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Tee’ing up tax reform

​​Tax plan uncertainty

The plan to overhaul the tax code remains the biggest uncertainty to the near-term economic outlook. Until we know the specifics of the plan, determining its impact will be impossible. And even once that occurs, discerning the precise impact will still present a serious challenge. Currently, Congress is considering two versions of the tax overhaul, one in the Senate, and one in the House. There are some significant differences between the two versions, which eventually must be reconciled. The current budget resolution permits an increase in the deficit of $1.5 trillion over the next 10 years, and the two tax bills under consideration provide different paths for Congress to arrive at that figure. Generally, the House version of the bill skews slightly more toward cutting corporate taxes while the Senate version of the bill skews slightly more toward cutting individual taxes. Both versions of the bill hew in favor of cutting domestic business taxes, both for corporations and for pass-through businesses, which are taxed as individual income. The House version provides for more immediate tax cuts in 2018 while the Senate version phases in tax cuts more gradually over the next decade. Therefore, the House version would offer a more immediate impact on the economy in the short-term while the Senate's phasing could spread the stimulus into later years.

We continue to believe that the likelihood of tax reform passing this year to be roughly 50 percent. The two bills differ enough that reconciliation could take some time to achieve.

Here are some key differences that will need to be reconciled before a vote can occur:

    • State and local taxes: The House version of the bill will continue to allow taxpayers to deduct property taxes up to $10,000, but eliminates the deduction of local income and sales taxes; the Senate version eliminates all local deductions.
    • Mortgage interest: The House version provides that, for new mortgages on a primary residence, interest on the first $500,000 borrowed can be deducted while interest on secondary homes and homeowners equity loans can no longer be deducted; the Senate version would maintain the current threshold of $1,000,000 for deductible interest, but would eliminate the deductibility of home equity loans.
    • Estate tax: The House version of the bill would double the exemption to estates in excess of $10 million next year and then phase out the tax over a six-year period; the Senate version would double the exemption next year but not eliminate the tax.
    • Medical expenses: The House version would eliminate the deduction for medical expenses that exceed 10 percent of a taxpayer's income; the Senate version would not eliminate this dedication.
    • Student-loan interest: The House version would eliminate the deduction for student loan interest; the Senate version would not eliminate this deduction.

Some of these differences present a sizable challenge because there are thin Republican majorities in both the House and the Senate. But unlike the failed repeal of the Affordable Care Act, tax reform should not be a binary, all-or-nothing outcome. Enough middle ground between the bills exists that passage of a bill that will provide some measure of fiscal stimulus is factored into our outlook. The exact timing remains uncertain.  Until we know the final details, it'll be difficult to form an opinion on the implications for commercial real estate. 

But we can say that, based on the broad strokes outlined, we view the (tax reform) proposals as being more negative for residential real estate because of the potential changes to mortgage interest and property tax deductibility. 

Home ownership rate quietly creeping upward

These potential changes to the tax code arrive at a time when the homeownership rate has been quietly increasing. At the end of the third quarter the ownership rate stood at 63.9 percent. That represents the highest level since the third quarter of 2010. The rate has been rising since it appears to have bottomed out at 62.9 percent in the second quarter of 2016. While it remains below the long-term average of 65.3 percent and well below the peak of 69.2 percent reached during the housing bubble, the increase is notable because there is a well-publicized lack of new and existing homes for sale. 

If greater inventory were available for purchase (especially new homes) the homeownership rate would be higher. 

The increase signals a potential shift in the market. Millennials, who are increasingly reaching the point in life when they begin to get married and buy houses, now represent roughly 40 percent of the homebuyer market.​

House passes new bill clarifying HVCRE rule

Also last week the House passed a bill that should clarify what constitutes a high–volatility commercial real estate (HVCRE) loan. There has been a great deal of confusion surrounding this classification since it was introduced by the Basel III regulatory framework. Because HVCRE loans are deemed riskier, banks are required to hold more capital in reserve against these loans. But the HVCRE rule did not clearly state the circumstances that would cause regulators to classify a loan as HVCRE. The House bill spells this out in better detail, focusing on real estate that generally does not produce any income and requires some sort of development or redevelopment to become income-producing. 

The commercial real estate lending industry supported the bill because it should provide a boost to lending for such projects. 

What else happened last week?

Weekly unemployment claims data demonstrated the strength of the labor market. The temporary increases due to the hurricanes have been more than reversed. The four-week moving average (which smooths out weekly volatility) declined to its lowest level since 1973, when the labor market was far smaller than it is today.

What we are watching this week

This week will be busy with a number of key releases. Inflation for October, measured by both the producer price index (PPI) and the consumer price index (CPI), will be released. In recent periods producer price inflation has been accelerating while core consumer price inflation has been decelerating. We expect that trend to continue, but with the two series diverging it could only be a matter of time before producers try to pass more of the increase on to consumers. Retail sales for October should be flat versus September, but could show a more meaningful increase in core retail sales. Housing starts and building permits for October look to rebound versus hurricane-constrained levels in September.

Thought of the week

There is no clear relationship between corporate tax cuts and wage growth in the developed world, according to data from the Organization for Economic Co-Operation and Development.

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