Owner Wade McGuinn says most of his company’s financing comes from equity markets that “loosened up” after the law, which reduced individual and corporate taxes by $1.5 trillion, went into effect on Jan. 1.
With more capital available, McGuinn hired 14 new people, doubled his company’s community count to 14 (including the Aug. 18 opening of Pleasant Springs, the builder’s sixth neighborhood in Lexington, S.C.), and increased his standing inventory by 40 percent.
McGuinn Hybrid Homes is on track to close 300 homes this year, up from 135 in 2017. Tax reform, McGuinn says, has definitely had a positive impact on the housing market.
No one can say with absolute certainty that tax reform is stimulating homebuying activity. But most of the 13 builders that Professional Builder interviewed in August agree with McGuinn that it’s more than simply coincidence that sales of new homes were up nearly 13 percent year-to-date through August, compared with the same period a year earlier; that construction was up, too, and that home values are rising.
And some predictions about what tax reform may lead to, such as buyer migration to lower-tax states as a result of limits on mortgage interest and property tax deductibility, so far seem exaggerated, builders say.
More telling about the tax reform’s impact has been how few builders say they’ve made changes to their companies’ planning or business strategy in anticipation of even stronger economic growth. “We’re doing what we’ve always been doing, and we’re pretty busy,” says Steve Krasoff, president and CEO of Scott Felder Homes, in Austin, Texas, which expects to close 300 homes this year. But Krasoff also believes the tax cut has created an upbeat, if somewhat amorphous, vibe in his market. “We’re seeing a lot of good things. People are feeling more confident about their jobs and are buying homes.”
Builders note, however, that some of the tax reform’s benefits have been diluted by tariffs on products such as steel and lumber, which have contributed to a steady rise in building materials costs that, along with swelling labor costs, are chipping away at builders’ margins. Their construction overhead has led builders to increase their home prices this year.
Whether the tax cut has longer-term implications for the housing industry is only one of many things builders are keeping an eye on as possible benefits or threats. These include inflation, rising interest rates, ballooning personal and national debt, the availability of skilled workers, and volatile international trade.
If nothing else, tax reform has buoyed consumers’ confidence, especially about their employment status. “Homebuying is driven by job security,” says Michael Benshoof, president and COO of Berks Homes, which builds in Pennsylvania and Delaware. Wade McGuinn adds that when people have job security, “they spend money. And in Columbia, that activity is creating more activity.”
The National Association of Home Builders, which initially was vociferous in its opposition to the tax bill, did an about-face after successfully lobbying for changes that would have less impact on builders and homebuyers. Eight months after its passage, Jerry Howard, the association’s CEO, thought the tax bill was living up to expectations for the housing market. “There’s an increase in production [through August, the number of homes under construction was up 4.6 percent, according to Census Bureau estimates], and builders are expanding their businesses,” he says.
But not every builder is convinced tax reform is that big a deal. “The short answer is, it’s too early to tell. But I personally don’t think tax reform is affecting builders or customers at all,” says Doug Bauer, CEO of Irvine, Calif.-based TRI Pointe Group, the industry’s 10th largest production builder, which is active in eight states across the country. “When I’m out in the field, there’s no discussion about it.”
Even builders who view tax reform optimistically concede that, so far, its benefits are nebulous. For example, Phoenix-based NexMetro Communities, which builds single-family rental housing for developers in four states (Arizona, Texas, Colorado, and Florida), has been looking into “opportunity zones” created by the tax law in which to reinvest capital gains around the country. Josh Hartmann, NexMetro’s president, says his company is still awaiting details about those zones.
NexMetro expects to close 1,100 homes this year, up from 700 in 2017, and foresees 2,000 closings in future years. Hartmann says the new law’s 20 percent deduction for pass-through income based on wages is good news for builders, as is the quicker asset depreciation the law now allows. And predictions that tax reform would overstimulate construction in places like Dallas haven’t materialized, he adds.
Some builders may be on the fence about declaring tax reform a victory for housing because their own markets are down a bit this year. “So far, this year has been good, but not insane,” says Benshoof, whose company still feels the scars left from the last recession. “We’ve gone from white-hot to red-hot,” adds Beau Brooks, president of Grand Homes, in Dallas, where his company expects to close 500 homes this year, up from 426 in 2017.
Will MID eventually be DOA?
Another Dallas-based builder, Bloomfield Homes, in July announced plans to build 900 homes in the Hagan Hills and Ridge Ranch developments in Mesquite, Texas. Bloomfield’s average home price is $360,000, so its customers are less likely to be influenced by the tax reform’s changes in mortgage interest and tax deductibility, says Don Dykstra, Bloomfield’s chairman and owner. However, he can envision picking up some business from buyers who relocate from markets with higher taxes and more expensive homes in the eastern and western U.S.
Among the more controversial elements of the tax bill were the capping of interest deductions up to $750,000 of mortgage debt (from $1 million previously), and capping sales and local tax deductions at $10,000.
To cushion the blow from these changes, the new law doubled the standard deduction to $12,000 for individual filers and $24,000 for married couples filing jointly.
There have been early winners and losers as a result of these tax changes.
Neal Communities has seen a significant uptick in demand for homes in its Signature Collection, where prices range from $700,000 to $2 million. Pat Neal, Neal Communities’ founder and chairman–executive committee, attributes this bump, in part, to buyers from high-tax northern states moving to Florida, which doesn’t have a personal income tax and where sales tax is 6 percent. In Sarasota County, where Neal Communities is headquartered, the latest property tax rate is $3.39 per $1,000 of assessed value.
In Colorado, Saint Aubyn Homes is having its best year, on pace to close 800 homes. Travis Turner, the builder’s director of sales and marketing, says his company is seeing more homebuyers fleeing California and Illinois, “where you can sell your house, pocket $500,000, and pay cash for the same house in Colorado, with lower taxes.”
It’s still anyone’s guess, though, how extensively tax reform is spurring homeowner mobility. Bauer of TRI Pointe Group says he’s been hearing the same story about migratory homebuyers leaving California for 30 years. And Brooks of Grand Homes, whose average selling price is $550,000, thinks the changes in deductibility will ultimately “be a wash.”
What has changed, indisputably, is the housing industry’s attitude toward the once-sacrosanct mortgage interest deduction (MID) entitlement as a pillar of the American Dream. In 2016, just 10 percent of Americans claimed the deduction. John Burns Real Estate Consulting notes that about one-quarter of the MID historically has been captured by just five metro areas—New York, Los Angeles, Washington, D.C., Chicago, and San Francisco—which are likely to be hit hardest by the tax changes. But John Burns, the firm’s CEO, is quick to add that the doubling of the standard deduction “made the mortgage interest deduction a nonfactor for just about everyone.”
NAHB currently supports eliminating the MID—“which is now only beneficial to rich homeowners, who don’t need it,” Howard says—and using the savings as tax credits for first-time and moderate-income homebuyers.
Tariffs and Higher Prices
Finding product for those buyers, though, is problematic. Just about everywhere in the U.S. there’s a shortage of affordable for-sale and rental homes. There are many reasons for this dearth, including the lack of developable real estate, which is hamstringing construction. Tax reform has yet to break this logjam by stimulating investment, and regulations continue to confine where homes can be built.
Consequently, home prices have been rising: The Census Bureau estimates that the median sales price for a new home in August was $320,200, up 1.9 percent from the same month in 2017. An existing single-family home sold for $267,300 in August 2018, up 4.9 percent from the same month a year earlier, according to the National Association of Realtors. A condo’s average selling price that month was $244,500, up 2 percent.
Costs associated with labor have certainly contributed to making houses more expensive. Renee MacLees, marketing director for GHO Homes, in Port St. Lucie, Fla., says labor shortages on Florida’s west coast are forcing owners whose homes were damaged by last year’s hurricanes to pay extra to hire contractors from the eastern part of the state, where GHO operates.
Another factor that’s been causing home prices to spike, say builders, are tariffs imposed by the Trump administration on imports such as steel and lumber.
McGuinn, the South Carolina builder, defends tariffs that he believes level the playing field. His, though, is a minority view among builders, some of whom, like Turner of Saint Aubyn Homes, think tariffs are negating some of the positives from tax reform. “The tax cuts giveth and the tariffs taketh away,” quips Howard of NAHB.
The tariffs arrived at a time when the cost of building materials had been escalating for a while. Even though lumber suppliers pulled back a bit this summer, builders say they are still feeling the pinch on key commodities. “We’re very nervous about engaging in presales,” says Greg Prieb, owner of Prieb Homes, one of Kansas City’s largest builders. He has even thought about adding a line item to his contracts to account for lumber inflation. (Asked how he thinks that would go over with customers, he says, laughing, “probably not very well.”)
Several builders acknowledge that their companies have been incrementally but steadily raising their home prices this year to cover their hard costs. Benshoof of Berks Homes says his prices are up $3,000. Neal of Neal Communities claims that tariffs have helped make his homes $10,000 more expensive this year, “which, times 1,200 [the number of houses Neal Communities expects to close in 2018] is $12 million—that’s more than the benefit from the tax cut equals for our company.”
In Columbia, S.C., one of that state’s more affordable cities, McGuinn Hybrid Homes has increased its prices this year by $18,000, to an average of about $180,000. But McGuinn, the company’s owner, doesn’t think this is deterring purchasers. “When loans are at 4.75 percent, does a price increase like ours really keep people from buying a house?”
Other builders counter McGuinn’s argument by saying there’s a limit to what buyers will accept. “We’re already getting pushback,” Krasoff points out. And the industry isn’t that far removed from prerecession days when home prices soared, effectively shutting sizable portions of buyers
out of the market. “The only thing that could really stifle the housing market’s growth is if builders get greedy,” Turner cautions.
Did the Publics Gain an Advantage?
One company that continues to build homes for first-time buyers is Bill Beazley Homes, in Augusta, Ga., which expects to close 270 homes this year, 325 in 2019, and 400 in 2020. Its 1,500-square-foot models with a detached two-car garage retail for between $170,000 and $180,000.
President Stephen Beazley says his company is able to do this because, in Augusta, it’s the only landowner/builder/realtor (a Berkshire Hathaway franchise) left standing, so it can be particular about what land it buys and what homes it builds.
Bill Beazley Homes is a C corporation, and as such saw its corporate tax rate drop to around 20 percent as the result of reform. “The business tax cut is really important to us,” Beazley says, especially when banks are demanding 35 percent down on land purchases.
Pyatt Builders, in Carmel, Ind., is an S corporation, and the reform’s implications for pass-through businesses are a huge benefit, says company owner and president Todd Pyatt. “We’re excited to utilize the savings for future investment in the company.”
Brooks says that Grand Homes, which is family owned, restructured some of its development LLCs to take advantage of the new tax law. However, other private builders, such as Dykstra of Bloomfield Homes, think corporations got too good a deal. Neal elaborates that his company’s tax rate fell to 32 percent versus an average of 21 percent for corporations. “The difference in the marginal tax rates is huge and could be a factor in future land purchases because the publics could do deals that we can’t or won’t do since they aren’t financially right,” he says.
Bauer of TRI Pointe, a C corporation, concedes that the tax break improves his company’s earnings per share and gives it more capital to work with. “But it hasn’t changed the way we underwrite land,” he adds.
Reform Is One of Many ‘We’ll Sees’
In the final analysis, tax reform seems to have given builders some financial breathing room, but it doesn’t register as a game changer—at least not yet. It’s one of several blips on builders’ radar screens that bear watching as potential pluses or minuses for the housing market.
A bigger, more ominous, blip is the shortage of available lots, which the Federal Reserve has predicted could significantly weaken housing’s growth. In light of that warning, Beazley says his company has “put in” between 600 and 650 lots to ensure it has enough to build on over the next two years.
Rising interest rates and inflation are other factors over which builders are fretting. “As we’ve expanded we’ve tried to offer more square footage at a lower price,” McGuinn says, “but it’s been a challenge, with higher lot prices, the impact of tariffs, and price creep after the last recession.”
Even TRI Pointe, whose selling price averages $632,000, has been looking to build smaller homes on smaller lots to keep its prices under control.
Tax reform also pales beside larger macroeconomic factors that impact housing, such as the country’s $1.1 trillion deficit and political divisions that change the rules of the game with every election cycle.
“Builders want three things,” Neal says. “Low cost of operations, low interest rates, and a powerful U.S. economy. What we have now are higher costs, chaos in the financial sector, and the potential for less economic security. I sometimes wish they would have left things as they were.”