Changes in federal tax laws are being contemplated to slow the pace of condominium conversion and to encourage development of apartments.
As the laws are currently structured, apartment owners have dramatic capital gains tax incentives to sell out to condominium converters. The tax disparity has been described as the difference between a 68 percent tax bite on ordinary income for a high-bracket dealer in real estate and a 28 percent tax for a seller qualifying as an investor paying on a capital gain.
In turn, there are tax incentives for prospective buyers of the condo units. Like all homeowners, they qualify for income tax deductions for mortgage interest and property taxes.
In a nutshell, those tax incentives for apartment sellers and buyers have resulted in the "condomania" sweeping the real estate market.
But there is one more element: a significant profit motive for the middleman -- the developer who handles the conversion process. The converter usually makes between 10 and 20 percent on the sale, before taxes.
During the conversion process, the price of individual units rises sharply, of course.Rehabilitation costs add to the price of units, as do marketing, legal and financing costs.
But there are other major motives behind condominium conversion. One is the lessening investment return to landlords who consider themselves hamstrung by rent control or the threat of it. Another is a sharp rise in the costs of utilities, maintenance and operation of rental dwellings.
As a result, many apartment owners find it more profitable to sell than to operate as landlords.
Why do apartment owners sell to converters rather directly to tenants?
Rep. Michael Barnes (D-Md.) -- who represents Montgomery County, where condo conversions have proliferated in recent years -- recently initiated a Congressional Research Service study that addressed the question.
"Under current federal tax law," the research service said, "it is almost always to the advantage of the landlord to sell his building to a condominium conversion specialist rather than do the conversion himself. If the landlord gets involved in the conversion 'business,' he risks having his capital gains taxed as ordinary income at much higher rates.
"As a result, developers have emerged as middlemen essentially buying rental buildings wholesale and selling retail."
Barnes, who has proposed federal tax changes to Rep. Al Ullman (D-Ore.), chairman of the House Ways and Means Committee, points to the federal tax structure as a contributing factor in the decline of the nation's rental stock.
"It is time for Congress to provide tax incentives for construction of new rental housing," Barnes said, while calling for "more favorable tax treatment for renters and landlords alike. If we fail to make rental housng an attractive private investment, displacement of senior citizens and the poor will continue. pAnd the ultimate cost to the federal government could be enormous."
An attorney for the owner of a large rental apartment complex under contract to a developer said he has concluded landlord-owners have grown tired of their role because of sharply diminishing returns on rental properties.
Owners have become disenchanted with rent controls, tenant organizations, evictions and the inability to make needed improvements without suffering a financial loss, the lawyer said.
"Most of them would rather sell, pay a capital gain and invest the profit in a high-yield federal bond or savings certificate," he added.
Barnes, who concedes the emergency of condominiums on the housing scene is not all bad, said condos have provided "housing opportunities to moderate-income households. But if a better balance is not struck in the tax code, the nation's rental housing crisis promises to get progressively worse."
In regard to the Barnes suggestion that apartment owners might do their own converting if capital gain tax breaks were provided, developer Nathan Landow agreed. He said such an incentive might encourage some apartment owners to do their own conversions and thus possibly avoid some of the middleman-developer profit while minimizing displacement of tenants.
Barnes said he is urging Ullmann and members of the House Ways and Means committee to consider an investment tax credit for construction of rental housing and tax credits to renters commensurate with the portion of their rent that goes toward property taxes and interest. He is also urging tax assistance of various forms to landlords to encourage greater profitability and productivity in the rental housing market.
Except for federally subsidized apartment construction for low- and moderate-income tenants (who pay no more than 25 percent of their income as rent), there is little new apartment construction in this depressed market. Even before construction lending rates topped 20 percent, developers of rental housing insisted the combination of high construction and financing costs made it impossible to produce units for a market that would accept the rents needed to make development profitable.
Looking at the nation's rental housing, Advance Mortgage Corp. recently predicted only 365,000 rental units would be completed this year -- the lowest total in 20 years.
As a result, the national apartment vacancy rate, which hovered around 5 percent in 1978 and 1979, is expected to decline to 4.7 or 4.8 percent -- barring a severe recession.
While many elected officials tend to regard condominium conversions as inimical to tenant needs and desires, developers insist home ownership has increased as the result of the condominium movement and the impact on the rental market has been minimal. In testimony before a Senate subcommittee on housing and urban affairs, condominium specialist James Laughlin of McLean said displacement of tenants by conversion has been overblown.
"In a typical building or project, 30 to 40 percent of the buyers are tenants from within the project and an additional 20 to 30 percent are tenants from adjacent, nearby or other rental properties," he said.
He also said 15 to 20 percent of the units are often purchased by investors who keep the apartments in the rental market, "albeit probably at a higher rental than in the past."
One developer insists conversions are not making a significant dent in the rental market because the total process affects less than 10 percent of the total rental stock and because most purchasers are former renters. Because rental buildings normally have a 30 to 40 percent turnover of tenants annually, conversions are also viewed as a stabilizing process.
Tenant pressures have caused developers to offer payments to those who decide to move rather than buy. In handling the problem of long-time elderly tenants, some developers -- such as this area's Giuseppe Cecchi, head of International Developers Inc. -- offer long-term leases at current rents, except for increased costs of operation.
Another viewpoint is that the entire condominium conversion movement would cause far less adverse reaction if the tenants were already paying rents more in line with today's housing realities and if the rental housing market was being enlarged by new construction.
Only 15 years ago apartment construction was booming and vacancy rates in new buildings were often higher than 10 percent. Competition was heated and landlords hesitated to increase rents for fear of losing tenants to another building.
Barnes attempted to put the current rental housing/condominium conversion situation into focus when he stated recently: "Landlords and tenants may tend to blame each other for their troubles but in this situation, Uncle Sam is the culprit."
He was referring, of course, to the need for tax changes that would make apartment ownership more attractive than condo conversion and also make apartment tenancy more attractive and stable for persons unwilling or unable to go the condo ownership route.
Whether the tax bill-writing Ways and Means Committee takes any significant action is anyone's guess at this point. Some citizens and some lawmakers already are convinced homeownership has become too financially attractive and the pendulum should swing in favor of tenants.
But with nearly 70 percent of all Americans now living in their own houses and enjoying those ownership "perks," it is unlikely a voter-conscious Congress would take something significant away from such a large bloc.
It seems more likely tax incentives might be provided for landlords and tenants to insure the continuation of a needed stock of private rental housing for a diverse society, one that has come to take for granted a choice of available housing opportunities.