Ever since the Treasury trotted out its tax reform plan last year, trade associations and consultants throughout the real estate industry have been massaging their econometric models in search of reasons why it should never become law.
The industry has a very basic reason for its opposition: the proposal would hit it squarely in the pocketbook. But the industry prefers not to put it quite so baldly, and has been casting about for a more presentable argument.
Now the builders and owners of apartments think they, at least, have found a winner: they contend -- with econometric studies to back it up -- that if the Treasury plan becomes law, apartment rents will 40 percent or more. Alternative plans such as Bradley-Gephardt and Kemp-Kasten would have similar, though less dramatic, effects.
Rents will leap, according to their econometric models, because rental income will have to make up that portion of a property's rate of return now supplied by the tax code. Thus, Congress is supposed to see, the real burden of tax reform would fall not on landlords but on tenants.
To swallow this line of reasoning, however, it is necessary to believe that landlords now charge less than the traffic will bear because of all the nice tax benefits they get. "My tenant could and would pay $700 for this apartment, but because of all the wonderful tax goodies I get I'm only going to charge him $500," these econometric landlords say to themselves.
The fact of the matter is that landlords, like other businessmen, charge as much as they can for their product. If the market would bear rents that were 30 or 40 percent higher, they would already be charging them.
When pressed, industry officials acknowledge that rents won't go up immediately, that this will take place over a period of years.
The value of long-range economic forecasts being only somewhat greater than that of long-range weather forecasts, one is left to wonder how, with all the factors that put pressure on rents, they can be so precise. The National Association of Home Builders, for instance, says the Treasury plan would boost rents 42 percent, Bradley-Gephardt 28 percent, and Kemp-Kasten 22 percent.
The answer is that this isn't how much rents will go up; it is what builders and owners figure it will take to make them whole after their tax preferences have been reduced.
Over the years, Congress has built very substantial benefits for rental housing into the tax code. Thus, when investors have purchased rental property, they have really bought two things -- real estate and tax breaks -- and sellers have priced their property accordingly. Each improvement in the benefits creates a windfall for sellers, who can build the value of the new break into their price.
Now, if Congress comes along and eliminates some of the benefits, owners will have less to sell, and prices will have to reflect that.
The impact will be particularly harsh on owners who bought in the early '80s when benefits were at their best with depreciation reduced to 15 years. Many of these purchases were undertaken based on a favorable "internal rate of return." Internal rates of return takes into account what the property is likely to sell for some years hence, and if that sale price is high enough it can show that a transaction will be profitable even if it results in annual cash losses during the holding period.
Obviously, anything that causes the purchase price to fall short of projections can throw the investment into the red.
But while the landlords' sudden concern for their tenants is a political position and should be taken as that, their plight is worth considering nonetheless.
Builders and owners, despite their image, are in fact providers of housing, a commodity that requires long-range commitment and planning. For the past decade, however, Congress has put rental housing on a tax roller-coaster, sharply improving its benefits in the early '80s, cutting them back somewhat last summer, and now considering cutting them back even more.
It is a very real question whether investors are going to continue putting their money into this sector in the face of these gyrations.
And that in turn leads to the issue of the wisdom of trying to shape society through the tax code. This is one of the fundamental questions that tax reform must address. We have gotten into this mess by trying to make the tax code pay for all the subsidies that society wants but would balk at if the full cost were laid out in an appropriation.
Congress needs to chart a stable course for housing investment, and real estate interests would servce themselves best by making a straightforward presentation of the economic realities of their situation.