financial aid and rants and raves

Screw this, I'm outta here.

(Ed note: I began this post a well over a month ago, not knowing what the final legislation would entail. Now we know, and the post reflects that reality, rather than my guessing as to the law. I'm still speculating as to the effect, of course.) 

Before examining the potential effects of the Trump tax plan on real estate values, the question of fairness should be explored. Is capping the SALT deduction fair? Conversely, is it fair to have a massive tax break that can only be utilized by certain taxpayers and not others? You can guess that I believe the change to be equitable. An alternative to the Trump tax plan would have been to give greater deductions to residents in states like Florida, but the new tax plan must also include tax increases so as to be budget neutral. Trump isn't cutting taxes so much as he's redistributing them and treating all federal taxpayers more or less the same, with the understanding that some people will still benefit disproportionately. Another reason it's fair, or at least not a double-taxation, as some have claimed, is that if you can't itemize deductions, not because you pay SALT, but they weren't high enough to reach the threshold, then you paid those taxes in full. Were those people double-taxed?

The issue for those of us living in a high tax locale is that we've been conditioned to expect these deductions, and have planned our lives accordingly. We've done the math, and the subsidy we get enables people like myself to live in Westchester (or San Francisco, or Chicago, or Manhattan, or Boston, etc.). For more than a few people, it may not be a choice, and this is my situation. Considering what I do for a living there is no other job in the country where I'd get anything close to what I get here. Whether or not I like living in Westchester is irrelevant. Luckily, I do, as I'm from here and most of my family and friends are also here. More importantly, my fiance has no intentions of leaving in the short to medium term, though the long term is entirely different. I'm home, for as long as I can afford to be here.

Therein lies the rub, to channel the Bard. If I have to stay, but can others leave? Much hay has been made the wealthiest residents leaving for greener pastures, and it's a serious issue. When 1% of taxpayers pays 47% of your state's income tax, even a handful of these individuals leaving for Palm Beach could cost hundreds of millions of dollars. Lest you think I'm exaggerating, here are some numbers worthy of crunching: New York collected 47 billion in state income tax in the fiscal year (FY) 2016, and if I am correct about the 1% paying 42%, then a small number of people pay nearly 20 billion in state income tax. So what happens if 10% of that 1% decided to leave New York? That would cost 220 million dollars, so the risk is real. I admit these numbers are inaccurate - they're way too low, as I'm stating that each person in that 1% paid the same amount in taxes. The 10% that left could have been paying much more than $220 million; it could be $2 billion. Whatever the figure, New York cannot afford the lost revenue.

These numbers can be used to fuel the other side of the argument: the tax plan may be fair on paper, but the rich have options that others don't, so the law's effects are so unevenly distributed. What effect doubling the standard deduction would have to ameliorate that imbalance, I cannot say. In any event, when don't the rich have more options than the average person? There's also the abject panic on the part of progressives, realizing their pet social engineering projects are suddenly at risk, but I'll leave that topic for another time, when I can gloat properly.

Moving on to real estate, the easy answer seems to be that the law will reduce prices in certain markets where write-offs will either be eliminated altogether due to the standard deduction doubling, or reduced to the point it makes certain homes unaffordable. While that's most likely correct, it doesn't go deep enough for the purposes of this post. A better hypothesis is one of localized disruption and steep price decline, where most other areas will shrug. Yes, prices in Westchester would fall, but could prices in Fort Pierce rise? Going deeper, could prices on Hutchinson Island fall, but prices near Indian River State College rise? What happens to rents? I certainly have ideas, but my predictions are worthless without some verifiable research to back them up, hence the link storm I'm adding to all these posts. Let's treat this as an academic exercise, rather than just spouting off at the keyboard.

When I was searching for my first home purchase, I was told I could afford a certain amount that was much higher than ended up spending. The number given was based mostly on my salary (much lower than it is now), but it was also based on being able to deduct mortgage interest, property taxes on the apartment itself, and as I found out later, property taxes on the grounds, since I own a tiny percentage of the land, or something like that. I've lived here 10 years, and I still don't fully understand co-ops. I was also told about the STAR exemption, which gives most New Yorkers a rebate on their school taxes. Being able to deduct the taxes and interest increases the amount lenders believe you can afford to pay per month. If that monthly payment was (ahem) challenging, I was told that I can change my W4 form to reduce the withholding from my paycheck if I thought I'd have trouble. I'm going to get it all back anyway, so I'm basically getting my tax refund in my paycheck.

Using this conventional wisdom when determining what you spend on a home has its risks. Taxes almost always go up, and your income may not keep pace. Westchester is infamous for this phenomenon. Moreover, you may be encouraged to buy more home (sq. footage, lot size, neighborhood, etc.) than you can really afford. No one could have rightly expected the SALT deductions to be at risk, of course, but it's rarely a good idea to take on that much risk, no matter how many reassurances you receive.

Rather than possessing an intrinsic value, real estate markets are ruled by trends. The price of my co-op is directly influenced by the most recent sales of other homes in my area. If a studio in Ossining sold in 1 week for $65,000, then I, knowing that Cortlandt is more desirable than Ossining, and my maintenance is 300 a month less, can sell it for $75,000. If the other place was completely rehabbed with new everything, then I might list it for $60,000, knowing the new owner would probably gut the place. On the other hand, if my apartment was also fixed up, I might be able to sell it for $85,000. I can list it for whatever I want, and I've seen some truly ridiculous prices over the years, but some of that is a negotiation tactic, and some of it pure delusion.

Just as I would follow prices up, I would follow them down as well. If that same apartment in Ossining sold for $65,000 but only after it was listed for 6 months, then I would know I have to lower my price if I wanted a quick sale. If that didn't matter, then I can list it for whatever I feel it's worth, pay the carry costs, and wait. Few people have that luxury.

Instead of treating real estate as a monolithic entity, there are actually two markets that have to be examined: vacation homes and residential markets. The broadest geographic effect will be felt in the second/vacation home market. This does not mean prices will instantaneously tank, but that areas throughout the USA will see disruptions. The law could decimate the property value in those markets, as the law combines all SALT deductions, capping them at $10,000 per household (not per person) and lowers the total mortgage value from $1,000,000 to $750,000, though this only applies to new loans. If the combined mortgages are under $750,000, you can still deduct all the interest paid. Let's crunch some numbers to show the effect of capping deductions. We'll use my income as a point of reference, since I do hit the maximum tax bracket - barely. Let's assume I can still itemize, which I can. Let's also assume my effective tax is 17%. If my mortgage is $850,000 and I'm paying 4% interest, and the mortgage is new, that means I'm paying $4000 in interest I suddenly can't write off. The effect is nominal: I pay $680 more in taxes than before. If my mortgage were 1.2 million for this home, I'd pay $3060 per year, or $255 per month. The property taxes for the home, without STAR are a whopping $17,000, and after STAR maybe $15,000. The rules have changed, so I can't say for sure what the benefit would be. So now you're paying an extra $3910 per year, and I'm not even counting the state and local taxes, which are lost entirely. Let's say that's an additional $10,000, so you're paying an additional $1,700 and now the total is $5610, or an extra $467.50 per month. Ouch.


Suddenly that condo on the Jersey Shore is no longer as affordable. Again, existing vacation homes would still get the full mortgage deduction, so any negative effect would be slow, right? Not necessarily. I mentioned above that my co-op's value is directly influenced by the most recent sales of similar properties, going in either direction. Much of that effect is psychological, as real estate is as much a perceived investment as it is a required commodity. Everyone wants to feel as if he or she is getting a good deal, and if prices start to drop, the homeowner is more likely to list a property to avoid losing more money later. This increases the number of listings, creating more supply, further lower prices, encouraging more people to list. If the property goes upside down and the homeowner can no longer cash out via refinancing, then you're looking at a potential short sale, further depressing property values. Of course, plenty of homeowners in Myrtle Beach, Kissimmee, Reno, Taos, Lake George, the Berkshires, and a host of other places, are actual residents, eking out a living in the madness of a tourist destination, rather than wealthy people with too much money and free time, but these specific markets will be disproportionately affected when compared to bedroom communities, exurbs, etc. Boring is better in this situation, at least if you're the homeowner.

(Ed. Note, part 2: Your intrepid blogger, trying to cool off the laptop on which he's presently typing, decided to shut down his computer, which he almost never does. In doing so, 10 days worth of work disappeared, and he is trying to rebuild what he wrote as best he can. It may have only been 3 paragraphs, but they were good, damn it! He's also cleaning up teardrops spayed all over his keyboard. Anyway, on with the show.) 

Not everyone who suddenly finds himself either underwater on a second home due to falling prices or saddled with an expense she can no longer afford will automatically list that property for sale, economics be damned. There's always the prospect of renting out the home instead, and in areas dominated by tourism, the demand for rentals is often quite high. As an overarching phenomenon, it's hard to argue that an increase, however slight, in available rentals in the Keys, for example, could be considered anything other than a personal and societal good. The homeowner regains the tax breaks now lost, and locals gain a place to live, strengthening communities and giving local employers a steady pool of potential workers. Still, if not all homeowners now distressed will sell their second homes, not all of them will simply put an ad on Craigslist and hope to find a stable tenant who one hopes will pay the rent on time and not trash the place. There's another option what wasn't available in 2008: Airbnb.

While placing homes what would otherwise sit empty into the rental market is generally a good thing, with only the occasional bad tenant or absentee landlord who doesn't properly maintain the home as the potential negatives, the same cannot be said for Airbnb. In fact, the service has caused friction in areas that wouldn't even be considered part of the surrounding tourist industry even a few years ago. As another example, South Beach is generally defined as 5th street to Dade Boulevard, and when people talk about taking a trip to Miami, chances are they're talking about visiting this area, with all its clubs, hotels, restaurants, etc. You want to stay in the area, preferably without a car. If your hotel is between 8th and 15th streets, you can walk almost everywhere you'd want to go. Anything below 5th street is called either South Pointe, so named for the area's park, or the new hipster designation SoFi, which kind of makes my stomach turn. North of Dade Blvd. to 61st street is considered Mid-Beach, and 62nd to 87th streets make up North Beach. While there is some spillover effect on the southern and northern edges of South Beach, the neighborhoods outside of SoBe are mostly residential, with only a smattering of hotels or other attractions scattered throughout. You're staying in the Art Deco district, or you may as well stay in Homestead.

Airbnb changes that understanding. A quick search in zip code 33141 (North Beach) in February 2018, shows (to me) a surprising number of available beds. As someone who knows the area, if you're looking for a very quiet vacation spot far from the madness of Ocean Drive, you found your destination. On the other hand, there's not much else beyond a few local eateries and the beach, which is beautiful. I suppose if you want to spend time in Bal Harbor, which is about 1.5 miles north, it's a good choice. It's certainly cheaper than any of the hotels. With this example, a sleepy area known for little else beyond a bridge to a shitty area of Miami can suddenly be a place filled with tourists. I don't wish to overstate the phenomenon in this particular part of the city, but this wasn't even a thought 10 years ago.

Whether or not Airbnb is good for an area is outside the scope of this post, though it seems to be a net negative. I will say that the service is a viable investment strategy, and it has allowed owners to avoid foreclosure. It also allows investors to jump into markets that couldn't hope to be profitable otherwise. Moreover, you do get tax brakes for renting via Airbnb, though I am legally bound to direct you to a competent tax professional, which I am not. Evidently the website sends you a 1099 with your raw earnings, so it's not as if you can just pocket the money. Save those receipts, future landlords.

Some of this approach will work only in the short term, as hotels and cities really dislike Airbnb, beyond the obvious reasons of increased competition or disrupting neighborhoods. Hoteliers protests that these short-term rentals don't have to adhere to the same level of regulation, ignoring disability accommodations, fire and safety requirements, etc. Airbnb's gain all the benefits of being a hotel without the government mandated expenses. As someone who worked in the resort industry, I have to agree - to an extent. As such, the industry lobbies mightily against the practice, and have had some success. Cities hate the loss of rental homes and hotel bed taxes unpaid.  Again, local governments also have a point, and some jurisdictions have taken steps to either limit or ban the practice altogether. There's probably a legal argument to be made concerning what you're allowed to do with your own home, and even the most restrictive laws allow a homeowner to rent a room in his or her primary residence, so long as the owner is there and any relevant taxes are collected and a business license is current. Institutional investors are the true enemy here, and cities recognize this.

In researching this section of the post, I realize now that my prediction that the vacation home market will tank and that available rentals would rise was incorrect, as I fell victim to using outdated knowledge of real estate. Some markets will indeed drop, but the overall phenomenon will be a function of government regulation much more than free market forces. Other areas could rise, with investors pouncing on distressed sellers, driving up prices and killing the rental market. Anyone looking to make money in this way must research an area's laws and attitudes on Airbnb or similar websites more than the market itself. It's only a bargain if you're allowed to make money with it. I will say that cabin in the Poconos is tantalizingly within reach. Ha! Who am kidding? They're aren't any cabins in the Poconos, just abandon shacks formerly disguised as affordable homes for gullible New York commuters.

With the vacation home market out of the way, it's time to look at the residential market. Here it is as easy to predict what will happen as the vacation market was difficult. Depending on the location, either there will be serious declines in price, or none at all, or even an increase. I've been able to find plenty of articles on this topic, as the average reader may not care if a Yuppie in Denver can no longer afford a condo in Telluride (beyond schadenfreude), but what happens to the split-level ranch 3 houses down is a little more important.

Depending on the map used, most of America with see either a slight decline or no effect at all, as the doubling of the standard deduction would be more than whatever the homeowner could write off anyway. Indeed, these areas are the most likely to see a small increase, as they'll pay less in taxes, and have more free cash to buy homes. Certain markets, however, could be hit with serious drops in price. Scroll down to the handy map showing that the greater New York Tri-State area, along with Chicago, San Francisco, Los Angeles, will be severely impacted. On a personal note, Westchester County is at or near the top of every list I could find that predicted the markets with the worst decline, so I'm expected to take a hit on my co-op. With this decline, I expect an increase in rental units as people try to avoid foreclosure similar to the one I'm predicting in the vacation markets, and it's possible Airbnb will emerge to help distressed homeowners in a small way. Again, the website does blur the line between a bedroom community and a tourist hotspot, but I can't imagine people lining up to sleep in a spare room in Poughkeepsie or Camden or Oakland. I can see a homeowner renting out that spare room to a college student or young person just starting her career.

Regardless of tax policy, people need places to live, and owning your own home was always seen as the better choice financially, and it can be, but only in an inflationary environment. This was the lesson no one seemed to learn from the crash in 2008 to 2012. More than anything, the Trump tax plan puts deflationary pressure on home prices by taking away some of the incentives to own a home, be it a primary residence or a lake house in the Adirondacks. People also buy homes because it's perceived as cheaper than renting, though some of that is myth. There's still the advantage of stability for both the homeowner and the community at large, with people safe in the knowledge that they won't get kicked out of their homes arbitrarily; they can do whatever they want to the home, within the confines of the law, rather than the will of a landlord, and they can reasonably predict their housing costs. Towns gain the benefit of a stable population that (hopefully) cares for its homes, cares for one's neighbors, participates in the community, as well as maintaining predictable tax base. Owning your own home is also considered a form of savings, building equity and building a nest egg for retirement, often the largest form of retirement savings people have. Here too is somewhat of a myth, in the form of an oversimplification. Again, if your home keeps pace with inflation, then it could be a source of savings. The problem is when you buy too much home for your budget, and the cost of maintaining it, or other costs like taxes, overtakes the money regained when you sell it. Overextending yourself when buying a home is akin to falling for a bait and switch scam: you concentrate only on the potential benefits and lose sight of the added responsibilities and expense. Renting may or may not be a better choice financially, but it's much more flexible. The deflation mentioned above could be a local effect: a plant closing, a natural disaster wiping out infrastructure, urban decay, government regulations, or a personal setback. If you were a renter, you could leave an area with far fewer consequences than a homeowner.

Inflation lessens the value of cash and raises the value of assets: more dollars chase a finite amount of whatever you're trying to buy: oil, gold, houses, stocks, food, cars, labor, etc. It also lowers the burden of debt, as you repay that debt with currency worth less than the original debt, hence the reason you're charged interest. Deflation increases the value of cash, lowers the prices of assets, and makes debt more difficult to repay. The housing crisis took trillions (here I'm contractually required to say: "Yes, with a T,") out of the economy. Even if those were paper loses, i.e., equity you felt you could access to fix up the home, take a cruise, pay for college, etc., you lost purchasing power. This was true even for those who did things the right way: some people lost everything even if they bought a home they could truly afford and didn't have an adjustable-rate mortgage or take out equity. As the reckless fell, they took everyone else with them. You were then probably also saddled with an non-performing asset worth less than the amount you owed. It's no wonder people simply abandoned their homes and decided to rent or moved in family.

All of this analysis begs a final question: when would all this happen?  The law is already on the books, but the ramifications won't be fully felt until people file their taxes in 2019. It's not as if the future effects haven't been discussed ad nauseam but I don't believe any large scale changes will be seen until money is directly taken out of people's hands. With this understanding, I'm left with the knowledge that I must sell my apartment sooner than my personal circumstances would prefer. Who wants a studio that's below grade when you could get a one bedroom on the second floor with a balcony for the same price? The thought of ruining my credit with a short sale does not appeal to me either. I'm also left with a gap: I have to sell my apartment while prices remain high, but wait for those prices in Westchester to drop if I want to buy anything else. Now I'm forced to take my own advice: I will have to rent, and our market isn't exactly affordable.

Of course, this news isn't all bad. If I'm right that prices in both the Hudson Valley and second/vacation home markets will decline, if only temporarily, then this represents a huge buying opportunity for those in able to take advantage. I am not in that position at the moment. By my own estimation, I don't have to be - yet. I have some time to adjust, exercising some discipline and hard work. 2018 is shaping up to be an interesting year.