The Effects of Tax Reform on Real Estate: Some Empirical Results

This paper uses data on publicly traded real estate firms to examine the effects of two major tax reforms. Specifically, we analyze the effects of the 1976 and 1986 Tax Reform Acts (TRAs) on the risks and returns of real estate investment trusts (REITs) and other real estate firms, using intervention analysis. Since REITs have been a dominant force in the real estate equity markets, and since they are treated differently for tax purposes than corporations investing in real estate, we examine the two groups of firms separately.' While there exists much popular press literature which discusses the impact of tax reform on real estate, little empirical work has directly examined the market's response to these changes.2 Most previous work undertaken to examine the potential impact of tax changes has used simulation modeling to estimate the effects on real estate firms' values (e.g., Fisher and Lentz 1986; Hendershott, Follain, and Ling 1986). A review of the simulation literature is presented in Follain and Brueckner (1986). Turning away from the simulation technique, Nourse (1987) uses appraisal data to empirically estimate how the 1976 and 1981 tax laws affect capitalization rates (i.e., net income divided by value) for real estate. In contrast with the existing literature, we use market data to evaluate the empirical effects of the 1976 and 1986 law changes. The empirical results provide insights into the interaction between tax laws and the market for real estate assets. In the next section of the paper we discuss the historical background of the 1976