It may seem extreme, but with the stroke of a pen, our government bodies legislate the price of real estate. First, a quick review, then what is happening today, how it will affect real estate prices, and what you should do about it.
Nominally, most of our laws are designed to project a social policy. Real estate, both homes and rentals / investment property have long been part of that agenda.
Back in the early 1980’s the tax laws had been written in such a way as to provide large tax deductions (aka tax shelters) based on passive activity losses. High wage earners would then buy investment property so as to offset today’s income while building a nice retirement nest egg. The unintended consequence was to increase demand, hence increasing prices, until it was common to find small business people with real estate investment portfolios that only “made sense” because of their tax advantaged status.
The Tax Reform Act of 1986 removed many tax shelters, especially those for real estate investments, by limiting deductions for passive activity losses and limitations on passive activity credits. In so doing, the “value” of these investments which had been held more for their tax-advantaged status than for their inherent profitability was crushed overnight, leading to “the end of the real estate boom of the early to mid '80s as well as to the Savings and Loan (S&L) crisis.” [Wikipedia: as of 11/08/2009]
The Community Reinvestment Act of 1977 was “designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods.” [Wikipedia: as of 11/08/2009] Many argue this is the root cause responsible for many of the bad loans we have currently face. However, the act emphasizes that an institution's CRA activities should be undertaken in a safe and sound manner, and does not require institutions to make high-risk loans that may bring losses to the institution.
Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie Mae and Freddie Mac to devote a percentage of their lending to support affordable housing. In November 2000 Fannie Mae announced that the Department of Housing and Urban Development would soon require it to dedicate 50% of its business to low- and moderate-income families. [Wikipedia: as of 11/08/2009] It is unclear whether these government sponsored entities were ever forced to make a loan they didn’t want to. It would appear that while basking in the golden light of their profits, many lenders lost sight of their risks.
Monetary policy that lowered interest rates, hence increasing affordability, partially created the land rush of the 2000’s. With increased affordability came increased demand resulting in increased prices until the laws of supply and demand found equilibrium.
The Mortgage Forgiveness and Debt Relief Act of 2007 (and as extended by the Emergency Economic Stabilization Act of 2008) eliminated the treatment of forgiven debt as taxable “income”. That is, previously if you had a foreclosure (or short sale) and the bank recovered $100,000 less than it was owed, then that $100,000 effectively would have been considered taxable income. If you were in the 33% tax bracket, then you would have owed the IRS an extra $33,000. This law forgives that tax burden. The unintended consequence of this law is that it has ushered in the era of the “strategic default.” That is, people who choose to walk away from their debt obligation not due to need, but because their home’s value had fallen below the amount they paid. and there was no financial consequence to inhibit them. This accelerated the current foreclosure debacle and will continue to do so until it expires, is stricken from the records, or inflation brings home prices back to prices near where people paid.
The American Recovery and Reinvestment Act of 2009 provides a first-time homebuyer tax credit of $8,000 credit for all homes bought between 1/1/2009 and 12/1/2009. According to the National Association of Realtors approximately 20% of all home purchases in 2009 were due to this tax credit. This has had the intended consequence of slowing or halting the decline in home prices in most areas. In some areas in the entry level price range, is has caused such a surge in demand as to cause a 15-20% increase in prices.
As of 11/9/2009, the homebuyer tax credit has been extended and expanded to include repeat buyers and higher-income levels. The cut-off is homes under contract by 4/30/09 and closed by 6/30/09. This will maintain the heightened demand for entry level homes with pricing effects varied based on other local characteristics. This will also jump-start the move-up of the market. The limiting factor will now be the ability to get a loan. Hence, the market segment affected will most likely just be to the ability to get a jumbo loan.
Where does this leave our real estate investor and savvy home buyers?
First, know your market of interest. For your price range, how many months of inventory are there? What are the price and rent trends for your target type of home (e.g., 3-bedroom) ? Use FinestExpert.com to find cashflow positive or neutral properties with a high FE-Score and then view the details to confirm the real estate market trends.
If prices and rents have stabilized you should expect your market, at the entry level where most investments make sense (and coincide with homebuyer tax credits), to experience strong growth. Look to make your move immediately and get your next home or investment property under contract by the middle of January, before the seasonal price increases start to take hold. In 2009, some markets have already experienced a 15-20% price increase and have less than a month of inventory.
If you are looking to fix-and-flip, be sure to search using FinestExpert for discounted asking prices. There is a coming window of opportunity in the right market. Also, most first-time homebuyers do not have the extra reserves to rehab a property and, whether they realize it or now, need a rehabber to be part of their solution.
Naturally, not all markets are ready for growth… If there is cashflow and you have a long time horizon, then it may be worth considering. Otherwise, consider either another market or hold off until your market of interest stabilizes.
If you are looking at the $800K+ end of the market, there is nothing in place to stimulate that portion of the market. With the current credit markets and loan types available, we expect to see this end of the market decline further in the coming year with increased foreclosures and strategic defaults.
As a final caution however, please be aware that there have been mounting mortgage delinquencies that have not yet translated into foreclosures. If such foreclosures were to hit your market, would it cause a downturn in prices. Again, it depends on current inventory and local market trends.
