If you're renting, there are new reasons to buy. Tax reform likely to push up rents, as low mortgage rates hold
There's good news and bad news for tenants. First the bad news. Rents are going up, probably about 15 percent this year, as a result of tax reform.Skip to next paragraph
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Now the good news. Lower interest rates make buying a house or condominium more affordable today than in nearly a decade. Real estate experts say that this may be the time for renters to trade in their leases for a deed of trust.
``There's a point at which rents and mortgage payments cross,'' says Cecil Sears, director of economic research at the real estate consultants Rountrey & Associates and co-author of two books on rental housing. ``At that point, people turn from renters into owners.''
The drop in interest rates sent the median mortgage and interest payment down to $560 in January 1987, and closer to $400 after tax deductions. That is getting awfully close to the median $329 rent for unoccupied apartments. Then last fall, tax reform stripped investors who owned rental units of most of their tax advantages. Now they are passing along the higher after-tax costs in the form of higher rents.
``As long as tenants and taxes were paying for the property, I was going along with 6 to 7 percent rental increases,'' says Jerry Varnon, a real estate investor who controls 21 properties in northern Virginia. ``Now we're talking about increases of 14 to 35 percent,'' he says, adding, ``The tax bill is disasterous for the poor and lower middle class.''
Of course, such hikes won't occur everywhere. In cities with rent control, like New York, a present occupant is safe. But if they move, they will likely face much larger increases, since owners will be trying to recoup their losses on controlled units with greater hikes for new tenants. Of course, in depressed regions like the South or overbuilt places like California, competition will keep rents stable.
By taking away shelters for investors, tax reform has opened the door for renters to become owners. For example, Mr. Varnon recently transferred half-ownership to several of his tenants, reducing his losses on the property. Last fall he deeded half ownership of a detached townhouse in Woodbridge, Va. to the tenant who had been paying $800 a month in rent. Varnon's monthly payments to the bank were about $1,000, leaving him $200 short.
Under the new arrangement, the tenant pays half the rent ($400), half the mortgage ($500), and Varnon pays that $900 to the bank, cutting his shortfall in half. Though he loses half interest in the property and his deductions for managing and maintaining the property, he says it's worth it. ``I don't have to manage tenants anymore,'' he says. ``I don't have to worry about trying to get plumbers, electricians, and glass people out to the house. I will gladly give up my deductions in return for some peace of mind.''
Many investors bought rental houses for tax reasons, not economic ones. ``Now they're in a bind,'' says Sears. ``In markets where there's a large supply of rental units - the South and the West Coast - you'll see owners trying new techniques to make the numbers work ... especially if they get more rent in the guise of equity, and if the former renters lose the equity if they can't make the payments.''
Whether tenants will be amenable to such conversions - especially apartments into condominiums - is another matter, says Scott Slesinger, executive vice-president of the National Apartment Association. ``A lot of people want to turn apartments into condos, but a lot of people want to turn base metals into gold, too,'' he says. ``The condo market is the easiest market in the world to glut ... and people are scared to buy them because they may be difficult to unload.'' He does think, however, that people renting houses - about 30 percent of all rental units - would be eager to buy their homes.
If you are thinking of buying property, real estate experts suggest looking at a few factors first.
Your tax bracket. The lower your income, the lower your tax deductions, especially after this year, when maximum tax rates drop to 28 and 15 percent. For people in the 15 percent tax bracket - and most renters will be - there will be ``almost zero tax advantage'' for owning over renting, says Gaylon Greer, the Morris S. Fogelman chair of real estate at Memphis State business school.
He figures for the median $80,000 house, the interest deductions are $5,700. As of 1988, the standard deduction is $5,000. So you would be saving $105 a year in taxes if you are in the 15 percent tax bracket. Rents are sufficiently lower than mortgages that you would save more money renting, he says.
Inflation. Generally, people buy homes for shelter and because they expect them to appreciate in value, and not just for the tax deductions.
If you think inflation will pick up to, say, 4 or 5 percent a year, ``there's a window of opportunity to buy before inflationary expectations are embedded in interest rates,'' Greer says.
``If you wait to see if your expectations are right, it will be too late,'' he says, since bankers will raise interest rates before you can lock in today's 9 percent rate. Of course, if your property appreciates marginally or not at all, you will have probably paid too much.
Location. In depressed areas, rents have dropped dramatically, but many think housing prices have fallen farther. If you think the South will rise again, economically speaking, now may be the time to buy, says Greer. ``In Houston or Dallas, the economic abnormality is virtually certain to correct itself.''
Mobility. In general, if you stay put for a while the cost of ownership is lower, says John T. Reed, author of several books and a newsletter on real estate investment. But if you think you may move in a couple of years, he says, ``the transaction costs at either end would probably outweigh appreciation.''