Real Estate and the Tax Reform Act of 1986

42 Pages Posted: 28 Jun 2004 Last revised: 28 Mar 2021

See all articles by Patric H. Hendershott

Patric H. Hendershott

University of Aberdeen - Centre for Property Research; National Bureau of Economic Research (NBER)

James R. Follain

Federal Home Loan Mortgage Corporation (FHLMC); National Bureau of Economic Research (NBER)

David C. Ling

University of Florida - Warrington College of Business Administration

Date Written: December 1986

Abstract

In contrast to the conventional wisdom, real estate activity in the aggregate is not disfavored by the 1986 Tax Act. Within the broad aggregate, however, widely different impacts are to be expected. Regular rental and commercial activity will be slightly disfavored, while historic and old rehabilitation activity will be greatly disfavored. In contrast, owner- occupied housing, far and away the largest component of real estate, is favored, both directly by an interest rate decline and indirectly owing to the increase in rents. Low-income rental housing may be the most favored of all real estate activities. The rent increase for residential properties will be 10 to 15 percent with our assumption of a percentage point decline in interest rates. For commercial properties, the expected rent increase is 5 to 10 percent. The market value decline, which will be greater the longer and further investors think rents will be below the new equilibrium, is unlikely to exceed 4 percent in fast growth markets, even if substantial excess capacity currently exists. In no-growth markets with substantial excess capacity, market values could decline by as much as 8 percent from already depressed levels. Average housing costs will decrease slightly for households with incomes below about $60,000, but increase by 5 percent for those with incomes above twice this level. With the projected increase in rents, homeownership should rise for all income classes, but especially for those with income under $60,000. The aggregate home ownership rate is projected to increase by three percentage points in the long run in response to the Tax Act. The new passive loss limitations are likely to lower significantly the values of recent loss-motivated partnership deals and of properties in areas where the economics have turned sour (vacancy rates have risen sharply). The limitations should have little impact on new construction and market rents, however. Reduced depreciation write-offs, lower interest rates, and higher rents all act to lower expected passive losses. Moreover, financing can be restructured to include equity-kickers or less debt generally at little loss of value.

Suggested Citation

Hendershott, Patric H. and Follain, James R. and Ling, David Curtis, Real Estate and the Tax Reform Act of 1986 (December 1986). NBER Working Paper No. w2098, Available at SSRN: https://ssrn.com/abstract=227265

Patric H. Hendershott (Contact Author)

University of Aberdeen - Centre for Property Research ( email )

Aberdeen AB24 2UF
Scotland

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

James R. Follain

Federal Home Loan Mortgage Corporation (FHLMC) ( email )

8200 Jones Branch Road
McLean, VA 22101
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David Curtis Ling

University of Florida - Warrington College of Business Administration ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-9307 (Phone)
352-392-0301 (Fax)

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