Tax reform, reduced housing affordability, limited inventories, and rising home prices and rents dominate the headlines. All are interrelated. As REALTORS®, we need to read past the headlines and make sense of the facts for our clients. The goals of this article are (1) to give you some information to address questions that may arise from recent headlines and
(2) to clarify the conclusions drawn concerning these headline topics.
Headline No. 1: Tax Plan Will Hurt Homeowners
Lawrence Yun, NAR Chief Economist, November 2017
The National Association of REALTORS® (NAR) says, “Home values could drop 10 percent if the Senate or House tax reform bill is signed into law. The bills double the standard deduction and, as a result, fewer people itemize using the mortgage interest deduction. This will give people less incentive to buy a home.” Added Lawrence Yun,
“It will lead to a renter nation and away from an owner nation.”
Analysis Based on Actual 2017 Sales Transactions
I arrived at the conclusions below from an analysis of three actual 2017 sales transactions (in Newport Beach, Mission Viejo, and Aliso Viejo), as well as an additional scenario where the purchase price was the same as the U.S. median home price. All four properties were later leased as investment properties. Purchase prices ranged from $245,000 to $2.9 million. Housing payments before and after the application of tax benefits were compared to the monthly rents.
- Newport Beach: $2.9 million purchase price, $7,900 monthly rent. It is clearly better for a person to rent this property than to purchase it. If the tax reform bill is signed into law, more than $40,000 in potential tax benefits (e.g., property taxes and the mortgage interest deduction) will be lost. Assuming 2 percent appreciation, the return on equity (ROE) is negative.
- Mission Viejo: $980,000 purchase price, $4,500 monthly rent. The total housing payment and rent for this property are within $100 of each other. After factoring in the tax benefits, it is better to purchase rather than to rent this property despite the approximately $9,900 in tax benefits that will be lost with the new tax plan. Assuming a 2 percent appreciation in the value of the property, the ROE is 6.57 percent.
- Aliso Viejo: This property (a condo) sold for $580,000 in 2017 and was leased for $2,850. No tax benefits will be lost through tax reform in this scenario. The analysis shows it is better to purchase this property when tax benefits are applied. The ROE is 5.13 percent.
- U.S. Median-Priced Home. Using the most recent median home price (Source: NAR) as a purchase price and using a rental rate of $1,600 per month (Source: Zillow), this scenario shows that it is better to purchase. No tax benefits will be lost with tax reform; and assuming a 2 percent appreciation rate, the ROE is 13.46 percent.
Some homeowners with a higher standard deduction (SD) may chose not to itemize; and, as a result, the tax benefits will not matter. In that event, all transactions analyzed except for the U.S. median-priced home show that a potential homeowner would be better off continuing to rent if no tax benefits were applied to the housing payment (Mission Viejo and Aliso Viejo are marginally better). Not all homebuyers base their decision on tax benefits, but it will impact the decision for some.
Assumptions for These Four Scenarios
Property tax deductions are limited to $10,000, the mortgage interest deduction (MID) is limited to loans up to $500,000, and the standard deduction almost doubles. There is also no opportunity cost factored into the analysis (see Table 1).
Table 1. Summary Analysis
This analysis confirms some of the conclusions that have been drawn about the possible impact of tax reform on homeownership. Homeowners at the high end will be greatly impacted through the loss of tax benefits. Lower-end buyers who base their decision regarding whether to purchase primarily on the impact of tax benefits may decide not to do so because the higher standard deduction may render the tax benefits unusable. And prices may need to correct (NAR says by as much as 10 percent) as a result of the impact of tax reform and how it affects the decisions to buy or rent. The impact of tax reform will vary for each situation, and it will be important to analyze each situation and the assumptions that are being made.
Headline No. 2: Homeowners Can’t Count on Property Appreciation for Wealth
Faculty at Florida Atlantic University, Florida International University, and the University of Wyoming, November 2017
According to the authors, “On average, renting and reinvesting wins in terms of wealth creation regardless of property appreciation, because property appreciation is highly correlated with gains in the traditional financial asset classes of stocks and bonds.”
Some of the follow-up articles that resulted from this study included headlines that prompted some readers to conclude that renting is always better than owning, such as the following: “Homeownership Doesn’t Build Wealth” (CNBC, November 16, 2017). This is an example of where you need to read beyond the headlines. This study is based on the assumption that renters will invest the savings generated by renting rather than buying and, as a result, will create more wealth by renting than by owning a home. The assumption is that the renter will save and reinvest, not consume. Homeownership is a good, forced- savings vehicle and, because most renters are not likely to save to the extent necessary, continues to be a good alternative for wealth building.
Headline No. 3: 58 Percent of Homeowners Think the Housing Market Is Set for a Correction—Are Bubble Fears Founded?
Forbes, August 15, 2017
Bubble—No. The conditions that led to the housing crash in 2006 (i.e., easy credit, speculation, etc.) do not exist today.
Price Correction—Yes. If you believe in housing cycles, a correction is approaching. Depending on how you interpret the graph shown in Figure 1, the previous housing cycle lasted anywhere from ten to seventeen years, flat from 1990 to 1997 but picking up momentum in 1997 until it burst in 2006/2007. Cycles have historically lasted seven to ten years, and we are in the ninth year of the recovery. As a result, a correction may be on the horizon. Other factors, including the potential for increasing interest rates and the lack of affordable housing, also suggest that a correction may be coming.
Figure 1. Depending on how you interpret the numbers, the previous housing cycle lasted anywhere from ten to seventeen years, flat from 1990 to 1997 but picking up momentum in 1997 until it burst in 2006/2007. Historically, housing cycles have lasted seven to ten years, and we are in the ninth year of recovery.
David Girling completed his undergraduate work at the University of Southern California and earned a Master of Business Administration degree from the Anderson Graduate School of Management at the University of California, Los Angeles. In 2008, he formed Girling Real Estate Investment Group (Girling REIG) with his father, Bing, and has more than thirty years of experience in the financial services industry. Dave and Bing are affiliated with Villa Real Estate.