Go Rent, Young Man!

In a culture where owning a home is seen as an important stepping stone toward achieving the American Dream, many young potential homebuyers viewed the recent December 2017 U.S. Congressional tax bill as another impediment to their goals of moving out of rented apartments and their parents’ basements. While the bill’s advocates praise the unabashedly-named “Tax Cuts and Jobs Act of 2017” for its potential to stimulate the economy through corporate tax cuts and lowered income taxes for many Americans, key features of the bill show clear signs of hurting those looking to participate in the housing market in the near future.

Namely, restrictions placed on deductions for property taxes, mortgage interest and home equity loans will put financial strain on homeowners, particularly those who still have paid back their housing debt in full. Given these disincentives towards purchasing new homes, the National Association of Realtors has publicly opposed the GOP tax reforms, with the Association’s chief economist Lawrence Yun decrying that the bill “will lead [the United States] to a renter nation and away from an owner nation.” For young Americans looking to purchase their first homes, these effects will likely have a noticeable impact. A 2011 study conducted by the intergovernmental Organisation for Economic Co-operation and Development (OECD) found that a 10 percent increase in the maximum loan-to-value ratio of housing-related loans will yield a 12 percent rise in homeownership rates among younger households (aged 25-34), compared to only a 3 percent rise in aggregate homeownership across age groups under the same conditions; restrictions on housing tax deductions that inevitably reduce the real value of housing loans will disproportionately decrease demand for mortgages among younger Americans.

Despite these limitations for those looking to purchase their first homes, the purported macroeconomic consequences of such a development may offer several silver linings that may be beneficial to the entire economy and housing market in the long-run. Firstly, the disincentives of this tax bill may assuage several experts’ worries that young Americans are rushing into buying homes before achieving the necessary credit and financial stability needed, especially since such a high proportion of the public still views homeownership in a positive light. A study done by Pew Research Center found that over 80% of Americans polled believed that owning a home “is the best long-term investment in the U.S.,” even after a decade of volatile housing prices which played a key role in the 2008 Great Recession.

Prior to the tax bill, demand for homeownership had been revving up, especially for younger first-time homebuyers. According to the National Association of Realtors 2017 Home Buyer and Seller Generational Trends report, millennials and Generation Y (aged 36 or younger) consisted of 34 percent of home buyers, by far the highest proportion for any age group. Aarti Shahani of NPR suspects that this may be because “while people 5 or 10 years older may still be shell-shocked from the housing crash, this younger generation seems ready to start [a] new chapter – even if it didn’t go well for their parents.” Furthermore, a 2016 Bank of America study found that 75 percent of first-time buyers would “prefer to bypass the starter home,” a colloquialism that refers to the affordable home that buyers typically buy before “purchas[ing] a place that will meet their future needs.”

Housing experts that Shahani consulted largely agree that monthly mortgage payments should be comfortably below 28 percent of a household’s monthly gross income in order for buying a home to be a financially safe option. However, findings in 2013 Consumer Expenditures statistics compiled by the Bureau of Labor Statistics suggest that households under the age of 25 are dangerously close to this threshold, spending approximately 25.7 percent of their monthly income on mortgage payments. Alarmingly, some experts believe lending standards have loosened once again in the past 2-3 years, with loan officer and housing expert Logan Mohtashami remarking that he’s seen customers with FICO scores as low as 620 receive loans; for what it is worth, 620 is also the benchmark the St. Louis Fed set for classifying subprime loans in the three years leading up to the housing crisis (2005-2007) in a 2008 paper published by economists Yuliya Demyanyk and Otto Van Hemert.

A second positive development stemming from these tax changes is a possibly significant decrease in home prices. Home sellers will likely face depressed demand in the market due to the aforementioned restrictions on housing-related tax deductions, with the National Association of Realtors estimating that home values could drop over 10 percent upon the bill’s passage. While a huge blow for existing homeowners’ net worth, this potential development would be highly beneficial for first-time homebuyers who are looking to stop renting in a few years’ time.

While homeowners actively looking to sell may lament the probable decline of the worth of their housing assets, a particular small-business deduction found in the Tax Cuts and Jobs Act of 2017 will increase the capital gains of any existing homeowner opens his property for rent. According to Amanda Becker of Reuters, the “pass-through” rule is a provision in the tax bill that will create a 20 percent business income deduction for sole proprietors and owners in either partnerships and other non-corporate enterprises. Investors in single-family homes will be able to write off all the expenses of running a rental home, as properties can still be considered businesses under the current tax code; if these homeowners are willing to convert some of their properties into rental residencies, the current tax climate will be very favorable to their endeavors.

Lastly, these economic pressures encouraging renting fall in line with sustained behavior trends within the housing market amongst younger demographics. A 2017 Pew Research Center study showed that between 2006 and 2016, the number of household heads who owned homes fell by 1.1 million; meanwhile, the number of household heads renting rose by 8.7 million within the same span. While this trend likely was primarily influenced by the Great Recession and housing crisis, it is worth noting that the number of homeowners steadily dropped for the entire decade, well after the economy started to recover. As the study notes, these increases were particularly significant for young adults, with approximately 65 percent of households headed by people under 35 being rentals in 2016 (compared with only 57 percent in 2006). In a separate Pew Research Center study, it was reported that 72 percent of renters polled in 2016 wanted to buy a house sometime in the future, a statistic down from 81 percent from just 2011 when the effects of the housing crisis were readily tangible. While it is apparent that the great majority of young Americans still prefer the idea of owning their own homes, renting homes is clearly not a foreign concept and is a currently a widespread practice.

Recent changes in the economy may shed light on a widespread evolution of consumer preferences. The rise of platforms such as Uber, Airbnb and even the Zagster bike-sharing initiative on Dartmouth’s campus all seem to show an increased willingness – especially amongst millennials – towards sharing expensive durable goods. Perhaps these behavioral shifts are part of the reason why young adults are increasingly receptive about renting instead of buying homes. With ever-mounting college tuition and healthcare costs, young Americans would be wise to strongly consider adapting to these trends, and to look at longer-term renting options. While the tax bill’s changes may make owning a home seem even more far-fetched for many young Americans in the short-term, perhaps the economic incentives embedded in it will further dispel the narrative that owning a home is quintessential to achieving the American Dream.