When the tax plan first came out, my initial reaction was mostly a freak out.
Something like this:
The market could drop significantly!
The suburbs will be destroyed!
It could be a bloodbath!
And a lot of buyers and sellers came to ask what I thought could actually happen as a result.
As things progressed into 2018, it seemed like things calmed down, transactions continued, and cooler heads were prevailing.
My sentiment was that the market was structurally sound and things would continue apace, as long as sellers reacted with pricing adjustments.
It looked something like this:
And as time has passed, there has been a divergence between what’s selling and what’s not.
I’m looking at the tax plan to see what in it is causing this divergence.
It seems easy to say that things under $2mm are selling because buyers in this price point can avoid the most adverse parts of the new tax plan.
And for the most part, this is true.
However, some things below $2mm aren’t selling.
I’m not going to cover that for the most part.
For this post, we’re talking about property under $10mm.
Really, in the range of $2-10mm.
So what is causing property not to sell?
Looking through the lens of the new tax plan, what is detrimental to the market seems to be the combination of:
- Lack of full deductibility of real estate taxes
- Increased tax liability due to Tax Reform at the end of 2017
But more than all of this, the most visible number is carrying charges for an apartment, either on a per square foot basis or through a high maintenance level (in a cooperative building).
It seems that an apartment’s carrying charges are causing the most pause for buyers, though a lot of buyers may not articulate it in this way, which we’ll discuss below.
For right now, my gauge of the market has moved more into something like this:
I would assert that monthly charges are the biggest thing holding a property back from being sold.
Let’s combine three main impacts of the tax plan, and then add in the monthly charges to the discussion.
First, we have the limit in the mortgage deduction, which went from $1.1mm to $750,000, for which the interest is tax deductible.
It’s an unfortunate change for buyers, and it’s a difference of about $7,000 per year that buyers can’t deduct.
$350,000 mortgage, 4% interest rate, 50% deductibility based on highest tax brackets.
Obviously changing tax brackets, higher or lower mortgage rates can make a difference here.
It’s a discussion point for buyers.
At its most basic, the deduction went down by about 1/3.
As mortgage levels rise for borrowers/buyers, the impact of the change lessens slightly, but the impact is being felt.
Second, we have city and state taxes, which aren’t deductible anymore against federal income taxes paid.
I had argued that almost everyone I spoke to was taking a smaller hit on their overall tax liability than they perhaps expected- and that the market may not adjust too low as a reaction to this change in tax policy.
However, buyers just paid income taxes in April, and as they started to pay quarterly estimated taxes at that time, and are now paying adjusted real estate taxes for the 2nd quarter, the reality of this change is really happening for buyers.
I would argue that the impact is just starting to be felt, and buyers are getting more and more concerned about it.
Third, we have real estate taxes, which can only be deducted up to $10,000 per year.
Practically speaking, this means that most apartments of 1000 square feet or smaller have taxes that fall at or under this level- while other properties will have taxes in excess of this level.
Taxes in New York City have tripled in the past 12-13 years, with no expectation of a respite.
The first two factors are second-level (indirect) impacts to a buyer’s thought process.
Less purchasing power, less cash flow on a monthly basis, perhaps less money at the end of a year to save for a purchase or for post-closing liquidity.
Add to this the inflation that’s happening for private school, cost of living in New York City.
The third factor, real estate taxes, added to the cost of running and maintaining buildings, whether 90-year-old Prewar Coops, or post-war properties, has gone up significantly and is the most direct impact on a buyer’s thought process.
Labor Costs are up, maintenance costs are up, financing costs are up.
And the result is a much higher monthly charge and real estate tax than has ever been seen.
It looks like this:
A 2-bedroom condominium can have a monthly charge (including real estate tax) of $2.50 to $2.75 per square foot, approaching $3000 per month in many cases.
A 2-bedroom coop can have a monthly charge of at least $2000 per month and likely reaching the $2500-3000 level, too.
For larger units, monthlies in smaller buildings have started to look extremely high.
$5000, $6000, $8000 per month has started to look scary.
Combine with other tax impacts, a soft rental market, and the optics of these charges has scared away buyers, who can spend quite a bit less if they just rent.
So what is happening is that apartments with high charges are sitting on the market for much longer on average.
A building’s charges can be independent of the real estate taxes in New York City.
Pricing MUST be compelling to overcome high monthly charges.
We will keep close track of these numbers going forward, as I think it may be the most significant issue going forward, and it impacts every area.
Buyers will need to see value in the pricing of these properties with costs outside the norm- or buyers will somehow have
to accept these high maintenance costs as a new normal.
Until then, high real estate taxes and costs of maintaining fully-staffed, aging buildings in New York will be a drag on the Real Estate market going forward.