New York’s real estate industry was one of the big winners in the recent federal tax overhaul, but housing advocates worry it will have a chilling effect on affordability.
As the corporate tax rate falls, so too will the value of affordable tax credits, making them less enticing to would-be developers. Also, stricter rules on foreign banking are expected to stem the flow of capital into subsidized housing projects.
Combined, these changes will hamstring the country’s future affordable housing supply, according to expert analysis, potentially costing the country billions of dollars in revenue.
Meanwhile, the burden will be shifted to local governments to incentivize affordable housing production, a daunting task for New York where taxpayers will already be pinched by a new federal cap on state and local tax deductions.
In the short term, though, the Tax Cuts and Jobs Act of 2017’s most disruptive feature might be its own complexity.
“This tax bill is 500 pages and it was done extremely quickly at the end of the year, so the biggest thing we’ve seen is confusion about what it means on the investment side,” said Jeff Jaeger, founder of Standard Communities.
“It’s hard to have stable investment in affordable housing when people don’t know what the bill means in its totality.”
The new tax code includes a permanent cut to the corporate rate, from 35 percent to 21 percent, and it also reduces the rate on pass-through entities, such as partnerships and sole-proprietorships. The Low-Income Housing Tax Credit, or LIHTC, is intact but by standing pat at four and nine percent while the overall rate dropped by 14 percent, its value has decreased considerably.
After analyzing the new tax law, the national accounting firm Novogradac & Company LLP projects there will be between 219,200 and 232,300 fewer LIHTC-funded affordable housing units compared to the expected output under the previous code.
As a result of this slowdown, Novogradac predicts a net loss of 262,000 jobs, primarily within the construction industry, as well as a total loss of $22 billion in business income and $8.5 billion in taxes.
“There’s a huge ripple effect,” said Claire Altman, a New York-based attorney specializing in affordable housing and an executive vice president for the lobbying firm Capalino+Company.
With affordable housing experience dating back to the last major federal tax overhaul in 1986, when the LIHTC was created, Altman said it’s common for the industry to pause and evaluate after even minor policy tweaks because of how nuanced the deal-making process is in this space.
“In New York City, affordable housing development is very complicated, it’s not unusual to have six or seven sources of money on a single project,” she said. “It’s typical that, after a new tax reform, it takes a while for investors to digest it and figure out what it means for them.”
Jaeger’s company, Standard Communities, builds and preserves workforce housing throughout the country, including the Polyclinic Apartments in Hell’s Kitchen, which it purchased for $110 million last fall to protect its affordability. He said he’s noticed a marked decline in investment in his field during the month since the tax reform was signed into law as would-be sponsors sift through the details.
Once the dust settles, Jaeger fears he’ll find a market landscape that is toxic to affordable development, especially if the yield rate on the 10-year Treasury bond continues to rise. Of particular concern to him are the changes made to the Base Erosion and Anti-abuse Tax, or BEAT, which is imposed on capital that moves between foreign companies and their U.S. subsidiaries to prevent tax evasion.
By Novogradac’s calculations the new BEAT rate, which is scheduled to double during the next seven years, can erode a LIHTC investor’s credit benefits by 20 percent by 2025 and as much as 100 percent thereafter.
“It’s really a shame,” Jaeger said, “because it’s a limit on foreign companies investing U.S dollars into the U.S economy and getting a tax incentive for it.”
Workforce and low-income housing are not the only sectors impacted by the new tax law. Market rate ownership in New York is also considerably more expensive now that residents can only deduct $10,000 of state and local taxes and the lower cap on mortgage interest rate deductions. Steve DeNardo, CEO and founding partner of RiverOak Investment Corp., tackled the issue during a panel discussion hosted by the Real Estate Services Alliance and the Fordham Real Estate Institute last week. As the cost of ownership increases, he explained, even some high-income New Yorkers are seeing their buying power diminish just enough to keep them in the rental market.
“People on the cusp, fewer are going to buy condos and probably opt, if nothing else, to stay in their apartments longer,” DeNardo said. “So apartments become more interesting to us and more valuable, especially if you can hang on for three to five years because it’s going to take a while for all this to sort out.”
Speaking at the same panel, Brad Klatt, co-founder of Roseland Property Company and Canoe Brook Partners, said he’s already seeing this trend play out. While his staffs would normally hound tenants who draw six-figure salaries, hoping to coax them into renewals, he said many are coming in of their own volition because their next typical next destination, the condo market, has become less appealing.
A surge in the city’s high-end rental stock has kept asking rents low but Klatt said he believes that could change as reduced after-tax cash flows convince more tenants to choose rents over mortgages.
“I saw this [headline], it says ‘Renters are Winners in the New Tax Law,’ well, I don’t think that’s true,” Klatt said. “I think the answer is that rental owners are the winners in this tax code.”
Aaron Carr, founder of the Housing Rights Initiative, a New York non-profit, said Congress missed an opportunity by temporarily dropping the cap on mortgage interest rate deductions from $1 million to $750,000 through 2025 instead of eliminating it altogether.
“The mortgage interest deduction has virtually no impact on boosting home ownership rates,” he said. “Eliminating [mortgage interest rate deductions] and diverting the capital to affordable housing would, however, have an impact on the half of American renters who are housing cost burdened.”
Despite the dark cloud cast by the new law over the affordable housing market, Altman said there may be a few silver linings.
Two vital programs were protected by the tax code: private activity bonds—one of the primary sources of funding for subsidized housing development—and the New Market Tax Credit, which incentivizes commercial developments in economically distressed areas and could be used, Altman said, too offset costs in mixed-use housing developments. Likewise, a new program that establishes Opportunity Zones where corporations can funnel capital gains into development projects in exchange for tax breaks.
“It will take a couple months for things to settle and investors to fully understand the changes made to the tax law,” she said, “but talking to syndicators that we work with they think it will be a month or two, not many months, before that happens.”