Tax Reform: A Tale of Two Sectors
On December 22, President Trump signed the “Tax Cuts and Job Act” into law, marking the first major tax overhaul since President Reagan’s in 1981. As the effects of this tax reform ripple across virtually all industries, will it be a rising tide lifting the boats of business or a current creating choppy conditions?
Since the bill moved from intention to implementation, Mizuho’s healthcare services analyst Ann Hynes has explored how tax reform will impact the healthcare sector. Real Estate Investment Trusts (REITs) analysts Richard Anderson and Haendel St. Juste have also taken a close look at the implications across the real estate landscape.
Just What the Doctors Ordered
Mizuho US Healthcare Services Equity Research Analyst Ann Hynes said she believed “tax reform should be a significant positive cash flow event, especially for healthcare services companies that tend to have limited international exposure and significant capital expenditures.”
So far, investors seem to agree, with the healthcare sector a top performer year-to-date among the major S&P sectors.
REITs: Mostly Positive but a Key Selling Point is Diminished
REITs analysts Richard Anderson and Haendel St. Juste think investors may benefit from a couple of helping hands that reduce the tax rate on dividends. The help is especially impactful for a sector that is required by law to pay out a minimum of 90% of taxable net income in the form of dividends to shareholders. Assuming the highest tax bracket, the following scenario plays out:
- Under the old tax laws, REIT dividends were taxed at 39.6%.
- Under the new tax laws, REIT dividends are not only taxed at a lower rate of 37%, but 20% of pass-through dividends are now deductible.
- Taken together, the new effective rate for dividends taxed as ordinary income would be 80% of 37%, or about 29.6%.
These factors could spark incremental demand for REIT shares in light of the more attractive tax environment for dividends. But the tax reform also gives rise to more competition for REITS versus other investments. The corporate federal tax rate going from 35% to 21% is a win for every tax-paying entity, but REITs do not pay corporate tax as long as they pay 100% of taxable net income in the form of dividends. Perhaps, the analysts reason, this may narrow the profitability gap between REITs and non-REITs. In the meantime, the related increase to US interest rates has encouraged some investors to sell REITs for other income-oriented investment options. We expect this to be a short-lived phenomenon until a new paradigm is reached at the long end of the interest rate curve.
Very Early Days
Judging from press coverage across the business and political spectrum, we are in the very early days of the tax reform’s impact. Pundits seem to be taking a patient approach to see if it creates economic growth that offsets the reduction in tax tables or sparks a rising deficit environment. Either way, watch this space.