, but also to lenders. Both, he said, have a finite amount of money available to inject into a real estate transaction. If either is faced with investing in two relatively similar deals — one in Michigan, the other in North Carolina — that investment is all but certain to head south because of the MBT.
“In Michigan, the after-tax net operating income of that asset is less than it is in North Carolina and therefore it’s less valuable, and that’s typically 75 basis points, or so. Add on top of that the perception that the whole state is sort of inexpertly linked to the outcome of the auto industry. We have had about 100-basis-point penalty because of the perceived extra Beta, in terms of our investment value,” he said.
On one hand, there is the short-term value loss of buying commercial real estate here because of the MBT. On the other hand, there is another deterrent that stems from the economic uncertainty clouding the state — and the nation, as well.
Before investing, most investors want to know what their rate of return will be for a period of at least three to seven years. But if investors can’t get a decent handle on the financial future, they’ll either back off or go to where they can do that. And they can’t do that in Michigan.
“It’s difficult to forecast what the economy is going to do because it’s sort of difficult to know forward what our tax burden is going to be. So, therefore, it’s difficult to have visibility or guidance on corporate earnings, and markets typically don’t like uncertainty,” Cummings said.
“I’ve heard a lot of this referred to as an ‘experiment,’ and typically markets don’t like experiments. That’s really what we’ve had in Michigan with the Michigan Business Tax. For all those quantifiable reasons, there is also what I call the ‘intellectual barrier’ to would-be investors or businesses coming to Michigan.”
By intellectual barrier, Cummings means the MBT is complicated for an investor to figure out, and that is likely to send someone elsewhere with their investment.
So how have the MBT and the state’s economic uncertainty affected lending regarding commercial real estate? Cummings said of the area’s national banks, he knows of one that is lending regularly. The local banks, he said, are willing to lend, but mostly to people they have ongoing relationships with. But regardless of whether a lender is national or local, Cummings said all the banks are looking for one thing: a total return.
“We need deposits. We need all the ancillary business around that project to make it make sense for us,” said Mark Augustyn, senior vice president and commercial group leader at Mercantile Bank. “But if we get the owner’s business with it and all of the business around it — the personal deposits and their home mortgages — all that makes it much more of a relationship package. Those are the credits that are getting done in today’s market.
“If we’re going to do a project in that asset type, it’s got to make sense to the bank — not just the borrower, but the bank, as well. And that doesn’t just mean the project has to be of quality and the owners have to be of quality, but the return on that project needs to be a return that is appropriate,” Augustyn added.
Cummings said having banks look for a total return is a good thing and a change from recent years when developers were shopping from bank to bank and lenders were buying deals.
“They’re shoring up their balance sheet with deposits. They’re getting interest on that money that is deposited with them, as well as the spread on the loan they’re making. They’re looking for that total return out of a relationship and are trying to build relationships.”
Augustyn said reports that banks aren’t lending are a bit skewed because the number of loan applications being made have dropped considerably the last two quarters or so. Just like consumers aren’t buying cars or other durable goods, real estate developers are also waiting to see where the economy is headed before moving forward with a project.
“We’re turning down slightly more than we historically have, but the applications are dramatically down. I think you see an entire nation kind of sitting on their hands. Someone doesn’t want to go buy a TV because they’re worried about their job; not a lot of people want to buy or start a new project because they’re not very comfortable where the next six or nine months or year, year- and-a-half will go,” he said.
“Everybody has kind of cut back and said, ‘I want to wait and see.’ That’s caused a stall in the market,” he added.
Augustyn also said commercial real estate has become the residential real estate of two years ago. As some projects are currently struggling in the market, banks are reluctant to finance more developments of the same type.
A revenue estimate made by the state in January projected the MBT would raise $1.89 billion this year, a 22 percent hike over the $1.55 billion the tax generated last year. That increase stands in stark contrast to the overall revenue estimate to the state’s general fund, as total taxes to the account have been forecast to fall by nearly 12 percent this year from 2008. Another revenue estimate will be made this month.