When the Republican Party first put forth its plan to reform the country’s tax laws, housing experts worried it could put a damper on home-buying activity. Now that the GOP’s tax plan is the law of the land, some fear those predictions may be coming to fruition.
A new report from analysts at the Federal Reserve Bank of New York examined the drop in home-sales activity between the fourth quarter of 2017 and the third quarter of 2018. The figures in the respective quarters were adjusted for any seasonal factors impacting the housing market at those times of year. In that period, new home sales fell 7.6% nationwide — with the Northeast and West regions sustaining the most substantial drops in sales activity.
New Federal Reserve Bank of New York findings suggest that the recent changes to the federal tax code have contributed to the slowdown in home sales that occurred throughout much of last year.
The researchers, Richard Peach and Casey McQuillan, examined the influence of a variety of factors — mortgage interest rates, property tax rates, the top marginal income-tax rate and home price appreciation. Their findings suggest that the recent changes to the federal tax code have contributed to the slowdown in home sales that occurred throughout much of last year.
During the period reviewed, the top marginal income-tax rate dropped from 39.6% to 37%, reducing the potential savings from itemizing one’s deductions by 2.6 percentage points. Moreover, property tax deductions are now capped at $10,000, meaning that at the margin these state and local taxes are no longer deductible. The mortgage interest deduction was also cut in half, which in effect increases the mortgage rate a homeowner is paying, the researchers argued.
With all these factors taken into consideration — along with the higher mortgage rate and the lower rate of home price appreciation — the user cost of capital, or opportunity cost, of buying a home increased between 1% and 5% for homeowners affected by these tax code changes. In other words, it’s gotten more expensive to buy or own a home. But experts say the new tax code is just one piece of the puzzle.
Other studies suggest that tax reform has hurt the housing industry
The New York Fed analysis builds on other research that has suggested the GOP-led tax reform package could have created trouble for homebuyers and homeowners.
Realtor.com compared home sales activity in counties where there we a high concentration of households claiming the mortgage-interest deduction versus those where that was not the case. In the so-called “high-impact” counties, home sales had dropped 5.4% in October from the previous year, driven entirely by a smaller number of sales of homes priced at less than $750,000. Comparatively, in counties where few households claimed the deduction historically, sales were up 5.7% year-over-year.
(Realtor.com is operated by News Corp NWSA, -1.55% subsidiary Move Inc., and MarketWatch is a unit of Dow Jones, which is also a subsidiary of News Corp.)
The role that interest rates play in housing
The recent tax code changes went into effect just as mortgage rates began increasing notably. During the period the researchers highlight, mortgage rates rose by roughly 60 points. “Mortgage rates do have an impact,” said Realtor.com chief economist Danielle Hale. “If mortgage rates do stay low, that’s certainly going to be helpful for the market especially as prices are high.”
‘Mortgage rates do have an impact. If mortgage rates do stay low, that’s certainly going to be helpful for the market especially as prices are high.’—Realtor.com chief economist Danielle Hale
To control for this factor, they compared this recent episode with two previous instances where interest rates increased by roughly that much — between the second quarter of 2016 and the first quarter of 2017 and between the first and fourth quarters of 2013. “It’s impossible to control for everything,” Hale said of the New York Fed researchers’ approach. “The framework they take is a really helpful one.”
In the two other time periods where mortgage rates rose by 60 basis points, sales were not as harshly affected. New home sales actually rose 10.3% nationally during the 2016-2017 period, and only fell 1% in 2013.
That would then suggest that mortgage rates alone don’t explain the downturn in housing. At the same time, mortgage rates began approaching the 5% threshold in 2018, which may make a bigger psychological difference than in the previous periods where rates were below 4.5% or even 4%.
The impact of tax reform won’t last forever
Taxes are just one factor consumers consider when making the decision to buy. And while right now some may feel compelled to move because of high tax rates or to hold off on buying because they can’t deduct as much mortgage-related interest, over time these issues won’t seem as prohibitive.
For instance, the smaller mortgage-interest deduction may not steer someone away from buying outright, said Skylar Olsen, director of economic research at Zillow ZG, +1.35% Instead, it may mean they simply alter their approach to financing the purchase.
“After all, people buy homes for more than just the financial calculus,” Olsen said.