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Real Estate Research provides analysis of topical research and current issues in the fields of housing and real estate economics. Authors for the blog include the Atlanta Fed's Jessica Dill, Kristopher Gerardi, Carl Hudson, and analysts, as well as the Boston Fed's Christopher Foote and Paul Willen.

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March 2, 2018

Tax Reform's Effect on Low-Income Housing

The recently enacted Tax Cuts and Jobs Act of 2017 substantially reduced corporate taxes, from 35 percent to 21 percent. Some commentators and practitioners have voiced concerns about how the new tax law will affect demand for Low Income Housing Tax Credits (LIHTC), America's primary mechanism for producing new or refurbished affordable housing units. According to Dawn Luke, chief operating officer with Invest Atlanta, the lowering of the corporate tax rate continues to present challenges to the market in terms of LIHTC pricing, with credit prices being lowered by as much as 16 cents on the dollar for projects in the near-term pipeline. Luke says this means that several affordable housing projects could become bottlenecked as developers scramble to find subsidy to fill this gap. In addition, this firm expects that declining demand for LIHTCs will generate 20,000 fewer low-income housing units a year, a roughly 15 percent decline.

It's worth taking a few moments to review how the LIHTC actually works. The LIHTC program, created as part of the Tax Reform Act of 1986, allows developers to receive tax credits in exchange for committing to rent their units for 30 years to households earning less than 50 to 60 percent of the area's median income. Private developers apply to receive an LIHTC subsidy through their state housing authorities, and are allocated a subsidy equal to a percentage of construction and eligible soft costs. Developers awarded an allocation receive a 10-year annuity of nonrefundable tax credits that they can use to offset positive future federal income tax liability. For example, through the program, the developer of a $10 million apartment building could receive up to $1.17 million a year for 10 years. (This assumes that, to receive a basis boost, the developer would receive a 9 percent allocation and the project would be located in either a sufficiently low-income neighborhood or a high-rent metro area.)

Due to the rental restrictions, it is virtually impossible for LIHTC properties themselves to generate enough tax liability to claim the full value of allocated tax credits, so developers need to have either sufficient other federal income tax to offset or the income tax of a limited partner. These outside investors, usually organized through a partnership called syndication, would contribute a fixed dollar amount to the developer upon completion of the subsidized property in exchange for 99.9 percent of the equity, including allocated tax credits, of the project.

The allocated tax credits themselves offer a dollar-for-dollar reduction in future tax liability, so changing the corporate tax rate does not directly reduce their statutory value. So why might the after-market value of the credits fall with the new tax law?

First, the recent tax cuts reduce the pool of firms with sufficient tax liability. If a business has less tax liability than it has tax credits, that business would effectively leave money on the table. The business would have to at least wait until it had enough tax liability to claim the subsidy. Several past investors in LIHTC properties, including Fannie Mae, learned firsthand how illiquid their LIHTC investment actually was after the 2008 financial crisis. With the lower corporate rate and other favorable provisions that are coming out of the new tax law, some firms that previously may have found the investment profitable may well reconsider.

Even firms that expect to have large profits may now have greater uncertainty about their future taxes as they work through the 1,100-page bill. The increased risk could cause firms to value less any future reductions in their tax liability.

The owner of an LIHTC project, like owners of all residential buildings, gets to deduct the building’s depreciation over a 27.5-year schedule. These depreciation allowances, coupled with LIHTC rental restrictions and relatively high operation costs due to compliance with those restrictions, often result in large expected tax losses that go beyond the allocated tax credits. For example, the $10 million apartment building mentioned above would be expected to generate more than $290,000 in depreciation allowances a year that outside investors not limited by passive-loss restrictions (such as C corporations) could use to offset other taxable income. The reduction in the corporate rate from 35 percent to 21 percent would lead to about a $626,000 decrease in outside investors’ willingness to pay developers for those deductions under reasonable assumptions. (A potential headache is that depreciaton allowances are subject to recapture if the project is eventually sold for more than tax basis. This provision rarely needs to be enforced.) This represents a 5.9 percent reduction in the overall valuation of the investment, which could require additional debt on the property and perhaps make some projects no longer feasible.

At the same time, lower taxes should expand the supply of market-rate housing. Only a small fraction of low-income households occupies newly built, rent-capped homes produced under the LIHTC. Most of these households use their own earnings or HUD vouchers to pay the market rents for older, existing apartments. A recent study by Stuart Rosenthal in the American Economic Review showed that while newly constructed units are often unaffordable for most households, they eventually supply the majority of future low-income affordable housing. This "filtering down" occurs as a result of physical depreciation or shifts in style or location preferences. If lower taxes generate new market-rate construction—and thus increase the aggregate supply of housing—these lower taxes should lower rents throughout the market or increase landlord participation in HUD voucher programs.

Eriksen and Lang suggest two changes to the LIHTC program that would increase the supply of affordable housing produced under the program without increasing tax expenditures. The first, and most immediate, would be simply to make the allocated tax credits through the LIHTC program refundable, because uncertainty about future tax liabilities reduces both the pool of otherwise eligible investors and the market value of allocated tax credits. Making this change would also give some developers at least the option of claiming the credit themselves rather being forced to partner with outside investors. The second change would allow developers to claim an actuarially equivalent subsidy over a shorter time period than the currently required 10 years. Developers and LIHTC investors are thought to have a much higher cost of capital than the federal government. In the extreme, allowing developers to claim the full value of refundable tax credits when projects are completed would give them the greatest flexibility in financing their projects.

Increasing the supply of housing affordable to low-income families could be achieved using other policies that focus on reducing other barriers to increasing housing production, like state and local zoning laws that limit the location and density of multifamily housing. A bill working its way through the California legislature would appear to be in this spirit.

Cunninghamc Chris Cunningham is a research economist and associate policy adviser at the Federal Reserve Bank of Atlanta; Mike Eriksen is associate professor of real estate in the Linder College of Business at the University of Cincinnati.

The views expressed here represent those of the authors and not the Federal Reserve Bank of Atlanta or the Federal Reserve System.

January 24, 2018

Housing Headwinds

In a recent post, we described the outlook for housing growth in the Atlanta Fed's district as "slow and steady." In this post, we look at what other Fed districts are hearing about housing growth and attempt to reconcile those anecdotes with recent signs from the Atlanta Fed's GDPNow.

The most recent Beige Book characterized residential real estate activity as "constrained across the country." Of the 12 districts, only one (the Federal Reserve Bank of Chicago) raised its classification of the pace of residential construction, and five lowered their assessments. The other districts remained at little or no change, including San Francisco, whose pace was still strong despite shortages of land and labor. Indeed, several districts cited tight labor conditions as limiting new construction.

With labor and, to a certain extent, land market conditions holding back construction, we might expect the prospects for residential fixed investment (RFI) in the fourth quarter of 2017 to be dreary. However, recent releases of GDPNow indicate that residential fixed investment should make a relatively strong contribution to fourth-quarter real GDP growth after being a drag in the second and third quarters (see chart).

Interestingly, brokers' commissions are making the largest contribution to RFI, followed by permanent site (single and multifamily construction) and improvements. The increase in brokers' commissions reflects the increase in the real value of home sales that resulted from the acceleration of house prices as well as from a sharp increase in the number of existing and new home sales reported for October and November 2017 (see chart).

An increase in both house prices and the number of houses sold is consistent with strength in housing demand. We look to the supply of housing to understand the Beige Book's description of constrained real estate activity. Housing inventory provides an indication of supply conditions. Eleven Fed districts reported that residential inventory conditions were tight (the remaining district did not mention inventory). Several stated specifically that low inventory was restraining sales and that the low number of available houses is putting upward pressure on house prices.

Constrained residential real estate and construction activity does not mean that the sector is doing poorly. It just means that, the housing market's positive contribution to economic activity could be greater if land and labor market conditions were more favorable.

The national Beige Book comments are consistent with our view of housing sector conditions in the Southeast—specifically, that supply-chain constraints imply that near-term residential investment growth will be steady and measured.

Photo of Carl Hudson Carl Hudson, director of the Center for Real Estate Analytics


September 29, 2017

Did Harvey Influence the Housing Market?

The August housing and construction data are starting to trickle in. So far, the data tell us that residential investment could be a drag on third-quarter gross domestic product growth. They also tell us that U.S. existing home sales were down slightly (-1.65 percent) from the month-earlier level but flat to slightly up (0.19 percent) from the year-ago level. Housing starts tell a similar story: total starts were down slightly (-0.84 percent) from one month earlier but up slightly (1.37 percent) from one year earlier. Year over year, new residential sales were down 1.2 percent.

The Atlanta Fed conducts a monthly survey of residential brokers and homebuilders in the Southeast to detect emerging real estate trends before the release of official statistics. In the most recent Construction and Real Estate Survey, many builders said they expect home sales to be flat over the next three months relative to the same period last year, while most brokers continued to anticipate slightly higher sales. A large share of builders expect construction activity over the next three months to hold steady or increase slightly.

The survey included a handful of special questions to give better insight into current market conditions and pressure points. The first question asked whether Hurricane Harvey had an impact (directly or indirectly) on their business. Most respondents said that Harvey did not.

Chart-one

Those who said they experienced some effects from Harvey (35 percent of homebuilders and 24 percent of residential brokers) were asked to provide more details. Some respondents said they have seen upward pressure on fuel costs, extended lead time on deliveries, and additional pressure on already tight labor markets. Several respondents cautioned, however, that it was too soon to assess the full extent of the impact.

We should note that Hurricane Irma passed directly through the region toward the end of the polling period. As a result, disentangling which storm the comments referred to was sometimes difficult. We will follow up on the impact of Irma in next month's poll. We hope that affected builders and brokers will be able to respond.

In the second set of special questions, we asked residential brokers and homebuilders to look ahead over the next 12 months and rank risks to their housing market outlook. Declining affordability emerged as the top risk facing the housing market, followed by supply-chain constraints and lack of for-sale inventory.

Looking ahead over the next 12 months, please rank order the following risks to your housing market.
Average Rank Order Score
Builder Rank Order Score
Broker Rank Order Score
Declining affordability
57 56 57
Supply chain constraints
51 64 38
Lack of available for-sale inventory
41 28 54
Waning consumer confidence
35 32 38
Other
21 27 15
Credit availability challenges
11 17 6

Note: Respondents were asked to rank order the factors. A rank of one scored 7 points, two scored 5 points, three scored 3 points, and four scored 1 point. No scores were assigned to ranks greater than 4.

Separating broker and builder responses shifts the top risks a bit. Considering broker-only responses, the top risks were declining affordability and lack of for-sale inventory. For the builder-only responses, the top risks were supply-chain constraints and declining affordability.

Anticipating that supply-chain constraints would, in fact, be one of the top risks to builders' housing market outlook, we also asked builders to complete the same exercise with supply-chain constraints. Builders said rising costs (of vacant developed lots, or VDLs, materials, and land) along with labor shortages topped the list of supply-chain constraints.

Looking ahead over the next 12 months, please rank order the following risks to your housing market.
Rank Order Score
Rising cost of vacant developed lots (VDLs)
43
Upward pressure on material costs
30
Labor shortages
23
Rising cost of land
22
Other
21
Dwindling lot inventories
19
Costly land titling process
17
Upward pressure on labor costs
14
Construction financing challenges
11
Burdensome/costly local ordinances
11
A&D financing challenges
7
Burdensome/costly federal regulations
3
Burdensome/costly state regulations
3

Note: Respondents were asked to rank order the factors. A rank of one scored 7 points, two scored 5 points, three scored 3 points, and four scored 1 point. No scores were assigned to ranks greater than 4.

The responses to these special questions confirm some of the anecdotes we've heard through other channels—that is, builders are worried about declining affordability and tight inventory levels. Also, importantly, supply-chain constraints remain a barrier to any acceleration in bringing new inventory to market. Interestingly, ADC (or acquisition, development, and construction) credit challenges appear to be less pressing now than in years past, while concerns about construction costs appear to have become more elevated. Views on labor shortages remain unchanged—they have been and continue to be a top concern.

We conducted this poll September 5–13, 2017. It reflects the views of 17 homebuilders and 18 residential brokers across the Southeast. View the Southeast Construction and Real Estate Survey results in more detail on the Atlanta Fed website.

Photo of Jessica Dill By Jessica Dill, economic policy analyst in the Research Department and


Photo of Carl Hudson Carl Hudson, director of the Center for Real Estate Analytics


November 3, 2015

Keeping an Eye on the Housing Market

In a recent speech, Federal Reserve Bank of San Francisco President John Williams suggested that signs of imbalances were starting to emerge in the form of high asset prices, particularly in real estate. He pointed out that the house price-to-rent ratio had returned to its 2003 level and that, while it may not be at a tipping point yet, it would be important to keep an eye on the situation and act before the imbalance grows too large. President Williams is not the only one monitoring this situation. Many across the industry are keeping a watchful eye on the rapid price appreciation (see here, here, and here), including my colleagues and me at the Atlanta Fed.

While it is too soon to definitively know if a bubble is forming, the house price-to-rent ratio seems like a relevant measure to track. Why? Basically, because households have the option to rent or own their home, equilibrium in the housing market is characterized by a strong link between prices and rents. When prices deviate substantially from rents (or vice versa), the cost-benefit calculus in the rent-versus-own equation changes, inducing some households to make a transition. In effect, these transitions stabilize the ratio.

In an effort to better understand house price trends, we chart the house price-to-rent ratio at an annual frequency on top of a stacked bar chart depicting year-over-year house price growth (see chart below). Each stacked bar reflects the share of ZIP codes in each range of house price change. Shades of green indicate house price appreciation from the year-earlier level, and shades of red indicate house price decline. The benefit of considering house price trends through the lens of this stacked bar chart is, of course, that it provides a better sense for the distribution of house price change that is often masked by the headline statistic.

Looking at these two measures in concert paints an interesting picture, one that doesn't appear to be a repeat of the early 2000s. While the house price-to-rent ratio indicates that house prices on a national basis have been increasing relative to rents, the distribution of house price change looks a bit different. In 2003, roughly 20 percent of ZIP codes across the nation were experiencing house price appreciation of 15 percent or more on a year-over-year basis. In 2014 and 2015, less than 5 percent of ZIP codes experienced this degree of appreciation.

chart-1

To better understand the regional variation, we repeated this exercise at a metro level using the Case-Shiller 20 MSAs (see charts below). (House price-to-rent ratios for Las Vegas and Charlotte were not calculated because the Bureau of Labor Statistics does not provide an owners' equivalent rent for primary residence series for these markets.) This more detailed approach reveals that elevated price-rent ratio readings were only present in a few, perhaps supply-constrained, metropolitan areas (see top right corner of each chart for the Saiz supply elasticity measure). Moreover, current home price appreciation across ZIP codes does not have the breadth that was present during the early 2000s.

Notes: (1) All price-to-rent ratios are indexed to 1998, except Dallas and Phoenix, which are indexed to 2002. (2) SE = Saiz's Supply Elasticities. Pertains to city boundaries, not metropolitan areas. For more information, see Albert Saiz, "The Geographic Determinants of Housing Supply," The Quarterly Journal of Economics (August 2010) 125

As John Krainer, an economist at the San Francisco Fed, pointed out in a 2004 Economic Letter, "it is tempting to identify a bubble as a long-lasting deviation in the price-rent ratio from its average value. But knowing how large and long-lasting a deviation must be to resemble a bubble is not obvious." We will continue digging and report back when we think we know something more.

Photo of Jessica DillJessica Dill, economic policy analysis specialist in the Atlanta Fed's research department