By Oren Jacobson, Market Analyst - New Home Star //
Throughout the entire year, we have been having intensive conversations about tax reform and its implications. We were concerned that the risk of failure was far more substantial than the potential upside of passage, so we urged caution. We raised a red flag for our partners in regard to the risk of an economic pull back due to failed investor expectations on policy. The good news is that we won’t be able to test whether or not our prediction was accurate. We are now left to question what the tax reform means for the industry.
Let’s begin with the basics. Areas with high prices and high state/local taxes should logically expect downward pressure on pricing. This comes as a result of decreased mortgage interest deductions and newly capped state, local and property tax deductions. Unlike many others, we are not necessarily predicting price decreases, although this is a reasonable expectation. Downward pressure simply means that one factor with an impact on pricing will be pushing downward. Supply constraints could counter and offset this trend. In that case, areas with lower supply may experience an offsetting position between the upward pressure of supply constraints and the downward pressure of increased cost of ownership due to tax changes.
Now, let’s examine the more complex component of this question. Specifically, let’s focus on the areas that won’t be directly affected by the cap on deductions and the mortgage interest deduction changes. By and large, the overwhelming majority of individuals who can afford to buy a new home will be impacted by the tax cut. Having more money in their pockets would spur increased spending and heightened consumer confidence. The theory states that increased spending will stimulate the economy. This growth, for obvious reasons, is great for the housing industry. It is reasonable to assume additional stimulus in the economy and a greater growth pace during the next 12-24 months. As such, we should expect a continuation of the positive momentum and growth from the last several years into 2018, especially in areas not impacted by the issue outlined above. There will also most likely be a further boost on top of this.
You may be curious about why this is so complex, especially when it seems rather simple. Here is the wrinkle that we must watch and be cognizant of. First, pricing is elevated (on a national average) above pre-recession peaks because supply is limited. We must be cautious about the intensity and velocity of pricing changes. Additionally, if the tax bill passes, it could urge those who have been wanting to sell their existing home and, therefore, increase supply and offer more options to consumers. This would assist in the alleviating of supply pressure, but could also create more competition for new home sales. If the current delta between new and used remains constant, there will be tremendous pressure to justify value and potential for an increased demand for concessions.
Finally, an increase in economic activity could shift investors away from bonds (which have a direct impact on interest rates), impacting affordability. If increased ability to consume leads to increased demand, prices in the general economy will rise. Price inflation in excess of wage inflation would cause buying power to decline. The FED will be watching this trend closely. They may raise the funding rates in order to prevent runaway inflation which could potentially have a countervailing effect on the economy. However, this is likely to take time. Macroeconomists who have this concern are not projecting the issue until mid 2019.
