Tax cuts are now the law of the land, ushering in the "How will it affect me?" phase. One of the most vocal interest groups is the housing sector, insisting the bill's provisions will adversely affect the sale and construction of homes in the United States.
The National Association of Realtors characterized the legislation as "an assault on housing." And while the final version proved to be more commodious than the original House proposal, real estate professionals continue to decry the impact they anticipate as the law rolls out.
Bottom line: not to worry.
There are substantial changes to the tax treatment of residential real estate in the legislation, it is true. Most significant is a reduction in the cap on the size of a mortgage qualifying for deduction of interest expenses, from $1 million to a mere $750,000. Obviously, the effect of the reduction falls more heavily on the expensive east and west coast markets, and is likely to result in a discount of the selling price for million dollar homes in the near term. But just how big an impact? Estimates vary, but don't lose any sleep over the fortunes of the jumbo market.
Christopher HopkinsEconomist Mark Zandi of Moody's Analytics estimates average home prices will be about 4 percent less than they would otherwise by the middle of next year. According to S&P/Case Shiller, prices have risen by 6 percent each year for the past 5 years. So if Zandi's forecast is correct, prices will rise by only 2 percent in 2019, somewhat less than cataclysmic.
Consider the example of a $1.2 million home with $1 million of mortgage debt at 4.5 percent interest (the question of why someone would carry that level of debt is reserved for another installment). The new law cuts the allowed interest deduction by $11,250. Now assume the homeowners are in the 35 percent tax bracket. The change results in an annual loss of $3,938. Recalling that the couple must earn above $400,000 to land in that bracket, the net increase in outlay is less than 1 percent of income.
For the finance geeks out there, discounting 10 years of higher taxes at a 4.5 percent mortgage rate yields a present value of $31,000, or about 2.5 percent of the home's price, far less than the 4 percent estimate.
Of course, there are varying estimates of lower prices depending upon geography, ranging as high as 10 percent in some extremely expensive markets. This is also due in part to the law's limit on deductibility of state and local taxes, including property taxes. But those markets have heretofore benefited from a disproportionate tax subsidy at the expense of taxpayers in more modest markets, so in a way this is just a partial equalization of longstanding tax preferences.
A recent study by the Council of Economic Advisers under the original House proposal of a $500,000 cap predicted average home prices would decline by less than 4 percent in the short run, and forecast little change in overall home ownership (the final bill settled on a $750,000 limit). Meanwhile, an additional consequence is the expectation that 92 percent of taxpayers will now opt for the increased standard deduction, rendering the mortgage interest deduction moot for most average taxpayers.
It is also worth recalling that the majority of the benefits from the other aspects of the tax cut bill accrue primarily to higher-income taxpayers and corporations (hence shareholders). Savings from tax reduction elsewhere is more than likely to compensate for any hit from real estate taxes and interest deduction.
Hardly an "assault on housing."
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.