By now we’ve all read the predictions about the big declines coming to many housing markets in 2018 as a result of the recently passed tax reform bill.
The tax bill caps the deduction of state and local taxes (including property taxes) at $10,000 per year, eliminates the deductibility of interest on second homes, and caps the deductibility of interest on new mortgages greater than $750,000, while at the same time raising the standard deduction for a married couple from $12,000 to $24,000.
The general consensus is that the increase in the standard deduction is in no way large enough to offset the loss of these deductions in high-tax, high-home-price states such as New York or California. The National Association of Realtors is projecting home price declines of 10% nationwide with declines of up to 21% in some high-cost places as a result of the tax code changes.
In almost every resort community, median home prices are at least $400,000. In some places, they’re above a million, but chances are there is nothing available in the single-family market that’s below $400,000 in any desirable beach or mountain community. The vast majority of locals in a resort community can’t afford a $400,000 home, let alone a million dollar home. The housing market in a resort community is driven by the second homebuyer and the money that homebuyer has earned in a high-income place like New York, Los Angeles, or San Francisco.
In many articles, there are predictions that not only will home prices in the high-tax, high-home-price states drop dramatically, but that the same thing will happen to home prices in resort communities.
In making these predictions, these authors and analysts miss one fundamental point – second home buyers are different than primary home buyers – a second home purchase is more likely to be a lifestyle purchase than a tax motivated purchase.
So what’s driving the second homebuyer?
It’s not likely to be the mortgage interest deduction. Almost 40% of second home purchases are made in cash. Cash buyers are not driven by the availability of the mortgage interest deduction. Additionally, more than half of second homebuyers who took out a mortgage put down at least a 30% down payment even though a smaller down payment would have created a larger mortgage interest deduction. Second homebuyers are not maximizing their mortgage interest deduction potential now.
It’s also not likely to be the property tax deduction. 60% of taxpayers earning $500,000 to $1,000,000 and 30% earning more than $200,000 are paying the alternative minimum tax (“AMT”). The AMT currently wipes out the value of itemized deductions for property taxes and mortgage interest. If you’re earning enough to buy a second home in a well-to-do resort community, the current tax code is not treating you well, and tax reform isn’t doing anything to change that.
Instead, the second homebuyer is driven by lifestyle, demographics, and investment potential. Baby boomers are aging and have the money to own a piece of paradise. They can use it when they want, rent it if they need the cash, and historically the price of housing in paradise has increased, so there is the opportunity for a return on their investment.
The tax code is doing nothing to change demographics or the finite number of houses that can be built in Key West, Aspen, or Mammoth Lakes. Housing demand still exceeds housing supply in resort communities and tax reform has done nothing to change that. Even if the tax changes drive a few buyers or owners from the market, the are others who have missed out of the post recession run up in prices waiting for an opportunity to jump in.
There may be some temporary adjustment in prices, but when supply is limited (and housing supply is limited in a resort community), and demographics drive demand, we’re not likely to see a major or prolonged reduction in resort community housing prices.
Bill Hettinger, Ph.D.