The Tax Bill’s Impact on Bay Area Housing

This is the third column I am writing about the same tax bill now consuming both houses of Congress. Is anyone else beside herself or himself about this or am I the only one who thinks partisan politics has hijacked the original objectives of our elected officials…which is to serve the people? Whether it’s an R bill or a D bill, it comes at a disproportionate expense to the State of California and other coastal states. I’ve discussed the elimination of deductibility of the state and local taxes. But I haven’t yet discussed the impact on the California real estate market. There are two major impacts that I see. Perhaps you can decide for yourself if they are good or bad.

The first is supply of rentals. With lower caps on mortgage interest deductibility and the elimination or capping of real estate tax deductibility, more supply of rentals could come on the market. For people with second homes in the Bay Area, in fact, throughout the country, the quickest way to make your real estate and mortgage interest tax deductible once again is to rent out your property. As a business expense, these costs are still deductible against income. On a relative basis, this makes the decision to rent out an empty home even more compelling. With additional supply of properties coming on the rental market, the price of rentals should, in theory, feel pressure. However, we have just had massive displacement from the fires in the North Bay so it is difficult to predict how much additional supply of rentals will be absorbed by demand if it were to come on the market.

The second impact is the potential repatriation of untaxed profits of US companies sitting in foreign subsidiaries. There is anywhere from $1.7 trillion of US profits that were earned remain abroad due to the 35% corporate tax rate. If that rate is lowered (there is a special rate for repatriated money), it could cause of a flood of liquidity to the United States that would be equivalent to two more Quantitative Easings. This potential tsunami of cash will inevitably find its way into the capital markets first into money market funds and then short term treasuries, then other short term debt, then the broader bond market, then finally the public and private equity markets. All this cash will inevitably, through the public and private equity markets, find some its way into the housing market in the Bay Area as well as other cities affected by rocketing stock prices and new IPOs. The already ridiculous price tags of homes in the Bay Area may already have another leg up.

I think the increased supply of rentals will happen within a year of the implementation of the tax law whereas the rising real estate values may take years to play out. Provided the bill passes as is, the action plan is clear to me: buy real estate if there is an initial correction following the tax bill. The long term inflationary hedge it provides may be even more compelling in the next 10 years than it has in the last 10.