When President Trump was running for office, he made a lot of big commitments. Whether you love him, hate him, or are just trying to ignore the current political climate entirely, his success or failure in keeping those commitments will affect your real estate investing strategies and returns. One of the biggest effects will be how tax reform, if he achieves it, will change the housing industry.
According Gary Cohn, director of the National Economic Council, the current administration will “absolutely” get tax reforms underway this fall even if other initiatives, like healthcare reform and a border wall, stall out. He told MSNBC at the end of June that, “We were going to get tax reform if [the current Senate healthcare bill] passes or it doesn’t pass.” He added that regardless of the healthcare outcome, in September the administration will be “100-percent engaged in tax reform.”
While much of the talk revolving around tax reform has centered on simplifying the current tax code, which nearly all critics agree has a number of problematic loopholes. They do not agree what those loopholes are so there could be some unexpected fallout if the currently proposed reforms go through.
NAR’s Response & The Middle Class
The National Association of Realtors (NAR) warned in May 2017 that “While tax reform proposals swirling around Washington, D.C. promise lower tax bills for American families, new estimates indicate that many middle-income homeowners may actually see a tax increase if those bills go through.” The NAR recently published a study in response to the White House’s “Better Way for Tax Reform” proposal that it released last year.
PricewaterhouseCoopers’ analysts, commissioned by the NAR, estimated that middle-class homeowners with adjusted gross incomes between $50,000 and $200,000 would see their taxes rise by an average of $815. They also predicted that the new tax format would hit mortgage interest deduction savings and real estate property tax deduction savings hard, causing them to drop 82 percent between 2018 and 2027. The report also indicated that the group believes this particular tax reform strategy could cause home values to fall by an average of 10 percent “in the near term.”
It’s important to note that the groups did not analyze the White House’s actual tax reform proposals, but rather something described as “a proposal with many similar elements.” However, the similar proposal does include limiting tax rate divisions to only three, with the top income tax rate being 33 percent, eliminating nearly all itemized deductions with the exceptions of charitable donations and mortgage interest, and eliminating alternative minimum tax as an option. Both the publicly-floated White House tax reform proposals and the plan analyzed for the report would cap tax rates on pass-through business income at 25 percent.
At first, it might be hard to see how these simplifications and overall lower tax rates could be a bad deal for such an important part of our population. However, the key to the problem lies in that critical $50,000-$200,000 income range. That income is squarely “middle class” in most of America, and when something hurts the middle class, it tends to hit the broader economy as well.
In this case, the mortgage interest deductions, and other deductions (mostly no longer itemized, by the way) will not even out for middle-class homeowners, especially if they have mortgage balances between $100,000 and $500,000.
Homeownership & Tax Reform
Non-homeowners, by the way, would benefit by continuing to not be homeowners, because across all income categories they are likely to see tax decreases. This could lead to a stronger demand for rentals, which could be an interesting and potentially positive window of opportunity for investors, but you will have to consider the other major fallout from this proposed simplification: falling home prices in the short term.
PwC analysts predict that home prices will fall by 10.2 percent in the short term, while in the long-term price impacts “could be smaller as the supply of owner-occupied housing responds to lower demand,” as they described it. Basically, households still have to form and still must be housed, so the housing market might adapt as fewer owner-occupants sell and fewer new households purchase homes, opting instead to rent in single- or multifamily formats.
Not surprisingly, NAR president William Brown is not a fan of the bill. In a press release covering the release of the NAR-PwC study, he said, “A tax reform proposal that hikes taxes for homeowners is a raw deal, and consumers know it.” He added that he believes those leading the charge for tax reform have “the best of intentions” and will respond to the troubling research appropriately by addressing the concerns raised in the report.
Across the country, realtor groups have responded to the report by rallying together to reach out to their local representatives. Given that the NAR is a powerful lobbying force in Washington, D.C. it seems likely their concerns will be heard, but until fall, it is difficult to predict how this administration may respond to them.
Tax law can change. Never invest in anything just for the tax benefits. The benefits of owning property go far beyond tax breaks, and I will continue to teach people what those are. Renters who continue to rent will still be renting 30 years from now. Imagine what their rent will be after 3 decades! Based on history, they would be paying 2-3 times today’s rent.
On the other hand, a renter who becomes a home owner has locked in a fixed rate for 30 years! Their payment never increases unless they pull cash out in a refinance. The 30-year fixed rate mortgage is one of the greatest wealth builders today.
The homeowner will own the home free and clear in 30 years, just in time for retirement. Additionally, that home will likely have increased in value. Based on history, it could be worth two to three times today’s values.
The same is true for buy & hold real estate investors. You can also lock in a 30-year fixed rate mortgage. Actually, conventional banks will give you up to 10 of these loans, so you can buy 10 rental properties. After 30 years, your tenants will have paid off that loan. People who buy homes and lock in a fixed rate mortgage will likely see increased cash flow every year as rents go up but their payment stays the same.
Kathy Fettke is the founder and co-CEO of Real Wealth Network. You can reach her at firstname.lastname@example.org.