SALT Tax Code Housing Impact Now Visible
Since tax reform was passed by President Trump and the state and local tax deductions (SALT) were eliminated, the implications for the housing market have begun to take effect. The impact of these reforms has been most pronounced in higher income tax states where property taxes are also high. For expensive homes with high property taxes, prices are weak and declining. But for locations where state and property taxes are low, values are booming. The difference between these locations can mean a difference in the year ahead between homes appreciating by more than 10% and homes depreciating by over 10%.
Nationally, home values are climbing. Zillow estimates that the median home value is up almost 9% in the past year. While the Case-Shiller National Index is up 6.4%. But these averages fail to tell the whole story. As my father loves to say, “If you have one leg in a bucket of boiling water and another leg in ice water, on average the water is comfortable.” Across the U.S. the months’ supply of home inventory is currently at 4.3 months. This is down sharply from about 12 months at the peak of the recession. Four months supply is a very low level of home supply and this limited supply is a key driver pushing average prices higher.
Monthly Supply of Houses in the United States
However, this average of home supply is highly misleading. I live in New Jersey, a state with both high state income and property taxes. The elimination of the SALT deduction has increased demand for less expensive homes with lower taxes and decreased demand for more expensive homes with higher taxes. The result has been a pronounced difference in home supply and absorption rate. The least expensive homes in my town now have almost zero months of supply while mid-priced homes have about a 7-month supply. The most expensive homes now have an outrageous supply of over 25 months, a figure that has been growing and does not yet appear to have peaked. Twenty-five months is a staggeringly long level of supply. Indeed it is more than twice as long as the peak reached during the 2008 recession.
Home values of these more expensive homes in states like New Jersey are likely to fall until supply is more balanced with demand. Sellers are slow to grasp the new reality and have been reluctant to reduce prices. They are clinging to the value of their homes prior to the elimination of the SALT deductions and these misperceptions are reinforced by tax assessed values and a stronger economy. Sellers also see that a lot of lower priced homes are experiencing bidding wars and wrongly assuming that the market is stronger than it is for their homes. This perception is now beginning to crack as the length of time on the market rises. Comparable home prices will eventually adjust and it shouldn’t take too much longer. Home values for the most expensive homes in the highest property tax states are likely to fall approximately 10%-15% from the impact of the elimination of SALT deductions, and we expect this to be reflected in the next 12-18 months. There may be a period in which prices fall even more to adjust for the large spike of inventory that remains stuck in the market. This pressure will also be magnified further by the elimination of the mortgage interest deduction which is now capped at $750,000. Combined these factors are having a profound impact on supply at the high end of the market.
Things are not all rosy for the smaller homes in high property tax states, however. As top-tier homes suffer a decline in prices, assessed values will come down and with them, the amount of property taxes collected by the states. But as smaller homes see values appreciate, those owners will bear a larger share of the overall property tax burden. States with lower state and property taxes are likely to attract new residents and so see home values increase at a faster rate than the U.S. average until the market reflects the new tax structure. This could take years to happen as these changes will likely have some marginal impact on households and families when they make a determination of where to work and where to live. This will only accelerate the migration out of states like New Jersey into lower tax states, such as Florida, and this could have a profound impact on the financial well-being of states like New Jersey, California, and Illinois which already have strained budgets.
These changes will have ramifications for home builders and the mix of housing built across the country and within each state. Demand for larger homes in high tax states will decline. Demand in these markets was already weak since the retiring baby boomer population has been downsizing while the millennial population looks for smaller sized starter homes and apartments. Indeed, the elimination of the SALT deductions may finally slow or reverse the decades’ long march higher in the size of the average home. Home builders are not all the same. Some, which specialize in smaller homes and apartments, should do well. Home builders that have a lot of large home inventory may find themselves selling these homes for much less than expected. After a few years, the market will adjust, but in the meantime, the elimination of SALT is putting a little salt in expensive homeowner’s post-2008 wounds.
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