The Real Story…

News and commentary about the real estate market and related topics.

Dave Parrish, ABR®, CSP, GRI, ePRO®,REALTOR ®, RE/MAX MarketPlace
The opinions expressed here are my own and don’t necessarily represent those of RE/MAX International.

Is the Mortgage Interest Deduction in Jeopardy? (Part -1)

Over the course of the last several years there has been increasing attention focused on the nation’s ever increasing debt. The consensus is something has to be done…  With that in mind the job of the Bi-Partisan Deficit Commission (National Commission on Fiscal Responsibility and Reform) has been given a serious and challenging task to move the nation from the status quo toward fiscal responsibility. The problem is that no one seems to be willing to have the corrections or reforms impact him or her personally in any fashion that would seem to lessen his or her personal benefits.

One of the sacred cows of the U.S. Tax Code has been the Mortgage Interest Deduction (MID). Approximately 40 million Americans claimed the mortgage interest tax deduction last year. It was estimated by Congress’ Joint Committee on Taxation that between 2009 and 2013, this deduction will allow about $600 billion in potential tax revenue to stay in homeowners’ bank accounts instead of going to the Treasury. In 2009, the tax break was worth over $80 billion to homeowners, or about 2 percent of all federal spending.

Since 1913 the tax code has provided deductibility of interest paid for the purchase of a home. The mortgage interest deduction has long been considered the cornerstone of American housing policy. The belief is that it makes owning a home more attractive, and proponents including the National Association of Realtors (NAR) argue that it helps stabilize neighborhoods by increasing homeownership. But the mortgage interest deduction is up for reconsideration as the country’s deficits continue to mount and its effectiveness is brought under consideration.

Why the Mortgage Interest Deduction (MID) was created

The deduction was added to the tax code with the assumption that it would increase homeownership and stabilize neighborhoods because homeowners are more involved in their communities than renters. That principle was likewise the driving force behind the creation of Fannie Mae, Freddie Mac and FHA.

However, according to a study by the Tax Policy Center, these assumptions aren’t true. It turns out that neither of these assumptions is necessarily true. For instance, for a half century (until the recent real estate boom and bust) home ownership rates in the U.S. have barely budged despite the value of the mortgage interest deduction. Similarly, there is no clear connection between home ownership rates and the availability of mortgage deductions in other countries.

While homeowners are more involved in their communities than renters, this may not be a cause and effect relationship. Does owning a home change people’s feelings about their area, or are the same kind of people who get involved in their communities more likely to buy homes?

There is also the question of who benefits most from the MID. It seems almost impossible to defend the MID on grounds of fairness and equity. The benefit is only realized by people whose income is high enough to warrant itemizing deductions, and its value rises with their tax bracket… that is the more you make the more you get to deduct.

A study for the Urban Institute and Tax Policy Center by Eric Toder, Margery Austin Turner, Katherine Lim and Liza Getsinger estimates that its elimination would cost the average household an average of $559 more per year in tax. But the impact is highly progressive: for bottom quintile the average increase would be just $2 or 0.01% of after tax income; for the middle quintile, $215 or 0.49% of income; and for those in the top quintiles minus the very richest 1%, it would average $1,723 to $4,234, or 1.59% to 1.63%. Only for the richest 1% does its relative importance decline.

The study notes that the MID has not been found to increase home ownership, which makes intuitive sense: the families that benefit most are precisely those most able and likely to buy a home regardless of the tax treatment. It only encourages them to buy larger homes, and to do so with more debt; anyone who pays off their mortgage gets no benefit.

Is a tax deduction the most efficient and equitable way to accomplish goals

The deduction, whether it accomplishes its goals or not, is hardly the most efficient mechanism for doing so. The mortgage interest deduction confers the highest benefits on those who would probably buy homes anyway: the wealthiest segments of society. Economists James Poterba and Todd Sinai figured that it saves about $523 per year for those earning between $40,000 and $75,000, and $5,459 per year for taxpayers earning over $250,000. Those with the lowest incomes don’t generally itemize, so they get no benefit at all from the tax deduction.

While it is true that homeowners with larger and relatively young mortgages who itemize deductions do enjoy the tax benefits of an interest deduction (mortgage subsidy), subsidies for home ownership are of questionable value in increasing homeownership. If we are to have subsidies, as a means of increasing homeownership, it makes more economic sense to target those with lower incomes in a way that those benefits could actually be realized. Perhaps a better way would be to replace the deduction with a tax credit so that the benefit can be accessed without the need to itemize deductions and does not increase disproportionately for higher income earners who are not in need of subsidies to afford homeownership.

Next week we will look at the actual proposals of the Bi-Partisan Deficit Reduction Commission and what is likely to happen.

Until then… May the Market be with you.

The Real Story…

News and commentary about the real estate market and related topics.
Dave Parrish, ABR ®, CSP, GRI, ePRO ®, REALTOR ®, RE/MAX MarketPlace

The opinions expressed here are my own and don’t necessarily represent those of RE/MAX International.

Contrarian…

I grew up in a family where conversation around the supper table was an informative debate. Each was taught to listen to the opinion of others around the table, to form and to share their own opinion and finally to offer the defense for their thinking. From this early experience I learned the practice of contrarian thinking… which is basically to consider an opposing view.

Now by definition a contrarian thinker is in the minority. It’s almost something that the true contrarian seeks out… “What is the direction everyone else is taking… Okay, I’ll go the other way!”

In recent columns, I have revealed a hint of my inclination to think in a contrarian way… More boldly today, I want to explore some contrarian thinking in real estate… First a statement of fact: We are in a Buyers’ Market. This occurs whenever the number of houses for sale exceeds the demand sufficiently to cause the buyer to be the driving force in a transaction. That is for a seller to sell, the seller will have to make more concessions to attract potential buyers.

Typically, this phenomenon begins to occur at a point when the number of houses for sale exceeds the number of houses sold in the past six months. The greater that difference the stronger the market favors the buyer. In the Birmingham market we currently have a 12.2 months inventory of houses actively on the market. In the Trussville market we currently have a 13.7 months inventory… A strong Buyers’ Market.

Conventional wisdom is that this is not the time to sell… Enter contrarian thinking. Is it really true that now is not the time to sell? At the present, there are many sellers sitting on the sideline waiting for the market to return or at least to improve prior to trying to sell. At the same time an increasing number of sales are foreclosures and short sales that continue to drive prices down. Unemployment adds to this cycle of price decline, as do changes in the credit market and appraisal practices. There is no reasonable rationale that would lead anyone to believe that this is a short-term trend. Hope yes; reason…No!

If prices are set to decline and not rebound for the foreseeable future, is today’s value the best you are likely to see for a while (best guess is 2020)? Now look at the Buyer Pool for your house. Today’s low interest rates and relatively low prices have the buyer pool larger than it will likely be as the economy begins to improve. Look at the recent uptick in interest rates: within a recent two week period, interest rates rose half a percent, a result of a single positive retail sales report. As the economy improves interest rates will raise despite the Feds’ efforts to keep rates low. Rising interest rates will decrease the Buyer’s buying power faster than price declines can counteract the loss of buying power. A half percent increase in interest rates has the same effect on a potential buyer as a 10% price increase.

The point is, yes, your house is worth less than it was last year and the year before… But it is also worth more today than it will be next year or the year after. Does this knowledge impact your decision to sell?

But be careful of thinking the same forces are at play for the Buyer… Yes, prices will continue to fall… But will the payment for the same house fall at the same rate as the prices are declining? Buyers realize that you have to consider all the factors that contribute to the monthly payment… not the least of which is the interest rate you have to pay.

The formula for success is more complicated than most imagine it, especially if you take the time to look at the market from a contrarian point of view as a means of testing the conventional wisdom

May the Market be with you.

The Real Story…

News and commentary about the real estate market and related topics.
Dave Parrish, ABR ®, CRSA, CSP, GRI, ePRO ®, REALTOR ®, RealtySouth

The opinions expressed here are my own and don’t necessarily represent those of HomeServices South.

Thanksgiving…

We are in the season of Thanksgiving… a season to reflect and express our gratitude for the past year and to celebrate the things that we value most. Forgive me as I move a bit off topic this week to reflect on this season and those things for which we are thankful.

After the turmoil of the last four years, I know it must seem strange to hear some one mention real estate and thanksgiving in the same breath.  That may especially seem so since we have not yet reached the end of the declining home values and of people losing their homes to foreclosure. While I do have a positive attitude about the long-term direction of real estate, I also recognize that for the short term, we are in for more pain for many and I’ll not try to spin it in any way to minimize the very real pain being felt out there.

Yes it’s a great market for buyers… especially those with nothing to sell. It offers: low prices, historically low interest rates and lots of homes to choose from. For sellers who are moving up, it can be a great market as well. But it’s tough for those making the move to a smaller, less expensive home or making that final sale. The market, while still changing and headed for improvement, is none-the-less forever changed.

For more and more people this time of economic stress has served as a wake-up call… a re-thinking of values, of what is truly important. Increasingly, I hear the desire to downsize and simplify… to disengage from the perpetual quest to acquire. Substituting instead the idea that “Less is more.” Putting first the important things. And that is not altogether bad. Maybe it’s even a reason to be thankful.

You see Thanksgiving is not just for “Good Times”… It’s for all times. Regardless of the times, it is the season of Thanksgiving and in that reflection I find that I am most grateful for my family and friends, my clients, the community I share with you. Know that I am praying that you will be blessed in the coming year. Remember: If you really want a wonderful Thanksgiving … Help someone.

Have a Happy and Blessed Thanksgiving.

May the Market be with you.

The Real Story…

News and commentary about the real estate market and related topics.

Dave Parrish, ABR®, CRSA, CSP, GRI, ePRO®,REALTOR ®, RealtySouth
The opinions expressed here are my own and don’t necessarily represent those of HomeServices South.

Recovery will not happen for all…

It may not sound fair but the truth is that the recovery, when it comes, will not happen for all.

It’s a well-known fact that the market is subject to the law of supply and demand. In the area of real estate these two forces are moving in opposite directions. At the height of the market, the real estate market experienced an artificial demand created by unsustainable and just plain stupid lending practices. That demand produced a phenomenal increase in housing starts and thus inventory to meet the “demand.”

Once the results of those lending practices were realized, the supply and demand were simultaneously hit in a manner only paralleled in the 1930’s. Foreclosures began to add to inventory while lending policies slowly eroded away the “eligible” buyers. Then came job losses, realization of the financial debacle, more job losses, more foreclosures, etc. But then you already know that.

The point here is: What does the future look like?

There are several dynamics at play here.

Supply: Supply is continuing to grow… largely attributable to foreclosures, but we’re still building new homes albeit at a much-reduced rate. This supply will continue to grow at least until unemployment falls below 7%. According to Mark Zandi of Moody’s Analytics, we will probably be at 7.0 – 7.5% unemployment in the third quarter of 2012. Even when we fall below 7% unemployment supply may grow due to shadow inventory and a natural lag time for the market to respond. Don’t expect any major relief in supply prior to 2015.

Demand: Demand will continue to weaken… Partly due to a return to sanity in the lending process; but also largely due to consumer confidence issues based on continued unemployment and the supply-demand gap. It is my opinion that demand can’t increase until unemployment falls below 6.5%… My guess this happens around mid 2014. Again expect some lag time for demand to be noticeable probably Q2 2015.

Consumer Expectations/Trends: Lots of things happening here… The McMansion era is over! The idea that less is more has definitely set it roots in the psyche of today’s buyers. Even so, consumers have come to expect more from their homes… energy efficiency, low maintenance costs, livability and style. Unless in a superior location homes built pre-1990 are considered functionally obsolete and are in for a serious hit. Even post 1990 homes must have been kept up-to-date and at least reasonable well maintained. Today’s buyers are rarely Do-It-Yourselfers… painting and replacing carpet can be major obstacles to making a sell. Increasingly younger buyers are considering more urban locations, as urban sprawl and commuting are seen as more than just undesirable… life style and freedom are major concerns.

Blighted Communities: There are whole communities that will be impacted by the game of musical chairs created by the supply and demand gap… With so much inventory to select from, buyers are increasingly avoiding those neighborhoods with those functionally obsolete homes, neighborhoods with high foreclosure rates and numerous unoccupied or ill maintained homes. At some point that level of decline is seen as too big a risk. So that, even a well-maintained and otherwise marketable property has little marketability due to the law of location. These communities will not recover, if the status quo is allowed to continue, and truth be known are probably already beyond any realistic hope of recovery.

Overall financial trends: While current lending rates are at historic lows, lending requirements are increasingly troublesome for many potential homebuyers… but not yet unreasonably so. The lack of inflation has reduced the leverage once available to the average homebuyer (more on this in a future column). Declining property values have produced another phenomena: the strategic Walk-A-Way (previously discussed here) is on a disturbing increase and likely to worsen the entire market if treatment remains as is.

Possible Cures/Aids: Any serious effort to restore the market has to be multi-faceted. Following are my suggestions:

1.     Rather than extension of tax cuts, provide tax credits for the following activities:

• Energy Reduction Measures for existing homes
• Other targeted activities that create jobs.

2.     Realizing that foreclosed and un-occupied homes exacerbate the decline of property values and communities, develop a program to encourage rental of foreclosed homes to existing homeowners at a reduced rate so as to reduce the number of un-occupied homes (something like a section 8 program). Such measures should have a required maintenance clause to qualify for the reduced rental rate. Many may see this as rewarding those who have defaulted on their mortgages. However, to allow homes to erode hurts all in the community, as well as the lender and the overall economy.

3.     Develop rules that identify Strategic Walk-A-Ways and charge the loss to the homeowner as taxable 1099 income from which they are unable to claim bankruptcy.

4.     Modify Bankruptcy laws to reward those individuals electing to honor their debt through Chapter 13 rather than Chapter 7.

Individual Actions: At the same time homeowners need to be aware of their position in the marketplace and its impact on future values. Planning ahead is the key idea. Consult with a trusted real estate professional to understand what is likely to happen with the market value of your home over time, so that you can avoid or at least lessen the potential negative impact of the market. If looking to take advantage of the decline in market values as a buyer, you will also need this expertise to plan your purchase for the future. A low price doesn’t necessarily translate to a good buy.

May the market be with you.

The Real Story…

News and commentary about the real estate market and related topics.

Dave Parrish, ABR®, CRSA, CSP, GRI, ePRO®,REALTOR ®, RealtySouth
The opinions expressed here are my own and don’t necessarily represent those of HomeServices South.

New House Tax Rumors Are Misleading…

As if the market wasn’t already confusing enough… This week we have seen a rash of rumors and forwarded e-mails that report that there is a new tax on house sales that is a part of the Health Care Reform Bill passed earlier this year that will impact all home owners who sell their home after 2012.

I have seen so many false claims circulated in this fashion that it has become a habit to check the facts at either FactCheck.org or Snopes.com.

First, the inaccurate rumor/claim:

3.8% tax on real estate transactions

Under the new health care bill – did you know that all real estate transactions are subject to a 3.8% “Sales Tax”?… [ I have omitted the balance of the sample e-mail, as it is purely political in nature ].

The problem with such claims that are partially true is that they misrepresent the real truth of the matter and are usually used to inflame the uninformed. A half-truth is still a lie.

A half truth is a whole lie.     ~Yiddish Proverb

The most dangerous untruths are truths moderately distorted.    ~Georg Christoph Lichtenberg

The truth, I encourage everyone interested to check the facts out for themselves, is that yes there is a provision in the Heath Care Reform Bill viz. Patient Protection Affordable Care Act (PPACA) health care legislation that calls for high-income households to be subject to a new 3.8% Medicare tax on investment income starting in 2013.

Now, the important fine print that was left out:

The PPACA will generally impose a 3.8 percent tax on the lesser of “net investment income” or the excess of modified adjusted gross income over a “threshold amount” (generally, $250,000 for taxpayers filing a joint return, $125,000 for married taxpayers filing a separate return and $200,000 in all other cases).

Net investment income generally means the excess of (i) interest, dividends, annuities, royalties, rents, income from passive activities, income from trading financial instruments and commodities, and gain from the disposition of certain non-business property, over (ii) allowable deductions properly allocable to such income.

In determining the amount of net investment income, special rules apply with respect to dispositions of equity interests in certain partnerships and S corporations, and to distributions from certain qualified plans. This additional tax applies to taxable years beginning after December 31, 2012

The tax is then not a tax on all real estate sales; it is an investment income tax, which could result in a very small percentage (estimated at less than 5%) of home sellers paying additional taxes on home sales profits over a designated threshold amount.

However, the existing exemption/exclusion of allowable gain (not the sales price) on a principle residence of $250,000 for individuals, or $500,000 for couples will protect the gains from the sale of a principal residence for more than 95% of Americans. Again remember this is a tax on gains that exceed the threshold and exemptions, not the sales price.

Note investment property and vacation homes do not have the exemption and will be subject to the tax if the gains are experienced by a tax payer exceeding the adjusted gross income threshold of $250,000 for taxpayers filing a joint return, $125,000 for married taxpayers filing a separate return and $200,000 in all other cases

In short, if you’re a “high earner” and you sell your home at a substantial profit, you might be required to pay an additional 3.8% tax. However, given that the existing home sale capital gains exclusion on a principal residence ($250,000 allowable gain for individuals, or $500,000 for couples) still stands and no Medicare tax will apply for gains within those limits, that the bill’s definition of “high earners” encompasses less than 5 percent of all taxpayers, and that the median sales price of existing single-family homes in the U.S. was only $170,700 in March 2010, the Medicare tax will likely affect only a small percentage of home sellers when it is implemented in 2013.

In a real practical sense, I could only wish that this were our most significant issue at the moment. Gains on real estate sales aren’t the problem that most concerns home owners today. That day will eventually return. And it is possible that some of us may gain enough on a sale to pay a tax. You should have such a problem!

This information is not meant to serve as tax advice. Remember, when it comes to IRS regulations, you should check with your accountant for the most accurate and up-to-date information, as it applies to your individual set of circumstances.

And oh by the way, make it a habit to check-out the facts first!

May the market be with you.