Monday, January 26, 2015

Housing Tax Policy, A Series: Part 2 - Outline of the model

<Update:  These estimates are bound to change some more as I continue to review data and concepts.  I am purposefully kind of thinking aloud.  So please check on follow-up posts in the series if you are interested in these estimates.>

Here is the very simple model I am using in excel.

Colored cells are user input.  The model is simple, but I think the implications will be interesting and useful.  I'll walk through it briefly:

Tax Rates: The landlord is my baseline, so these represent tax exemptions for owner-occupiers.  Tax policy, especially in real estate, is complex, so I am open to boot-on-the-ground input on how steep the de facto taxes are for the marginal landlord.  These seem like a good starting point, partly based on some commenter input from the last post.

Rent Adjustments:  Property Tax, Insurance, and Maintenance apply to net rental income for all owners.  Property Tax would be more accurately portrayed as a portion of home price, but putting it here helps me to avoid circularity in the model.  This means that I need to be careful with this measure if I test values much higher than current levels, because I lose some of the feedback loop between taxes and home values by putting it into the formula here.  The Owner Benefit premium is the added value of having control over one's homestead.  The data might steer this one way or another, but I am starting in the ballpark of 30%.  This is in the range of a control premium in a corporate ownership context.  That is a slightly different context, obviously.  Actually, I suspect this premium is very household-dependent.  It is clearly nearly zero for, say, a college student, but could be much higher than 30% for a very high income middle class family.  This is a factor I might try to think through as I move through the issue.

Equity % is the equity percentage of the owner.

I am simply estimating the mortgage benefit based on the aggregate effect.  This would not be very accurate for individual households, since the usefulness of this tax deduction would vary with the size of the mortgage and the tax characteristics of the household.  But, I think it is a decent estimate for aggregate effects.  The Mortgage Interest Benefit comes from the leverage level and the Mortgage Benefit Factor, which will be 0 before 1986 and .06 after 1986.

I am pegging rent at $1,000 per month.  Rent is the baseline figure here, so Price to Rent will be the home price measure that will be most relevant.  Where I use home prices as a comparative measure, they will tend to be adjusted for rent inflation.

Owner Net Rent Value is the net adjusted rent income, either imputed or paid, of the homeowner, after accounting for all the adjustments above.

Capital Gains Usage reflects the ability of owner-occupiers to use the capital gains tax exemption.  I have it set at 25% before 1996 and 75% after 1996.  But, again, boots-on-the-ground input here is welcome.

Owner risk premium is the added return on investment that owner-occupiers would require because their ownership cannot be diversified and would tend to have some correlation with personal risk attributes, such as the local employment market.

The Capital Gains Exemption Premium is a product of the capital gains exemption, the usage of that exemption, and future inflation.

The intrinsic home value (Home Price) is based on a discount rate that includes the real rate, the owner risk premium, and the capital gains exemption premium (which is negative).  I can ignore inflation here because of my assumptions about home price appreciation and inflation expectations.  I have based intrinsic value on the DCF value of 100 years of rent.

The mortgage rate is the sum of the real rate and the inflation rate.

Here is the update of my basic estimates of the subsidies, before digging into the conceptual details of how they might work through the housing market, based on comments from part 1:

The Cap Gains levels are affected by other factors, and I might tend to find
that they are even lower in many contexts where the other specs change.

I am interested in how these factors might influence home owning decisions and home prices.  I will begin to review these issues in the next post.


  1. On you previous post, you noticed a surge in home appreciation right after the 1994 CRA Act. At first, that seemed to me a bit iffy.

    Then, I wondered. Suppose the 1994 Act accelerated, or was coincident to, urbanization?

    That is, we have seen a revival of American cities in the last 20 years.

    Urbanization means higher living costs---a smaller house costs more money. I think this is often improperly captured as inflation. People choose to live in a densely packed city will pay more housing, than if we are all spread out. The urban home buyers are getting more for their money, but in ways hard to measure, such as museums, schools, urban amenities, the hip neighborhood etc. "I live in Hipster-hood, NYC" makes a person feel more cool than to say, "I live about 40 miles outside Oklahoma City."

    I think also something is going on with rising disposable incomes. People have more, and are directing it into housing. Again, this looks like inflation, but it something of a bidding war.

    All in all, I suggest the CPI overstates inflation. The Fed right now may have us in deflation.

    1. Good point. I wonder if cpi captures the rising value of a growing city. Even a rent index tied to individual homes wouldn't catch the rising value of a city growing around you.

      But I should clarify a couple of things.

      The CRA coincided with a sudden shift up in the trend of the home ownership rate. But home prices didn't start to rise until a few years later, after the capital gains exemption change.

      Additional spending is flowing to housing. Regarding home prices, I try to use price/rent.