After any financial collapse, housing plays a key role in the hard slog that typically follows: a weak housing market feeds into a weak economy, which then feeds back onto a weak housing market. So even if the European banking system somehow avoids a meltdown, economic recovery in the U.S. will continue to languish unless we act more aggressively on housing.
No matter what the government might try to do to break the housing-economy cycle, the deleveraging process will still be painful and take some time. But that’s not an argument against action; just because a headache can still hurt some even if you take aspirin doesn’t mean you should skip the aspirin. One thing the Obama administration could do now -- probably with Republican support -- would be to attack the oversupply of housing stock by allowing a tax write-off for investors who buy empty properties and rent them out.
To understand why this would help, consider that the problems in the residential real-estate sector have two dimensions. First, we have an excess supply of owner-occupied housing, which puts downward pressure on prices. Second, millions of American households now have negative equity in their homes. Dealing with excess inventory by shifting vacant properties into the rental market would help to stabilize prices and thereby mitigate, to some degree, the negative-equity issue -- although additional action would also be warranted to attack such “underwater” situations. (A future column will discuss possible responses.)
It’s normal to have some vacant homes for sale as part of the market process that matches buyers with sellers. On average during the 1990s, for example, the home vacancy rate was about 1.5 percent, according to the Census Bureau. By 2008, the figure had risen to 2.9 percent. And by the second quarter of this year, the vacancy rate had come down only slightly, to about 2.5 percent. With this much supply still available, it’s no wonder that prices are still depressed.
Excess Empty Homes
The percentage-point difference between the latest vacancy rate (2.5 percent) and a more normal historical rate (1.5 percent) amounts to an excess inventory of almost 1 million vacant homes. (Estimates based on other methodologies are roughly in that range.) If the government does nothing, that extra inventory will be slowly worked off, as the economy gradually recovers and more households are formed. The question is whether the government can do anything to accelerate that process, to support home prices and, ultimately, to promote a stronger economic recovery.
One way to bolster demand would be to change our immigration laws to make it easier for foreigners to move here and buy homes. That might be a good idea, but it has no chance of being enacted soon. Former Federal Reserve Chairman Alan Greenspan once highlighted a different idea, focused on supply instead of demand: Get the government to buy the excess vacant houses and destroy them. He argued that could be the lowest-cost approach to mitigating a housing-driven decline -- but also noted that it would be politically inconceivable.
A more realistic approach would be to try to get the vacant houses rented out, rather than sold to owner-occupants. And one way to do that -- proposed by real-estate practitioners (such as Kyle Jividen of Alamo Appraisal Group in San Antonio) and economists (such as William Wheaton of the Massachusetts Institute of Technology and Gleb Nechayev of the research firm CBRE Econometric Advisors) -- is to provide an immediate tax write-off to investors who buy vacant houses and rent them out.
Currently, people who purchase residential real estate depreciate the value of the property for tax purposes over 27.5 years. To encourage other forms of investment, policy makers have allowed businesses to immediately depreciate the full cost of most of their investments. But real estate hasn’t been eligible. So Congress could give investors the incentive to buy vacant houses now by allowing them to write off the value immediately, as long as they hold on to the properties for some number of years and rent them out.
Lower Investment Costs
My colleague Richard Wagreich of Citigroup’s Financial Strategy Group has estimated the effect of such a tax break. He calculates that annual costs on real-estate investments would be reduced by about a third, given reasonable assumptions about tax rates for investors and the interest they must pay to borrow. The policy would also make more rental units available and lower their price, thereby encouraging more people to move out of existing households and into their own rental units.
To avoid abuses, the allowance would have to apply only to houses that have been vacant for, say, six months. And there would need to be provisions to take back the benefit in cases where homes were quickly resold rather than kept on the rental market.
What about the cost to taxpayers? By giving the deduction in full now, rather than gradually, the government loses the time value of money over that period. But when government bond yields are exceptionally low, as they are now, that cost is relatively modest.
One might think that since the government’s cost is relatively low, the benefit to investors must be low, too. Real-estate buyers, however, say the shift would lead to a substantial number of new investments.
To get some sense of the numbers, assume the policy induces an extra 250,000 housing units to be purchased each year and rented out, in addition to 500,000 other ones that would be bought and rented even in the absence of the immediate tax expensing. If the average price of those houses is $250,000 (roughly the national average), the 10-year cost to the government for each year the policy is in place would be less than $50 billion. Most of that amount, though, would be recaptured in future years, because the full deductions would already have been claimed. The cost to the government in present value would thus be about $10 billion for each year the policy was in place.
Maintaining this policy for two years would, under these assumptions, work off half or more of the excess inventory at a present-value cost to the government of $20 billion. That seems like a pretty good deal -- and at least worth trying.
To avoid letting the tax break outlive its purpose, it should be tied to the supply of vacant homes for sale. Once that number returns to a more normal level, the write-off should automatically end.
This kind of accelerated depreciation wouldn’t bring the housing market fully back to health. But since the economy is stuck in a rut and homes prices are a key reason, it is worth trying. Perhaps most importantly, in this era of political polarization, the idea of giving real-estate investors an immediate write-off for buying and then renting out vacant homes should appeal to Republicans. And that means if the administration proposes the idea, Congress could actually make it happen.
(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)
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