Financing

The Conclusion

Much of what was discussed in this series of posts deserved a lot more depth.  Discussion of housing, the Fed, the GSE, taxes…all of them…could and will continue to be written about and discussed by many of the smartest in DC, Wall Street and beyond.  I recognize I barely scratched the surface.

As I have said to those who ask, I am not sure what pricing for housing should be right now as the inputs to the market (supply, demand and interest rates) are all being unduly influenced by governmental policy.  Fair Market Values are set by a willing buyer and willing seller, neither of which is under undue stress to make a deal.  Knowing that monetary policy has kept rates artificially low and the money supply high while simultaneously restricting the ability for builders to build speculatively, tells me that the market is not a normal one.  Current policies are impacting both supply and demand…so does that mean home prices are real right now?  Which way will they move as DC gets out of the way (or will they?)  Likewise, besides the role of the Fed, if you see Fannie and Freddie either a) relaxing their underwriting guidelines or b) being dissolved by congress, then you can see either change would move prices in opposite directions.

What will happen?  Your guess is as good as mine.

I do believe that the policies currently originating from inside the beltway in DC are far more extreme than at any time in recent memory and thus, probably will not be here in short order. When the housing market regains its fundamental footing (which it somewhat has), then (hopefully) DC will get out of the way and let the real market forces be that which drives home values for the foreseeable future and not extreme monetary policy.

Ok, it sounds as if I am anti-government intervention, which is mostly true.  In reality, I am far more frustrated by the sweeping intervention of the past several years than the necessary periodic tweaks. And while I largely believe that the market adjustment which hit Richmond in 2008 (and lasted well into 2012) should have been far milder if not for flawed policies…that is not the central point in this article.

The true takeaway is this – understanding our government’s ability to both encourage and discourage behavior through the use of monetary policy (and thus lending practices) and tweaking (or changing) the tax code is paramount in understanding market values. Additionally, monetary policy itself cannot isolate a singular industry (like housing) and sometimes the interrelatedness of the marketplace may mean a policy designed to fix one aspect breaks something else.

Despite the fact that we all want to believe that we can dramatically impact our individual home’s value with paint colors, furniture placement or a kitchen renovation, the ultimate reality is that a seemingly benign policy change at Fannie Mae can have a massive impact on our collective home’s values. 2008 – 2012 showed this to be true more so than ever. Hopefully, DC has learned from their mistakes and will leave the market alone and allow it to reset itself with no more interference.  The rules and regulations introduced in the past several years created are likely to have no other real effect other than making obtaining a loan a more expensive, tedious and laborious process with no real risk eliminated.  When the interference ends and the market knows which set of rules to play by, it will heal.  When a market constantly lives under the cloud of potential sweeping change, stability is impossible.

In the previous two sections, the discussion was more national in scope as we discussed both The Fed and the GSE’s.  Part Three is both national and local in scope as it touches on building codes and the impact of taxes.

• Part One – Mortgages and the GSE Guidelines
• Part Two – The Role of the Fed
• Part Three (here) – Congress, Taxes, Zoning and Building Codes
• Part Four – The Conclusion

The Mortgage Interest Deduction (MID), Capital Gains, Tax Abatement, Federal versus State Historic Tax Credits, Dodd-Frank Financial Reform Act, the Downtown Master Plan…all are governmental interjections (City, State and Federal) into the housing marketplace that impact how properties are taxed, built, sold, approved and inspected.

While the impact of the Fed and the GSE impact how properties are purchased, the tax code impacts how they are sold.

The tax code, which is modified pretty regularly, places different rates of taxation on different asset classes with the biggest difference being the definition of long and short term capital gains.  An asset, held for a longer period of time is taxed at a rate lower than ones held for less time…which influences how an owner will behave. Consider the person who renovates homes for a living…purchasing and renovating a home creates the highest amount of income tax possible while renovating it, holding it for a few years and then selling it lowers the rate.  The incentive is to either not buy the home or to minimally renovate it.  Seems a little counter-intuitive to me.

Likewise, income levels also determine how and when an owner may deduct interest paid on a property.  In 1986, when there was a massive overhaul of the tax code, the treatment of passive losses (interest, depreciation) were changed to disallow the sheltering of ordinary income making many real estate investments far less feasible for many high earning individuals.

Why does this matter?

Owning property simply for the purpose of tax reasons is a dangerous game, but much of what we do is influenced by taxes.  As a good friend loves to point out, that which we need less of, tax heavily.  That which we want more of, tax less.  It is a very true statement.

The Federal Government, with the stroke of a pen, can dramatically alter an asset’s performance by simply changing a definition in the tax code. Treating passive income differently than active income had a massive impact on properties for investment properties and that one simple change turned many properties upside down.  And even when the market is given ample notice that a change in the code is coming or a temporary change is nearing its end (Sunset Provision) as the date for the change draws near, more and more are forced to either sell or buy and prices can be affected.  Understand this if you are in the investment arena.

In addition to the impact of taxes, there are numerous levels of interference from a multitude of agencies, many times with conflicting interests, making the process of building and developing harder than it should be.  Each level of regulation placed on any industry causes unintended consequences.

Several ‘Betcha Didn’t Know’ Anecdotes –

• Historic Tax Credits are effectively doubled if you build an apartment building (for rent) as opposed to a condo property (for sale) and thus the 2000+ apartments built Downtown since 2010 with no new condominium development during the same time period
• Dodd-Frank largely prevents a seller from holding financing (and it also eliminated free checking, fyi…)
• FHA will not do a condo loan in a condo project with no rental restrictions. VA will not do a loan in a condo project with ANY rental restrictions
• The Uniform Residential Appraisal Report make no adjustment for green/LEED/other responsible building practices despite the government’s latest mandate to improve building performance ‘by 30%’
• The IRS ruled that contributions into a partnership for Tax Credit purposes are, in fact, taxable (that one absolutely befuddles me)
• The sign ordinance in the City of Richmond is directly at odds with the Department of Historic Resources (in many cases)

Why does this matter?

It matters because each layer of compliance and regulation, while intended for the greater good (I do actually believe that, for what it is worth), simply creates another impact on the market which typically increases the cost of buying, selling or building. Each increase in cost has a corresponding effect on demand and thus, pricing. While mandating a home be 30% more energy efficient sounds great, when a home will not appraise (and thus not be financeable), a builder is far less likely to build it.

Ultimately, an shrewd property investor is acutely aware of the tax code.

Part Four – The Conclusion – May Be Found Here…

In Part One, we discussed the impact of the Government Sponsored Enterprises of Fannie Mae, Freddie Mac and (less so) FHA.

• Part One – Mortgages and the GSE Guidelines
• Part Two (here) – The Role of the Fed
• Part Three – Congress, Taxes, Zoning and Building Codes
• Part Four – The Conclusion

In next installment, the topic of the Federal Reserve’s role will be discussed.  While the complexity of the impact of the GSE’s is pretty hard to cover in a blog post, the impact of the Fed is even more so.  For those purists who read this, understand that the purpose of the article is not to fully explain monetary policy but rather to take a look at some base level impacts of Fed decisions.

Part II, The Fed

While the Fed’s primary goal is to create a stable monetary environment whereby long term interest rates are predictable and employment is maximized, they have other powers as well…the most notable of which is the regulation of the banking institutions in the US. By having the ability to influence the demand for money as well as the availability of it, the Fed has an incalcuable impact on the housing market.

During the 2008-12 adjustment, the Fed simultaneously made money incredibly cheap and very easy.  Partially for the reason of propping up failing banks (which would have been a catastrophe had they begun to fail en masse) and partially to spur economic activity, the Fed opened up its proverbial wallet and started tossing around cash like a drunk sailor on shore leave.  While on the one hand they became the nation’s ATM, they also placed restrictions on loaning it out to the end user (for reasons I am not sure I understand.) A good friend of mine in banking told me, back in 2011, that careers in banking were made by NOT making loans, regardless of a deal’s merits. Despite interest rates at historic lows, banks were hamstrung from making loans by regulators from the very entity giving them free money to loan.

The Fed has the ability to not only influence money supply, but how and what it is loaned upon. Their regulatory power gives the Fed the ability to influence how much housing can be produced through policies designed to discourage speculative building. By restricting the production of new supply (which they have undeniably done), they are pushing pricing up…and that may not be the worst thing in the world. The question is whether or not they realize the correct levels at which to relax restrictions. As we stand here in late 2013, the rate of supply of new homes has returned to just over half of the pre-bubble level after production of new homes languished off 70% or more during the darkest days.  By and large, we are still under-supplied.

While the need for the Fed is a real one, homeowners need to understand that the Fed’s mandate is not to protect your home’s value…it is to create long term stability in the interest rate markets and to maximize employment.  Sometimes those goals are aligned, sometimes they are not and sometimes housing gets caught up in the wash.

Part Three Discusses Congress, Taxes and Building Codes