Multifamily real estate investing is a long-term winner in the tax reform law. The Tax Cuts and Jobs Act creates incentives for workers to move where they can get more for their money and to choose renting over home ownership. Residential and multiuse developments retain their tax advantages, and private investors can shield more income in real estate funds.
In response to the bill, investors and business publications have been asking us about real estate and the tax reforms. A previous post discussed how the new tax law impacts individual real estate investors. Now, let’s look more closely at four major impacts the Tax Cuts and Jobs Act (TCJA) will have on multifamily real estate:
1. Low taxes will change housing choices.
The standard deduction for all taxpayers has roughly doubled to $12,000 for an individual or $24,000 for a married couple. However, new caps on real estate tax deductions for homeowners can offset this gain. Homebuyer tax deductions are no longer unlimited: homeowners who take out a new mortgage will be able to deduct interest debt only up to a $750,000 principal balance (deduction limits are unchanged for existing loans). State and local taxes, such as property taxes, are capped at $10,000.
The combination of a higher standard deduction coupled with lowered mortgage deductions is effectively a boost for multifamily housing. The law takes away the incentive for growing families to buy a home for its tax benefits, such as deductions on mortgage interest or property taxes, and encourages renters to move to bigger and/or better apartments rather than become homebuyers.
For Millennials who are recent college graduates or starting families, the lure is even greater to rent rather than buy, thanks to the new tax code, notes Bloomberg. These Millennials typically hunt for homes in urbanizing suburbs with good schools, parks and other services—and by renting, they don’t have to pay the property taxes for these amenities. In cities like Austin, Dallas, Denver and Houston, according to market research firm Reis Inc., one-third or fewer taxpayers now itemize their deductions. Reis predicts that cities such as these—with both lower taxes and strong rental demand—will see continued multifamily housing growth.
As a result, Moody’s Analytics predicts that home prices in high-tax states such as California, New Jersey and New York, will become less competitive. In these states, the market will be less enticing for buyers, which will reduce home appreciation and boost rentals—especially in high-end suburbs, city centers and infill communities.
2. Pass-through reform benefits real estate funds.
Most private equity real estate deals are pass-through businesses such as LLCs and S corporations. Profits are passed through to the partners’ individual tax bills at ordinary rates. In the 2017 tax reform, however, shareholders in these entities can deduct 20% of this business income. Although a complicated series of caps still apply to pass-through income, this aspect of the new tax code benefits real estate investors, notes the Wall Street Journal.
This benefit starts to phase out at $157,500 for single taxpayers and $315,000 for married taxpayers filing jointly. But the reality is, private investors in real estate funds will be able to shield 20% of their dividends from taxation, offsetting non-real estate related income on their tax return. Meanwhile, the 2017 tax law lowers the top individual tax rate to 37%, and raises income thresholds in the higher tax brackets.
3. Real estate companies retain generous write-offs.
The 21% top corporate rate will benefit multifamily businesses that aren’t structured as partnerships. However, while interest deductions are limited to 30% for most businesses, landlords can still deduct commercial mortgage interest in full, Reis notes.
Also, landlords have more depreciation choices, including 100% immediate expensing for property put in service before 2023. The National Multifamily Housing Council and other trade groups believe these corporate breaks promote apartments as a business model. They should also spur more value-add property investments that create real value in multifamily real estate.
4. More jobs will spur real estate growth.
Changes in the job market favor real estate investment in lower-tax states such as North Carolina and Texas, as well as transportation hubs such as Atlanta, Dallas and cities such as Chicago, where city and suburban residents may opt to rent in droves. If the tax breaks are successful at creating new jobs, demand will follow both for office space and multifamily housing for employees. Meanwhile, a Business Insider analysis says blue-collar workers across a range of industries will see tax cuts.
Bottom line, for the next seven years, taxpayers across the board will have more money to spend on rent and other things. After 2025, all tax cuts on individuals are set to expire. But most tax reforms that benefit multifamily real estate, including the caps on mortgage and local tax deductions, don’t phase out. Coupled with a robust job market and other workplace trends, the tax cuts promise to pay dividends for multifamily real estate and its private investors.