Housing Supply Fix? Grant Investors A Tax Exemption Benefit

OK, I'll be harsh.

Haven't we been waiting for "trickle down" to kick in for almost 30 years now?

Won't granting investors a permanent exemption from taxing their capital gains income lead to an increasing concentration of real estate wealth held by a tiny percentage of the population, while at the same time a vast and growing majority of Americans will become renters?

Didn't massive income tax cuts favoring the wealthy create a false impression the economy was booming, at least when measured by traditional barometers like GDP, when in fact prosperity was being showered on that lucky 5% while the rest of population fell further and further into debt and turned into what Phil Gramm called a "nation of whiners?"

Aren't there too many private jets in the air?

Didn't personal yachts get too big?

Weren't too many luxury condos built?

Jerry Speyer overpaid $5.4 billion for StuyTown and is probably going to walk away from it after making thousands of residents miserable by running it into the ground and defaulting on what will probably be looked back at as the most reckless, pie-in-the-sky, subprime, interest only, liar loan ever concocted to purchase a wildly inflated, run of the mill, working class property during the collapsed, manic, real estate bubble. Should we encourage his foolish behavior?

Last night, Larry Kudlow was preaching to the faithful and yakking up the idea of slashing capital gains taxes again as a means to jump start the economy. I have done well with investments and am comfortable financially, but Larry almost made me puke.

The United States is a "bottom up" nation and it has always been the reliable American consumer who pulled us out of financial bad times. Barak Obama was right when he kept saying, "You never hear John McCain mention the words 'middle class.'"

Some long sentences there.

Don't be too harsh.

The 4.5% gimmickry is no different than boosting the conforming limit. Same concept, with the same limited effects.

I think that the idea is great and will help with reducing supply but it will not be the total fix remember that by implementing this plan will only reduce properties that are great deals problem is what to do with the supplies that are overpriced at the current market. Unfortunately all the Government is doing is throwing rocks at a unstoppable wave of water that needs to be corrected.
Sincerely,
Jaime Sandoval
http://www.sanantoniotxrealestateforsale.com/

Hi Noah

As always, love your commentary, check it periodically every day. As for the tax exemption, is the current 15% long term capital gains tax really the hinderance that's causing investors to balk at buying and renting out? It's possible that the uncertainty regarding capital gains tax going forward could be an issue but in my opinion, that's not what stopping investors from stepping in.

I think what would be better (and more expensive for the gov) could be allowing investors to deduct a percentage of the mortgage interest from their taxes, like a primary home owner does. Not sure if the following makes sense from a tax point of view, but let's say have all rental income be taxed at 15% and have mortgage interest be deducted from a person's gross income.

AA - Its not that the 15% cap gains is burdensome, its that the govt is about to peg rates to 4.5%, down from 5.5%, because they think that is the way to revitalize the housing market and they will buy up loans from GSEs...they are meddling too much with markets and there will be a price to pay later on.

If someone cant afford to buy a home today, at 5.5% rate, then they SHOULDNT BUY A HOME! Meddling with rates to bring it down 100bps from this level, will make buyers come in for the wrong reasons. They will buy for the deal, and sell in a year when they realize they only bought because of the 4.5% lower rate, not because they should buy a home.

Its an alternative to this ridiculous measure they are considering. I think they should let the private markets, the investors, come in to stabilize housing and incentivize investors like primary residents with the catch that the property must be held for 5 years.

Your idea of allowing investors to deduct interest is another great one! This is the line of thinking that should be going on RATHER than meddling and pegging rates and buying up loans to artificially get rates lower

JB - thanks for comments!! I always appreciate your comments here.

"Won't granting investors a permanent exemption from taxing their capital gains income lead to an increasing concentration of real estate wealth held by a tiny percentage of the population, while at the same time a vast and growing majority of Americans will become renters?"

Yes, that is a side effect. But whats the alternative? A vast majority of Americans are becoming renters already because they bought a home they shouldnt have because rates were so low and lending standards went out the window. They should have stayed a renter to begin with. In a way, this statement is what led to the 'everyone should own a home' policies that Bush enacted and put us into this mess.

But we are at now now. And the problems are here. This idea is in response to what the govt is considering doing, which I think is way worse and will hurt us way more in the end. There are no easy answers here.

There are plenty of investors out there, capable, hard working, investors with excellent credit and money to put to work that are waiting for a reason and a market and a opportunity to invest in. Whether it be stocks, bonds, corporate debt, commodities, or whatever. Why not housing? Why not incentivize these investors to invest in housing, clean up the foreclosures, fix up the houses, and rent them out? We are looking for stability right because if housing drops another 15%, which it prob will and has to anyway, then the securities lose more value and our banks become more insolvent and more bailouts will come?

Its a never ending vicious feedback loop. I say limit the govt meddling, dont have govt purchase bad loans, dont peg the rate to 4.5% (if you cant afford at 5.5% you should NOT be buying anyway!), and consider alternatives. Thats all.

Thoughts?

I am against any gov't tinkering of house prices. There is a pretty strong force that is hard to ignore: housing prices / income. Reversion to the mean is pretty strong on that stat. I'm not sure fighting it is a worthwhile cause.

Also, all the refis at 4.5% will most likely benefit those who can afford their homes (i.e., their home will appraise out for the new loan, their debt amounts and income are sufficient for approval), thereby not helping improve the bottom-line situation much and reducing the amount being collected on "good" gse loans. It may be a slight break in terms of available disposable income to those who refi, but probably not the intention of the program.

Noah, I agree, if you wouldn't be tempted by a loan at 5.5%, and feel that 1% is what will make something become affordable, odds are you're too close to your affordability limit in the first place.

I have to think further about the alternative you've proposed. In many communitities there's, oddly enough, a shortage of housing while homes lie vacant because the rental markets haven't been sufficiently large to absorb displaced homeowners (obviously not the cities with large condo development). Perhaps if the program could be instituted for specific markets, as needed, instead of nationwide, it would overcome the argument that it promotes profits for those who already have and doesn't help those who have not.

Im not married to this at all. Im just talking out loud here. There has to be alternatives to govt meddling with rates!

JR, I too am generally against intervention to prop up housing prices. Housing prices, as you say, must revert to the mean, must become more commensurate with income, and rent/buy equations must make sense again.

You have some markets, however, where prices are staggeringly low, no sales are occurring, and you're having issues that go beyond mere pricing, decay, crime, etc. At some point it becomes more of a public policy than an economic equity issue.

I just read in greater detail and now realize I was wrong about the 4.5% issue as to refis, the new program is only for new home loans.

I know we're at now now, and housing stock is housing stock whether it goes to primary or investment, but I can't get it out of my head that giving primary home ownership an advantage over other types of real estate ownership as a matter of government policy is good thing. No matter what, there will always be renters with a need for non-permanent or cash flow appropriate housing solutions. But for those who plan on staying in one place for years and decades, I think giving primary home owners an advantage over those who simply have a stronger capital base, to be good. I think this housing bubble has trivialized the "shelter" part of basic human needs. So on this, I'm with JB. Perhaps there's a way to make it easier for both primaries and investors at the same time so home owners keep the advantage over investors? Also, I agree on SA Realtor's point on an unstoppable wave that needs correction. So, while such wierd lending practices were allowed to exist till now to create this problem, perhaps we need to fix the lending practices and let the market correct itself.

Brenda - where did you read that only new loans apply for this program? Not refis? Link?

Nobi - thanks for comment! I understand this side of the argument!

A few comments to address post #1.

concentration of wealth would not be any different with this idea because tax exemption would be limited to $500k. this is nothing for a multi-unit development, so a "big-time" investor would not see much benefit for multi-unit housing. Matching the investment tax exemption to the personal tax exemption would really only create significant benefits for 1-4 unit property, which is typically run by small-time mom-and-pop landlords, and will continue to be due to inefficiencies and natural barriers to creating scale.

1-4 family units are what needs to be propped up, so this would be a great component of a solution

Todd - I agree this idea would be targeted to the smaller time investors, mom/pop landlord types. Heck, I would buy a 200K investment property somewhere near me in a market that is distressed but the neighborhood is developed, safe, and busy.

To take advantage of the tax benefit for way down the road.

Noah, yesterday's post on Calculated Risk, referring to the WSJs article on the new Treasury plan, states that it's for new loans only and not refis. I'm pretty sure that's the right plan, but these days, who knows.

Noah - I read your blog pretty frequently, good stuff, especially when I was looking to buy the archives were helpful (bought in Brooklyn Heights in May, right before the world fell apart!). Anyway, I think your idea is a good one but wouldn't making real estate investment a tax-free endeavor result in a shift in investment capital from more efficient places to real estate? I understand tax policy can be used to adjust behavior, but in an environment where capital is not moving efficiently to businesses that could use it, do we really want to over-allocate to real estate again?

Granted the artificial lending rates might have a similar effect, but I would not imagine it would be as dramatic. Now, eliminating FIRPTA might be a better idea since it would simply make real estate investments for foreigners a tax-neutral decision when compared with investing in securities and commodities.

The 4.5% is only for home buyers. But refis rate would go down to stay in line, no?

interesting idea, Noah.

Another potential side effect of the tax plan:

Overbuilding. Further Tax incentivizing investment props may help shore up supply, but such shoring up may only be offset by further overbuilding.

Also will the potential overbuilding of of investment props ultimately compete with primary residential ownership in a manner that may further reduce values on both homes andninvest props alike as well as the many mortgage back securities each comprise?

I still think the key to homeownership and in turn solving the
supply problem, is for rates to come down. The tweak needs to occur in the form of regulating against high ltv loans, no docnloans, etc... In other words, spur the buyer but the correct
buyer. In this regard the supply should stay in line with demand.

Treasury should end the 'as close to explicit as possible without being explicit' backing of agency mortgage bonds and give them their full support. Given where Treasury yields are now, mortgage rates should already be lower than where they are.

UST vs. Agency spreads are still way too high. Every good day in the MBS market is met by an even better day in the Treasury market. Tighten the spread and send mortgage rates down while investors set the pricing. Any government imposed rate setting is bound to be short-sighted with limited effects.

Though a decision has not been made yet, limiting a rate setting to new purchases as opposed to purchases and refis is absurd. Lowering borrowing rates will hardly scratch the surface of unloading inventory. The most immediate and beneficial impact of lowered rates occurs when existing homeowners are able to reduce their monthly debt load by reducing their mortgage payment, thus freeing up capital to pump back into the economy.

I agree 100% that if a homeowner cannot afford a home with a rate of 5.5%, but can at 4.5%, that individual should not be making the purchase. $382/month is the difference between 4.5% and 5.5% on a $625,000 loan.

JB, as a resident of Peter Cooper Village, I really do like that paragraph regarding Speyer's purchase. They're still trying to increase rents for the market-rate tenants. Oh well, I think it was on Curbed yesterday that I saw that NYU is encouraging students who are having a hard time financially to spend some of their time at CUNY instead. Given this warm and fuzzy approach to financial aid, maybe some of the students will move out and Tishman/Speyer can quit turning this place into an overpriced dorm. Not on topic, but kind of amusing in an only-in-NY sort of way.

I would like to question the assumption that someone needs to stimulate the housing market. We are already looking at historically low interest rates. The capital gains tax exemption was enacted by Bush and favors flipping property making it more of a commodity than an asset. We allowed the situation to get out of control where the tax break favoring flipping and the low interest rates combined to create a speculative bubble. We need to allow it to deflate or stabilize.
The lower interest rate on purchases w/o a capital gains break (at least dont change it) would allow the market to stabilize w/o refueling investor based speculation.

I would have to disagree with you on this one Noah. I don't think we should be encouraging investors to buy. If you want to see what can happen when investors go crazy and buy everything under the sun, just head down to Miami or Phoenix.

Donald - thanks for comment. I totally understand this side of argument. Not married to this idea in any way, I just dont like govt meddling with rates to get people to buy

I'd like to echo Donald's sentiment here. Implementing something like this would have devastating effect in metro areas like NYC where home prices have not had the chance to get back into affordable ranges for first time home buyers, you would in essence be rewarding investors for keeping the system inflated, and take most of the good condition, affordable homes off the market because the investors will snap them up long before they get listed for the general public where those who would live in them would see them.

I worry about the backlash in this country if we continue in this "the rich need to get richer" line of public policy and finance industry thinking when it comes to fixing the countries financial problems.

all great feedback...love it

Yes, I think it would be horrible in places like Miami, NYC, OC, etc. But what about Detroit? We've had urban plans before that encourage investment in blighted areas. This is not just a matter of the market correcting for those who are losing their homes, it's saving the lives, sometimes literally, of those bystanders destroyed in the fallout of increasingly-abandoned neighborhoods. I don't think one idea, or plan, will be appropriate for the entire country. I think situational remedies may be warranted.

Why do we feel this incessant need to manually adjust the demand and supply curve? Are we really that addicted to ever rising real estate prices? Isn't this tinkering (low interest rates, no credit checks for loans, a bubble mentality) how we got into this mess in the first place? I'm sorry if someone bought a 200 sq ft studio for $500K, but deal with the fact that you're an idiot and stop trying to mess with the prices for the rest of us.

I just get so damn angry whenever I hear a TV pundit saying that "we need to put a floor under the housing prices"! Yes, the real demand is currently low because of high requirements for receiving loans, but for the last 5 years it's been artificially high because those same requirements were artificially low. Those prices, as compared to average salaries, was just plain simply unaffordable. Hey if we gave out loans for free, I'm sure we would get demand and prices even higher then they were in 2007!

Rob you are right. Im pissed too. But to see them consider pegging rates to 4.5%, because 5.5% is too expensive, and the methods they will do to achieve this, really worries me.

I know your not a fan of the 4.5% rate Noah, but I think rates here in NYC are more than the 5.5% you regularly cite because tons of buyers need jumbo loans, and bankrate.com currently has them at 7%. And that is a bit on the high side, so it would be nice to see those come down to 5.5%.

Bankrate.com doesn't know what they are talking about. There are great jumbo rates available for the high loan amounts required in NYC.

The biggest issue for NYC real estate is the disproportionate amount of equity required to purchase a condo or a coop versus a single-Family residence.

What a stupid idea. Promote speculation at the expense of investing. Further damage an already injured tax system. Increase the inequities of a system that is in deep trouble because it takes too much from the middle and gives too much to the rich. And why? In order to delay the much-needed popping of an unsustainable and enormously harmful housing bubble.

The only reason to do this is to hand out public money to private speculators. But if that is your goal, why not be honest about it and just write checks to everyone who has extra money and isn't currently fully invested? The rest of us would be delighted to give up schools or social security to pay for it, I'm sure.

For New Yorkers, the 4.5% is as irrelevant at the 5.5%. Chase quoted me 8% yesterday for a jumbo with minimum 30% down (higher for apartments over $2m).

Where are these great rates for jumbos?

Where are these great jumbo rates?

Chase is quoting 7.75% with a minimum of 30% down and additional fees for coops, 2-4 families, or loans over $1.5m. And a minimum credit score of 720, which is hard to get even if you are upper income and pay every bill on time.

I don't know what program Chase is presenting, but I am closing 70% financing up to a $1.5mm loan amount at 5.25% for a 5 Year ARM. The same program for a 30 Year Fixed is at 6.5%, 7 Year ARM at 5.625%.

As I mentioned, the rates are there, it's a matter of whether buyers have enough equity to place as a down payment.

Needamortgage - I have your mortgage.

PriceofCivilization - This idea, which is not a proposal at all or anything Im married to as if you read my site you know my feelings AGAINST all this intervention, was simply in response to govt pegging rates to 4.5%!

I guess you are new to this blog!

For anyone who missed James Lockhart's comments yesterday, he made it clear that there is no 'target rate' being considered by the government.

He, as I have said on this blog, stated that the goal is to narrow the spread between UST and MBS. If this spread were at more normal levels, mortgage rates would already be lower than 4.5%.

Rates LOWER than 4.5%? Now that is something I am looking forward to!

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The tax structure facing municipal bond investors has an impact on the interest yields on municipal bonds.
While interest income received from municipal bonds is exempt from federal income tax, whether the interest
income is exempt from state tax depends on the law of the state in which the investor resides. Some states tax
interest income received from both in-state and out-of-state municipal issues and some states exempt interest
income from taxes on both in-state and out-of-state issues. There are, however, many states which tax interest
income from out-of-state municipal issues but exempt some or all of the interest income from taxes on bonds issued
inside the state.
The differential treatments of interest income may apply to corporate as well as individual taxes. In practice, a
state can create a demand for bonds issued within the state by legislating a law that exempts interest income paid
by its own municipalities from taxes while taxing interest income from out-of-state municipalities. The creation of
such a demand for in-state bonds is not costless. The cost involved is the loss of state government tax revenue due
to the tax exemption on in-state bonds. However, investors residing in a state with such a differential tax treatment
will have an incentive to purchase bonds issued within the state and have a disincentive to purchase bonds issued
by other states. Thus, the existence of such a differential tax treatment should lower the interest yields on the
bonds issued within the state. In an efficient market the present value of the tax benefits should be fully reflected
in the price or yield of the bond.

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