The asset-correlation parameter in Basel II for mortgages on single-family residences

Bank capital ; Risk management ; Basel capital accord ; Mortgages

Understanding the Real Estate Provisions of Tax Reform: Motivation and Impact

Capital investment tax provisions have been changed numerous times in the last decade, with depreciation tax lives shortened in 1981 and lengthened ever since and capital gains taxation reduced in 1978 and 1981 and now increased. The first part of this paper analyzes these changes and attributes a large part of them, including the 1986 Tax Act, to changes in inflation: tax depreciation schedules and capital gains taxation that look reasonable when the tax depreciation base is being eroded at ten percent a year and an overwhelming share of capital gains is pure inflation take on a different appearance when inflation is only four percent. The remainder of the paper critiques the typical project model used to compute impacts of tax changes on real estate and report simulation results using a modified model.

Real Estate and the Tax Reform Act of 1986

In contrast to the conventional wisdom, real estate activity in the aggregate is not disfavored by the 1986 Tax Act. Within the broad aggregate, however, widely different impacts are to be expected. Regular rental and commercial activity will be slightly disfavored, while historic and old rehabilitation activity will be greatly disfavored. In contrast, owner- occupied housing, far and away the largest component of real estate, is favored, both directly by an interest rate decline and indirectly owing to the increase in rents. Low-income rental housing may be the most favored of all real estate activities. The rent increase for residential properties will be 10 to 15 percent with our assumption of a percentage point decline in interest rates. For commercial properties, the expected rent increase is 5 to 10 percent. The market value decline, which will be greater the longer and further investors think rents will be below the new equilibrium, is unlikely to exceed 4 percent in fast growth markets, even if substantial excess capacity currently exists. In no-growth markets with substantial excess capacity, market values could decline by as much as 8 percent from already depressed levels. Average housing costs will decrease slightly for households with incomes below about $60,000, but increase by 5 percent for those with incomes above twice this level. With the projected increase in rents, homeownership should rise for all income classes, but especially for those with income under$60,000. The aggregate home ownership rate is projected to increase by three percentage points in the long run in response to the Tax Act. The new passive loss limitations are likely to lower significantly the values of recent loss-motivated partnership deals and of properties in areas where the economics have turned sour (vacancy rates have risen sharply). The limitations should have little impact on new construction and market rents, however. Reduced depreciation write-offs, lower interest rates, and higher rents all act to lower expected passive losses. Moreover, financing can be restructured to include equity-kickers or less debt generally at little loss of value.

In Search of Empirical Evidence that Links Rent and User Cost

Most models of the rental housing market assume a close linkage between the level of residential rents and the after-tax user cost of rental housing capital. However, little empirical evidence exists to establish the strength of this linkage or the speed with which rents adjust to changes in user cost or tax policy. This paper develops and estimates an econometric model of the rental housing market in order to shed light on both of these issues. United States annual data for 1964 through 1993 are used to generate two-stage least squares estimates of a four equation structural model. Although the results are generally consistent with expectations and reveal several interesting relationships among the system variables, the estimates fail to identify a strong relationship between rent and user cost. About half of an increase in user cost is ultimately passed along as higher rent. The adjustment process also takes a long time, with only about a third of the long-run effect realized within ten years of a user cost shock. The fundamental reason for this result is that our estimate of the user cost series, based upon widely accepted procedures, is much more volatile than the residential rent series.

Why Do Some Real Estate Salespeople Earn More Than Others?

This paper explores the reasons why some real estate salespeople earn more than others. Data from a survey of members of the Illinois Association of REALTORS conducted in the spring of 1985 are the basis of the analysis. The central part of the paper analyzes via multivariate regression analysis over twenty factors thought to determine real estate sales success as measured by income from real estate brokerage. The most important findings include: (1) number of hours worked is closely linked to income; (2) income increases substantially with years of experience in the early years of a career (over 20% per year for the first five years), but these increases flatten out for the veteran with more than ten years of experience; (3) no significant differential in earnings is detected between men and women of the same age and with the same education.

In Search of Empirical Evidence That Links Rent and User Cost

Most models of the rental housing market assume a close linkage between the level of residential rents and the after-tax user cost of rental housing capital. However, little empirical evidence exists to establish the strength of this linkage or the speed with which rents adjust to changes in user cost or tax policy. This paper develops and estimates an econometric model of the rental housing market in order to shed light on both of these issues. United States annual data for 1964 through 1993 are used to generate two-stage least squares estimates of a four equation structural model. Although the results are generally consistent with expectations and reveal several interesting relationships among the system variables, the estimates fail to identify a strong relationship between rent and user cost. Only half of an increase in user cost is ultimately passed along as higher rents. The adjustment process also takes a long time, with only about half of the long-run effect realized within ten years of a user cost shock. The fundamental reason for this result is that our estimate of the user cost series, based upon widely accepted procedures with by to calculate user cost, is much more volatile than the residential rent series. In a recent paper, DiPasquale and Wheaton also find a slow adjustment process. Nonetheless, such sluggishness is surely different than many economists believe. We offer several possible explanations for this result. Among these is the possibility that the linkage between rent and user cost is too complex to be identified using 30 years of national data

An Estimation of Three Sets of indicators of Financial Risk Among Multifamily Properties

A lack of information about the financial condition of multifamily properties has hindered the development of a secondary mortgage market in multifamily mortgages and federal policies to finance multifamily housing. The purpose of this paper is to improve our understanding of the financial condition of multifamily properties. The centerpiece of the analysis is the 1991 RFS [U.S. Bureau of the Census]. Three sets of indicators of financial distress are examined in this paper. The first is interest rate related risk. We find that twenty five percent of the properties with mortgages have contract interest rates at least 87 basis points above the average contract rate, which was 10 percent at the time of the survey. This places these properties at a disadvantage in the market place because their costs are above average. On the positive side, many property owners were able to refinance or otherwise renegotiate their contract interest rates during periods of interest rate decline. The second is cash flow risk as measured by the ratio of net operating income to the mortgage payment (DCR). The measured DCR has a mean of 2.9 and a median of 1.36 among properties with a mortgage. A quarter of all properties with some mortgage debt have a DCR below unity. If one assumes our measure overstates the true DCR by 20 percent, then as many as half of the properties have DCRs at or below 1.1, which suggests that a large fraction of the multifamily stock suffers from cash flow problems. The third is risk due to low equity. Investors with little or negative equity in the property are more likely to default than are investors with a substantial equity stake in the property. Such risk is measured by the loan to value ratio (LTV). The average LTV is .43 among all properties; three quarters of all properties have at least one mortgage and the average LTV among properties with some debt is 55 percent. Higher than average LTVs are associated with several other property characteristics: properties owned by partnerships (LTVs about 5 percentage points higher than the omitted category); properties that receive some type of assistance, e.g., Section 8 (LTVs from 2 to 5 percentage points higher than non-assisted properties); and properties with ARMs, balloon mortgages, or multiple mortgages (LTVs about 6 or 7 percentage points higher than others)

The Demand for Home Mortgage Debt and the Income Tax

The goal of this paper is to learn more about the demand for the amount of mortgage debt owed by United States home owners. Mortgage debt is defined to be the amount of outstanding household debt secured by the owner’s principal residence; mortgages for second homes and other real estate are not considered, but second mortgages and home equity loans are. The analysis focuses on the behavior of individual households and examines variations in the their demand for mortgage debt with respect to a variety of characteristics such as household income, age, education, and other characteristics of the household. Of particular interest is the responsiveness of the demand for mortgage debt to the tax rate at which interest on mortgage and consumer debt can be deducted. The 1983 and 1989 Surveys of Consumer Finance are used to estimate the demand for mortgage debt. The analysis offers strong support for the hypothesis that the demand for mortgage debt is highly responsiveness to a change in the rate at which mortgage interest can be deducted. As such, the elimination of the mortgage interest deduction can be expected to lead some households to shift away from the financing of owner-occupied housing with mortgage debt and toward the use of their own assets (equity finance)