Will the New Tax Law Impact Real Estate Markets?

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Real Estate

Over the past few years, the real estate market in Los Angeles has been “good” for sellers; prices rise each year and houses sell fast. The market has not been so good for buyers because there are too few houses for sale and they have to pay more and often times are outbid on houses. 

The question that inevitably comes up is; will this market condition change anytime soon?  This is especially being asked now that Congress has passed the “Tax Cuts and Jobs Act” with significant changes to tax deductions allowed related to real estate.

There are a number of ways the new tax law changes some important deductions related to real estate.New Picture (11)

First off the amount of the mortgage interest deduction has been reduced from a maximum of $1,000,0000 to $750,000.  Also, the property tax deduction has been capped at $10,000.  Both of these changes could reduce people’s incentives to own property as the tax benefits are no longer as strong.  Also, since the standard deduction has been increased, you may not itemize deductions at all, making both the mortgage interest deduction and property tax deduction less important.

Another impact this tax bill has on real estate is the impact it will have on mortgage interest rates.  Although we have been expecting to see interest rates increase as the economy grows, this tax bill is basically stimulus spending and we can expect to see the interest rate rise fast than otherwise.

So with fewer incentives for home buyers and higher interest rates on the horizon, will we see prices go down?  Not likely.

The problem in the market now is low inventory and that will continue to prop up prices, especially here in Southern California.  There is nothing in the tax bill that will incent sellers to sell.  In fact, it is likely to have just the opposite effect.  The cap on the mortgage interest deduction is grandfathered in, so if you currently have a mortgage over $750,000 the interest is fully deductible up to $1,000,000.  If you were to sell, and get a new mortgage, you would now only be able to deduct the interest on the first $750,000. 

The impact of the federal tax bill will probably affect certain segments of the local real estate market greater than others.  For first time buyers and sellers of homes under $1,000,000, the California Association of Realtors (CAR) sees minimal impact. 

The impact of the tax bill is more likely to dampen price appreciation on higher priced homes, both because these homes require higher mortgages and property taxes, but also because these homes are traditionally part of the trade up cycle we see in real estate.  As more people hold on to the homes they are in now, fewer buyers for more expensive homes will be available.  CAR expects homes priced in the $1,500,000 range to see a 4.4% reduction in price appreciation due to the Tax Bill.

So the key takeaway is that latest tax reform will have some adverse effect on the Los Angeles housing market and the degree of impact varies by price and location.  In general, the Tax Cut & Jobs Act will reduce overall price growth but only by about 1%.  The housing supply problem will be increased as the tax bill will force homeowners to delay trading up or down to their next home. Mortgage rates will likely raise a bit faster as the economy heats up.