Tax Reform s Likely Effect on Housing

Transcription

1 Craig P. Holke Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS Tax Reform s Likely Effect on Housing February 13, 2018 Key takeaways» Recent tax changes, including the doubling of the standard deduction and placement of caps on mortgage interest and state and local tax deductions, will have specific housing-market implications.» These changes have the potential to affect housing demand and prices in markets across the country. What it may mean for investors» Although tax changes may act as headwinds to the housing market, we believe that the solid labor market, growing economy, and cuts to federal income tax rates will offset these changes. Key tax changes in the Tax Cuts and Jobs Act of 2017 (the Act) likely will impact activity across various sectors of the economy. In this report, we will discuss how the Act is likely to affect the U.S. housing market. Key changes in the amount of mortgage interest and state and local taxes that may be deducted, along with the increased standard deduction, will have implications for housing across the country. We believe that these changes will have mixed effects on the housing market, especially in certain high-priced and high-tax markets; yet the overall positives provided by the strong labor market and improved economic growth should offset these forces and lead to growth in the housing sector. State of the housing market The U.S. housing market was severely affected by the Great Recession. The run-up in home prices, supported by easy financing, led to a bubble in housing markets across much of the country. Home prices have recovered in most markets, especially in coastal and large, urban locales. Demand remains strong, supported by a healthy labor market and generally low mortgage rates, leaving most buyers comfortable making home purchases. Yet, supply is limited and affordability has become mixed. Rising home prices have had a negative effect that has been offset by the wealth effect of rising housing prices for existing homeowners and increased stockmarket wealth Wells Fargo Investment Institute. All rights reserved. Page 1 of 6

2 Specific changes in the Act affecting the housing market While there are many changes in the Act that have the potential to affect the housing market, the three with the greatest potential are: the 1) doubling of the standard deduction, 2) the limit placed on the mortgage interest deduction, and 3) the cap on the deduction of state and local taxes. First, the standard deduction will be doubled to $12,000 for single filers and $24,000 for joint filers in This doubling of the standard deduction reduces the incentive to itemize tax deductions, thus reducing the incentive of deducting mortgage interest expense. Second, the maximum amount of mortgage interest that may be deducted will be lowered from the previous $1,000,000 to $750,000 for all homes purchased after the Act was signed into law. Estimates are that this change would affect only 2.5% of existing mortgages in the U.S. However, a substantial portion of these mortgages are located in coastal and/or large urban markets. Finally, the issue that received the most attention in the final days of the tax debate was the limit on deductibility of state and local taxes, including real estate taxes. The maximum allowed as a deduction is now $10,000. This will affect a significant number of households, as the average deduction claimed in 2015 was $12, (The amount likely is higher now.) What effects will these changes have on housing? Many of these changes will affect different taxpayers in different ways. The doubling of the standard deduction is likely to have a negative effect on home ownership. In 2015, only 30% of tax filers itemized deductions. 2 Overall, 21% of tax filers claim the mortgage interest deduction. With the doubling of the standard deduction, this is expected to decline to roughly 4% of filers. 3 The cap on interest deductibility will mostly be felt in certain markets. This likely will impact demand for homes priced above $750,000, which should place downward pressure on prices. Homebuilders have focused on building higher priced, higher margin homes during the recovery. A change in demand for these homes may allow builders to focus on the neglected entry-level homes needed in many markets. The cap on state and local taxes will have widespread effects. This has the ability to affect many middle-class taxpayers that live in high-tax cities and states (e.g. California, Illinois, New York, New Jersey, etc.) Housing demand in these markets should face headwinds, as the cap may act as a deterrent for those purchasing homes. While it is not expected that a massive number of homeowners will change jobs, sell their homes, and move to lower tax areas, those with flexibility may choose to do so. It is important to keep in mind that all of these changes also are being offset by the lowering of the household s federal income tax rate. It will be interesting to gauge how these changes affect Millennials, in particular. There have been conflicting headlines stating that Millennials have put off home buying, yet they now are buying homes. They also want to live in urban centers, yet now are buying in the suburbs. In reality, in 2016, Millennials made up the largest group of homebuyers 1 Robertson, Lori, November 9, 2017, The Facts of the SALT Deduction. 2 Ibid 3 O Brien, Sarah, November 2, 2017, CNBC, Deduction is slashed for new homeowners as part of tax overhaul Wells Fargo Investment Institute. All rights reserved. Page 2 of 6

3 in the country, at 35%. 4 Of that group, 66% were first-time homebuyers. 5 Millennials are buying record numbers of single-family, detached homes, primarily in the suburbs. And while homebuyers across age groups rate tax benefits as a less important reason for buying a home than other factors (only 1% rate it as important), tax-reform changes (nevertheless) may have a negative effect on home buying on the margin. 6 An unintended consequence of these tax changes may be downward pressure on inflation. Chart 3 shows that housing inflation has outpaced overall inflation since Downward home-price pressure in pricier, high-tax markets, that have seen the most appreciation, should slow overall inflation growth. While this sounds like a good idea in principle, it will pose difficulty for a Federal Reserve (Fed) that is struggling to reach and hold its stated inflation target. Chart 1. Housing inflation has outpaced overall inflation following the recovery 6 Consumer Price Index (CPI), percent change, year-over-year, three-month moving average Recession CPI - Housing CPI - All Sources: Bureau of Labor Statistics, Wells Fargo Investment Institute. Data is from December 2001 through December CPI Housing: Measures the housing component of the CPI Index. See back for important definitions and disclosures. 4 Home Buyer and Seller Generational Trends Report 2017, National Association of Realtors. Data as of February Ibid 6 Ibid 2018 Wells Fargo Investment Institute. All rights reserved. Page 3 of 6

4 Investment implications While the housing market will face headwinds from tax changes, we believe that the overall housing market should continue to grow. The strong labor market will support demand, and lower income tax rates will help to offset changes in the amount of taxes that may be deducted. Home prices should continue to rise, but the rapid pace of increases will slow in markets that are adversely affected by the limit on mortgageinterest deductibility and the cap on state and local taxes. Financial markets may feel the effects from changes in housing. Homebuilders and Building Products, which are included in the Consumer Discretionary sector, may face headwinds, as different housing markets respond to tax changes included in the Act. These effects may be partially offset by the lowering of the corporate tax rate to 21%. Fixed income markets may be affected by how the Fed responds to changes in housing inflation. Lower inflation, resulting from downward pressure on housing costs, may slow the Fed s pace of rate hikes, even in the face of a more rapidly growing economy. Even with renewed market volatility, we believe that the economic fundamentals will remain positive in the coming year. The mix of homes may change, yet the housing market will continue to be a significant driver of U.S. economic growth. We believe that investors should follow their long-term investment plans and rebalance into underallocated asset classes as markets and valuation dictate Wells Fargo Investment Institute. All rights reserved. Page 4 of 6

5 Economic Calendar Source: Bloomberg as of 2/9/18 Date Report Estimate Previous 2/13/2018 NFIB Small Business Optimism /13/2018 Revisions: Producer Price Index 2/14/2018 MBA Mortgage Applications % 2/14/2018 CPI MoM 0.30% 0.10% 2/14/2018 CPI Ex Food and Energy MoM 0.20% 0.30% 2/14/2018 CPI YoY 1.90% 2.10% 2/14/2018 CPI Ex Food and Energy YoY 1.70% 1.80% 2/14/2018 CPI Index NSA /14/2018 CPI Core Index SA /14/2018 Retail Sales Advance MoM 0.20% 0.40% 2/14/2018 Retail Sales Ex Auto MoM 0.40% 0.40% 2/14/2018 Retail Sales Ex Auto and Gas 0.40% 0.40% 2/14/2018 Retail Sales Control Group 0.40% 0.30% 2/14/2018 Real Avg Weekly Earnings YoY % 2/14/2018 Real Avg Hourly Earning YoY % 2/14/2018 Business Inventories 0.30% 0.40% 2/15/2018 Empire Manufacturing /15/2018 Initial Jobless Claims 227k 221k 2/15/2018 Continuing Claims k 2/15/2018 PPI Final Demand MoM 0.40% -0.10% 2/15/2018 PPI Ex Food and Energy MoM 0.20% -0.10% 2/15/2018 PPI Ex Food, Energy, Trade MoM 0.20% 0.10% 2/15/2018 PPI Final Demand YoY 2.40% 2.60% 2/15/2018 PPI Ex Food and Energy YoY 2.10% 2.30% 2/15/2018 PPI Ex Food, Energy, Trade YoY % 2/15/2018 Philadelphia Fed Business Outlook /15/2018 Industrial Production MoM 0.20% 0.90% 2/15/2018 Manufacturing (SIC) Production 0.30% 0.10% 2/15/2018 Capacity Utilization 78.00% 77.90% 2/15/2018 Bloomberg Consumer Comfort /15/2018 NAHB Housing Market Index /15/2018 Total Net TIC Flows -- $33.8b 2/15/2018 Net Long-term TIC Flows -- $57.5b 2/16/2018 Import Price Index MoM 0.60% 0.10% 2/16/2018 Import Price Index ex Petroleum MoM % 2/16/2018 Import Price Index YoY % 2/16/2018 Export Price Index MoM 0.30% -0.10% 2/16/2018 Export Price Index YoY % 2/16/2018 Housing Starts 1230k 1192k 2/16/2018 Housing Starts MoM 3.20% -8.20% 2/16/2018 Building Permits 1300k 1302k 2/16/2018 Building Permits MoM 0.00% -0.10% 2/16/2018 U. of Mich. Sentiment /16/2018 U. of Mich. Current Conditions /16/2018 U. of Mich. Expectations /16/2018 U. of Mich. 1 Yr Inflation % 2/16/2018 U. of Mich Yr Inflation % 2018 Wells Fargo Investment Institute. All rights reserved. Page 5 of 6

6 Risk Considerations All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities. Definitions Consumer Price Index (CPI) measures the price of a fixed basket of goods and services purchased by an average consumer. An index is unmanaged and not available for direct investment. General Disclosures Wells Fargo Advisors is not a legal or tax advisor. Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company. The information in this report was prepared by Global Investment Strategy. Opinions represent GIS opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR Wells Fargo Investment Institute. All rights reserved. Page 6 of 6