Tax Reform: Effect on Home Prices

No material price effect so far, though it is still early after reform

By Frank Nothaft Housing Policy, Real Estate

The Tax Cuts and Jobs Act enacted in December was the largest change to the U.S. tax code in more than three decades.  Tax reform has touched every person and industry.  Let’s examine how it affects housing decisions made by families.

Overall, tax reform has lowered personal income taxes, not necessarily for each taxpayer but in the aggregate.  An increase in after-tax income, at the margin, generally increases the amount of shelter consumed and the likelihood of being a homeowner.  Economists refer to this as the ‘income effect’.  Thus, the increase in after-tax income should be a net plus for housing demand and homeownership, holding all else constant.

But all else is not constant.  Tax reform also lowered the maximum loan size for interest deductibility on new first-mortgage debt to $750,000, eliminated deductibility for some second liens, and capped the annual deduction for state and local income and property taxes at $10,000.  Further, the hike in the standard deduction will substantially reduce the number of tax filers who itemize, and lower marginal tax rates reduce the value of deductions for those who do itemize.  By raising the after-tax cost of homeownership, tax reform is expected, at the margin, to lower the amount of shelter consumed by owner-occupants and tilt tenure choice toward renting rather than owning. Economists refer to this as the ‘price effect’ because the relative cost of owning versus renting has changed.

Whether the ‘income’ or the ’price’ effect is stronger will determine whether demand for shelter and homeownership rates rise, fall, or are largely left unchanged.[1] 

To see if there has been any material effect on prices, we used CoreLogic sales data through February in high-cost areas, defined as those areas where the sum of annual mortgage interest and property tax were the highest, and compared the recent trend with the average of the prior four years. (Figure 1) We then did a similar comparison in the rest of the country, in other words, outside of high-cost areas. (Figure 2) The decline in the unemployment rate, robust stock market, and low inventory levels complicate these comparisons.  Nonetheless, two months after passage of tax reform, we have yet to see any material difference in home-price trends between high-cost and lower-cost areas, nor any meaningful change in price trends compared with earlier years.

Methodology

High-cost areas were determined using CoreLogic’s single-family public record data for 2017 for the median annual property tax payment and for the median origination loan size by ZIP code; a 4 percent mortgage interest rate was used with the median loan amount to estimate the annual mortgage interest payment.  The median property tax and mortgage interest payments were summed; the 500 ZIP codes with the highest sum were designated ‘high-cost areas’ and all other ZIPs as ‘non-high-cost areas.’  The source of the weekly median sales price in high-cost and non-high-cost areas was the CoreLogic Multiple Listing Service database.  Two-week moving averages of weekly median sales prices were used for analysis with the time series rescaled by setting the first two weeks of June equal to 100.

[1] Studies that have simulated the effect of tax reform on owner-occupied housing and home prices include PricewaterhouseCoopers, Impact of Tax Reform Options on Owner-Occupied Housing, Prepared for the National Association of Realtors, May 15, 2017; JPMorgan, The Impact of Tax Reform on the Housing Market, North America Securitized Products Research, November 22, 2017; and Moody’s Analytics, U.S. Macro Outlook: A Plan That Doesn't Get It Done, Mark Zandi, December 18, 2017.  The studies expect a negative overall effect on home prices in a national price measure; in addition, the latter two reports expect negative price effects that are larger in higher-cost areas or for higher-priced homes, and a net positive effect on home prices in lower-cost areas or for lower-priced homes.

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