Published on: November 17, 2017
A TAXING EFFORT
Who knew tax reform would be so difficult? The tax bills proposed in the House and Senate won’t find an easy route to enactment. Although the House has passed its version of tax reform, it differs from the Senate bill in several key respects, so a conference committee will have to reconcile those differences. Many of the potential sticking points are real estate-related, primary among them: The treatment of the mortgage interest deduction and deductions for state and local property taxes.
Housing industry trade groups have lined up solidly against the House bill, which would cap the interest deduction at $500,000 (the maximum mortgage on which interest can be deducted). But they aren’t all that enamored of the Senate version, even though it would retain the current $1 million deduction cap. Both bills would double the standard deduction, which, most analysts agree, would significantly reduce the value of the mortgage deduction for the majority of homeowners who claim that deduction now. Housing groups say the deduction provides a major incentive for homeownership; removing it, they warn, would reduce home values and roil housing markets nationwide.
Deductions for state and local taxes are another lightning rod for housing industry opposition. The Senate bill would eliminate those deductions entirely. After initially moving in the same direction, the House backtracked and retained a $10,000 deduction for property taxes. Housing industry executives have found that helpful, but Republican lawmakers in high-tax states on the east and west coasts say that’s not enough to allay their concerns about the negative impact on their constituents.
“While the Senate’s proposed tax bill makes the MID whole on paper by raising the cap back to $1 million in deductible interest, champions of the deduction won’t exactly be breathing a sigh of relief,” Zillow senior economist Skylar Olsen told Housing Wire.
Comments from Elizabeth Mendenhall, president of the National Association of Realtors, confirmed the prediction that the Senate Bill is unlikely to win the support of housing groups that oppose the House alternative.
“We’ve already seen that a near-doubling of the standard deduction, combined with the elimination of other deductions like the state-and-local tax deduction, can turn the American Dream into a nightmare for families, as the rug is pulled out from under them,” Mendenhall said. “Simply preserving the mortgage interest deduction in name only isn’t enough to protect homeownership.”
AN UNEXPECTED DEBATE
Housing industry opposition to the tax reform bills isn’t surprising. But the housing related provisions have triggered an unexpected debate over the value of the mortgage interest deduction, exposing skepticism that has been building quietly for some time, as analysts have questioned the assumption that the interest deduction provides an essential incentive for home ownership. A recent study by MIT economist Jonathan Gruber is one of several to conclude that the deduction, in fact, has “zero effect” on the decision to purchase a home.
Other housing policy analysts, and many liberal advocates of affordable housing, have long argued that the deduction primarily benefits higher-income homeowners who purchase more expensive homes (with larger mortgages and higher interest payments), and are far more likely than less affluent owners to itemize deductions.
The Congressional Budget Office has calculated that 75 percent of the benefits of the deduction go to the top 20 percent of earners. Todd Sinai, a real estate professor at Wharton, points out that mortgages larger than $500,000 (the break point for deductible interest under the House plan) represent a tiny portion of the total, and even for those large mortgages, he notes, interest on the first $500,000 would still be deductible. The limit “only affects a couple percent of households,” Sinai told The Atlantic, “and they are the households that can buy expensive homes.”
For the National Low-Income Housing Coalition, which has long contended that the federal “subsidy” provided by the interest deduction far outstrips federal funding for affordable housing, the tax plan represents an “historic’ step toward addressing that inequity. The problem, Diane Yentel, the group’s president, told the Atlantic, and the reason the organization is opposing the tax bill: It would use the savings from capping the interest deduction not to provide more affordable housing, but to lower corporate tax rates “which for us is a non-starter.”
MORE TO LEARN
We learn from experience, or so we’re told – but not always, and perhaps not everything we need to know. A current case in point: The last recession – the deepest and most painful since the Depression ─ should have produced a lot of learning. But analysts warn that the country isn’t prepared to handle the next downturn, which could be more damaging as a result.
An article in The Atlantic identifies five major concerns:
- Although middle-class households have largely recovered from the ‘Great Recession,’ many are living paycheck to paycheck, with few financial resources to provide a buffer against economic setbacks.
- The Federal Reserve has less flexibility than it had during the last downturn to use offset its effect offset its effects. The Fed retains some monetary policy firepower, the article acknowledges, “but it might not be able to respond with the force it did in the Great Recession.”
- The federal deficit limits the ability of Congress to use fiscal policy to blunt the impact of a downturn while partisan gridlock limits its will to do so. “A Congress that cannot agree on much of anything seems unlikely to agree on a stimulus package aimed at helping America’s most vulnerable, quickly and effectively,” the article notes.
- Many states have reduced their unemployment benefits, weakening the safety net that helps workers during a downturn.
- The worldwide impact of a downturn would deepen the domestic effects.
“In terms of global circumstances, political will, and fiscal and monetary firepower, then, the next recession seems in some ways more difficult to fight than the last,” the Atlantic article concludes. “That need not mean that it would be worse than the Great Recession, of course. But it does mean that it will be worse than necessary.”
Rising tides may lift all boats in economic terms, but as a byproduct of climate change, they are also likely to sink a lot of moderate-priced housing. Zillow estimates that a six-foot increase in sea levels would drown nearly 2 million homes with an aggregate value of more than $900 billion. Most of those homes (65 percent) are in suburban areas (picture the Houston suburbs flooded by Hurricane Harvey) and about 30 percent are in urban areas; only 12 percent are in rural communities.
“Living near the water is incredibly appealing for people around the country, but it also comes with additional considerations for buyers and homeowners,” Zillow Chief Economist Svenja Gudell wrote in the report. “Homes in low-lying areas are also more susceptible to storm flooding [risks],” which, she noted “could be realized on a much shorter timeline, as we have seen time and time again.”
The Zillow report estimates that nearly 40 percent of the homes most at risk are in the luxury category, with about 25 percent at the low end of the price range ($220,000 or less), where owners are less likely to have the financial resources required to install sea walls and take other steps that can reduce flooding risks.
“We’ve seen the enormous impact flooding can have on a city and its residents,” Gudell noted. “It’s harder for us to think about it on a long-term timeline,” but, she cautioned, “the real risks that come with rising sea levels should not be ignored until it’s too late to address them.”
We may have to add affordable housing to the endangered species list. Freddie Mac has calculated that the supply of homes affordable for low-income families nationwide declined by more than 60 percent between 2010 and 2016. The agency reviewed 100,000 properties Freddie financed initially and then financed again when the properties were sold, or the loans were refinanced. Eleven percent qualified as “affordable” on the first financing, but only 4 percent met that standard on the second.
“We have a rapidly diminishing supply of affordable housing, with rent growth outstripping income growth in most major metro areas,” David Brickman, executive vice president and head of Freddie Mac Multifamily, said, adding, “This doesn’t just reflect a change in the housing stock.”
The study highlights the need for government assistance to increase the affordable housing supply, Karen Kaul, a research associate at the Urban Institute’s Housing Finance Policy Center, told the Washington Post. The two GSEs financed a combined chare of 70 percent of loans on multifamily properties in 2008; by 2014, she noted, their share had declined to 30 percent.
“The affordability issues are becoming more severe at the lower end of the market,” Kaul said. “Absent some kind of government intervention or subsidy, there is just not going to be any investments made at that lower end of the market.”
IN CASE YOU MISSED THIS
William Cordray, who just announced his plan to resign as director of the Consumer Financial Protection Bureau, thought a personal appeal might persuade President Donald Trump to veto legislation overturning a CFPB rule prohibiting mandatory arbitration requirements in consumer financial contracts. The appeal didn’t work.
Walmart has announced plans to add designer brands to its Web site to make it a “premium fashion destination.” Walmart? Really?
Millennial women have higher credit scores than men, a recent study found, but they also have higher debt levels and lower home ownership rates.
After de-leveraging aggressively in the wake of the economic downturn, consumers have reversed direction; household debt outstanding in the first quarter totaled $12.7 trillion, exceeding the pre-crisis peak recorded in 2008.
Speaking of debt and downturns, the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, estimates that another debt crisis would require another bail-out for the secondary market giants, this one totaling nearly $100 billion. FHFA Director Mel Watt wants the two housing finance agencies to retain more capital in order to increase their financial buffer.
A COSTLY DELAY
Time is of the essence for many of the responsibilities boards execute – including (and perhaps especially) the dispersal of insurance proceeds collected on behalf of owners.
Parc Condominiums in Houston was one of many properties that suffered extensive damage caused by Hurricane Ike in 2008. When the contractor the association’s management company (AMI) hired initially to handle repairs did shoddy work, the plaintiffs in this suit (AMI Association Management, Inc. and Parc Condominium Association v. Sprecher), David and Leslie Sprecher, refused to allow this company to work on the three units they owned. Acknowledging the construction quality problem, which had elicited widespread complaints, the board directed owners to obtain their own repair estimates, which the Sprechers did. AMI submitted the Sprechers’ $97,000 estimate to the insurer, which issued a check in that amount, but AMI waited two years before turning over the funds. The Sprechers, who had sold their units “as is” in the interim, sued the association and the management company, seeking damages of $48,000 ─ the amount they claimed repair costs had increased while they were awaiting the insurance check. A jury found in in favor of the Sprechers, awarding them the $48,000 they sought.
AMI and the association appealed, arguing that:
- They had properly delayed disbursal of the insurance proceeds, because the Texas condominium statute prohibits owners from collecting until repairs have been completed;
- Because the Sprechers had sold their units, they had lost their standing to pursue the claim; and
- The plaintiffs had not proven the increase in repair costs they alleged.
On the first point, AMI and the association cited language in the condominium statute describing the process for disbursing insurance proceeds. When two or more units are damaged, the statute states, “insurance proceeds shall be paid to the Board, as trustee. . . to be held in trust for the benefit of Unit Owners . . . as their respective interests may appear.”
The defendants interpreted this to mean that the Sprechers could not collect the insurance until the repairs had been completed. But the court said that interpretation ignored relevant language in both the statute and the condominium declaration, specifying that the association, as trustee for the insurance payments, holds those funds in trust for unit owners “as their interests may appear.” That’s standard terminology in insurance policies, the court, said, and it means “the loss-payee – in this case, the unit owner – stands in the shoes of [and enjoys the same rights as]] the insured.”
Within that framework, the court noted, the jury could “reasonably” have concluded, that the Sprechers had the same right as the board to “hold the insurance funds in trust,” and that the failure to disburse them did not comply with the declaration’s requirement that the funds be used to benefit unit owners.
The court explained: “Applying the language in this case, the Sprechers’ interest in the insurance funds sprang into existence when the adjuster assessed the damage that Hurricane Ike caused to their units, estimated the amount of money required to repair that damage, and provided those funds to AMI. Thus, the Sprechers had the right to the insurance proceeds as soon as AMI received them, to undertake the repairs that AMI had charged the individual unit owners with completing.”
The court also rejected the defendants’ interpretation of another statutory provision they had cited to support their argument that repairs had to be completed before the insurance proceeds were disbursed. That provision requires the insurance trustee to disburse the funds “first for the restoration of the damaged common elements and units,” and specifies that owners “aren’t entitled to receive payment of any portion of the proceeds unless there is a surplus…after the property has been completely repaired or restored.”
According to the court, the “surplus” describes funds remaining after the insurance proceeds have been disbursed to finance repairs of units and common areas. The provision “only prohibits the unconditional payment of any surplus insurance funds before the work is done, so that those funds remain available to complete the repairs,” the court said, adding: “The statute does not restrict the transfer of insurance funds to owners or others (the board or the management company) for the purpose of making repairs, the court said. It only requires that the funds be used for the repair and restoration of the covered property” Neither the statute nor the declaration prevented the distribution of insurance funds to the Sprechers “as a matter of law,” the court concluded.
The court made quick work of the secondary argument that the Sprechers’ sale of their units before the trial eliminated their standing to pursue their claim: “Because [they] alleged injuries that occurred during their period of ownership and for which they have not obtained relief, we hold that they have alleged a live controversy.”
Although the Sprechers prevailed on the legal arguments in this case, they probably didn’t have a victory celebration. When it came to calculating their damage award, the court found that they had not submitted clear evidence that the increased repair costs they had claimed were attributable entirely to repairs related to the hurricane damage they had suffered. The evidence indicated that at least some of the added cost reflected the removal of asbestos, the court said, but the jury did not have the information required to calculate the amount by which the claim should be adjusted to reflect that unrelated work. And because Texas Appeals Courts can’t order a separate trial on unliquidated damages where liability is contested, the court remanded the case for an entirely new trial that will revisit all the issues raised here – not just those related to the amount of the award.
“Many people are basically skipping starter homes; they’re renting until their 30s, and that first house they buy is a million dollars. They just are not even buying the $200,000, $300,000, $400,000 home, which is a total mind shift as compared with previous generations. “[Millennials] are still buying homes — they’re just buying them later and buying them bigger. “─ Spencer Rascoff, Zillow CEO.