Most of the shareholders of Ala Moana Shopping Center — one of the biggest-business malls in North America, boasting over $1 billion in sales — don’t pay income taxes to the State of Hawaii.
That’s because the mall’s owner, Chicago-based General Growth Properties, is a real estate investment trust that benefits from a long-standing exemption from paying state and federal corporate income taxes.
It is one of at least 20 such real estate trusts in Hawaii that own nearly 300 properties, and critics calculate the loss of tax revenue to the islands in the tens of millions every year.
“It’s so abusive,” local real estate investor and developer Michael Fergus said of the current tax system. “Do these companies deserve a tax break?”
Per capita, Hawaii leads the nation in the value of these sorts of trusts, which are valued at more than $13 billion in the islands. That averages out to $9,678 for every single person in the state.
Known as REITs, these trusts were created by a law passed in 1960 with a stated goal of making it easier for average people to invest in, and potentially profit from, real estate investments. To entice investors, the companies receive tax deductions for dividends paid.
But in Hawaii, that effectively functions as a tax break for many out-of-state shareholders, leaving local residents and businesses to bear more of the tax burden.
Lawmakers considered removing the tax exemption last year at the encouragement of Fergus, who argued that it’s an issue of fairness and corporate responsibility.
When Congress created real estate investment trusts, the legislation was well-intentioned: It was supposed to make it easier for people who couldn’t afford to buy property outright to benefit from income-producing real estate.
The companies function in some ways like mutual funds, and are subject to certain requirements. To investors, they’re particularly attractive because they are exempt from corporate income tax as long as they pass on at least 90 percent of their taxable income to shareholders through dividends. REITs typically distribute all of of that income through dividends, according to the National Association of Real Estate Investment Trusts.
There are 291 REIT-owned properties in Hawaii, including hotels such as the luxury Fairmont Kea Lani Resort on Maui and the planned high-end mall at the International Market Place in Waikiki.
REITs located in Hawaii do pay general excise taxes and property taxes. But shareholders pay income taxes on the dividends in whichever state or country they live, which in many cases is not Hawaii.
For example, according to the investment research website Seeking Alpha, as of November last year more than 40 percent of General Growth Properties was owned by Canada-based Brookfield Asset Management. Other investors included the sovereign wealth funds of China and Abu Dhabi.
Fergus, who has worked as a real estate developer and investor in Hawaii for more than 35 years, is not whom you’d expect to be an activist in favor of jacking up taxes on real estate investments. And he says he’s generally a private person who is largely unfamiliar with the political process.
But he became passionate about real estate investment trusts when the Legislature passed a law in 2009 to help lessees on land owned by HRPT Properties Trust in Mapunapuna and Kalihi Kai to negotiate better rents with the Massachusetts-based company. Tenants of the REIT, which purchased the land from Damon Estate, complained that their new landowner was overcharging them.
“I thought, ‘Why do we allow this?’” Fergus said. “We can’t make them into good landlords, but the least they can do is pay income tax.”
Fergus thinks it doesn’t make sense that many businesses that benefit from Hawaii’s tourism industry, including malls and hotels, aren’t subject to the same taxes as other locally-owned companies. He pays income taxes on the earnings from his limited liability real estate company, which puts him at a relative disadvantage.
Even as Hawaii’s leaders have complained of tight budgets, the opportunity to bring in more tax revenue by removing the state tax break for REITs has largely stayed under the radar. Last year, Fergus was one of only two people to submit testimony supporting House Bill 1726, which sought to tax REITs without regard to the federal deduction for dividends paid.
Jenny Lee, an advocate for low-income people and an attorney at the Hawaii Appleseed Center for Law and Economic Justice, was the only other proponent on record in favor of the REIT reform bill last year. She says it’s an issue of equity. Hawaii’s state tax system was recently ranked as the second most unfair in the nation.
“We tax families with children who are working and in poverty,” Lee said. “They have a 6.8 tax rate, versus zero percent on these investors… It’s just an absurd situation that we see one is worthy (of a tax break) but the other is not.”
House lawmakers passed HB 1726 last year, but then-state Sen. David Ige, who is now governor, declined to hear the bill. It’s not clear why — Ige didn’t respond to multiple requests for comment.
Rep. Calvin Say, who introduced last year’s bill, said he doesn’t plan to do so again when the legislative session starts this month. He wants the state to update its aging tax infrastructure first before adding more responsibilities to the tax department.
But to Fergus, that doesn’t make sense. He estimates that there are only a few dozen REITs in Hawaii.
“To collect potentially $50 million a year, all we have to do is get 30 tax returns,” said Fergus, whose estimate was based on his own calculations. “It’s not much work at all. It could be years and years and years before they reform our tax system, but this is like $50 million slipping away every year.”
Mallory Fujitani, spokeswoman for the state Department of Taxation, said the agency doesn’t know how much money the government might gain from the legislation.
Unsurprisingly, General Growth Properties and similar trusts that own property in Hawaii strongly opposed Say’s proposal last year. Their main argument is that eliminating the tax break would discourage future investment in Hawaii.
Simon Leopold, senior vice-president at Michigan-based Taubman Centers, emphasized in his written testimony that his company is spending $400 million to transform the International Market Place, long the site of street vendors selling kitschy souvenirs, into a mall anchored by Saks Fifth Avenue.
The Outrigger Enterprise Group testified that without partnering with a REIT called the American Assets Trust, the company would not have been able to develop the Waikiki Beach Walk.
Tony Edwards, an attorney at the National Association for Real Estate Investment Trusts, said in a phone interview that New Hampshire is the only state that requires REITs to pay corporate income taxes. There are 174 REIT-owned properties in that state, which Edwards said is relatively few, although New Hampshire ranks 21 nationally for REIT value per capita.
“If Hawaii were to disrupt the conformity to the federal rules, they would be very much signaling an anti-investment and anti-business disposition,” Edwards said.
That’s a claim Hawaii leaders may be sensitive to. Largely because of the high cost of doing business in the nation’s only island state, Hawaii consistently ranks as one of the worst places to do business, and many policymakers want to improve that reputation.
But Peter Savio, a real estate developer who has been working in Hawaii for more than 50 years, said fears about discouraging investment are unwarranted. “If the REITs in Hawaii all announced they’re pulling out their assets, they’d all be snapped up in a week,” he said.
“We cannot afford to let this kind of money slip by the wayside based on this idea that it would have an adverse effect,” Savio said. “Are fewer people going to shop at Ala Moana? Are fewer people going to stay at the Hilton Hawaiian Hotel? There’s enough money that’s being made on Hawaii real estate that they should be happy to pay.”