Weekly Economic Update

Economic News:

The Fed Is Costing The Feds Money

Higher rates are costing consumers – and the government – more money.

We had a pretty sharp upturn in rates in August. Since then, interest rates have remained elevated. It was a bit unexpected because most market analysts were predicting rates to ease a bit in the second half of the year. This was not the way to start out the second half of the year if we expect rates to fall. Of course, the economy being so resilient in the face of rate increases by the Federal Reserve was a surprise as well. A stronger than expected economy has the markets expecting rates to stay higher for a longer period of time.

Another factor contributing to higher rates which is directly attributable to the Fed, is the US government borrowing so much money. Pandemic spending and the pandemic recession have contributed to soaring government deficits, which must be financed. Exacerbating the problem is the fact that every time the Fed raises rates, it has become more expensive to finance the deficit. And that higher cost creates more deficits. In 2023, interest on our debt is approaching 15% of total federal spending – or close to three-quarters of a trillion dollars.

Thus, higher rates are not only costing consumers more money, but the government as well. And they are contributing to higher rates in a classic “catch-22.” This week, the Fed decides whether to raise rates yet again. We are quite sure they are aware of the math we just presented. We don’t think this factor will cause the Fed to hold rates steady from here, but many analysts believe that another pause may be justified. Of course, what they say about the future of interest rates is what really will move the markets when they make their announcement.

Fannie Mae Sees 2024 Turnaround

Despite improved economic outlook, inventory and affordability challenges remain.

The outlook for the American economy has been much rosier lately, with robust spending figures and two straight months of Consumer Price Index (CPI) data edging closer to the Federal Reserve’s target inflation range. Such indicators have improved the odds of a soft landing and decreased the likelihood of a recession, according to Fannie Mae — but in terms of housing activity, it may not really matter. Per the latest forecast from Fannie’s Economic and Strategic Research (ESR) Group, home sales are set to “remain subdued within a tight range” regardless of whether or not the economy enters a recession. If it does, both affordability and inventory are likely to improve, due to falling interest rates. Those swings, however, are also likely to be offset, at least in part, by a softer labor market and tighter credit standards, as well as the psychological effect on consumers who may enter savings mode. If the economy does avoid a full downturn, the historical dearth of inventory, coupled with affordability woes and the impact of the interest rate “lock-in” effect, still provide enough downside risk to home sales activity. Fannie now forecasts total home sales of 4.90 million units in 2023, which would equate to a 13.6% year-over-year drop if realized and would hover around the lowest level of sales in more than a decade. The market is still expected to turn a corner in 2024, with projected total sales of 4.93 million units, which would be a 0.6% increase from 2023. Single-family originations are currently forecast at $1.60 trillion this year, similar to its previous forecast. Next year, originations are predicted to grow to $1.92 trillion, an increase from the $1.90 trillion previously projected by the ESR group. As far as whether or not Fannie expects a recession, the government-sponsored enterprise still foresees a “mild” recession in its crystal ball by the beginning of next year. (Source: Scotsman Guide)

Capital Gains Moratorium Promoted For More Inventory

Could a capital gains moratorium financially motivate owners to sell?

The housing supply has fallen to a historic low. Builders have not been able to keep pace with demand, resale stock is in short supply due to many social and economic factors, and the demand for housing from the millennial generation continues, with a younger generation of Zoomers right behind them. Affordability at all levels remains a challenge, the diversity of housing stock as means of allowing greater affordability continues to be a problem, and public officials are searching for answers in zoning, construction, tax credits, and repurposing of commercial office space as a means to boost supply and affordability. All of these efforts are important, but there may be yet another means of restoring harmony and balance to this supply equation. What we are proposing is a moratorium of two years at the federal level on the capital gains tax for real estate as a possible means for increasing supply, easing demand, offering more opportunity and selection, and just perhaps, returning appreciation to a more acceptable norm. The Boomer generation is one of the wealthiest, and has a lot of investment property, much of which falls into the affordable housing range, under $1.2 million in urban and metro areas. Many (not all) are hanging onto this property because of the 15% capital gains tax at the federal level, combined with the 5% capital gains tax at the state level, and a depreciation tax on top of this, making selling too expensive and egregious. By having a finite period of two years in which to financially motivate these individuals to sell, the housing market could be made to resemble a four- to five-month supply and force the market to return to some level of normalcy. This solution, however, must be implemented with considerable care and oversite so as to avoid flooding the marketplace and causing another housing recession. At each four-month interval during the two years, the program would be reassessed for its efficacy. The parameters would be re-evaluated to ensure they are not producing a deluge of homes coming to market nor a shortage. The numbers could be adjusted up or down, or not at all, based on what the national housing data is showing. The program could be regulated by the Department of Housing and Urban Development, which would have the right to change the parameters if the program needs to be accelerated or decelerated based on the number of homes coming to market or languishing on the market; it could do so by issuing a change at the end of each fourth month cycle. Because real estate is hyperlocal, each state would have the right to end participation at the end of each six-month interval during the two-year moratorium. (Source: Guest Opinion, WRE News)

Real Estate News:

The Evolution of Downtown

Cities looking for solutions to convert unused office space into housing.

City centers are struggling to fill the gap left by commuters who now come into the office a few days a week, if at all. These workers were patrons of downtown businesses, from restaurants to dry cleaners. Without them, offices are desolate and businesses are shuttering. To save these downtowns, cities are trying to turn unused office space into housing. San Francisco officials are making efforts to adjust current building codes and get rid of extra fees for office-to-residential projects. In Washington, D.C., the mayor wants to put more money into a tax relief program for office conversions. Even cities like New York, where many companies have offices, vacancy is becoming a problem. Office vacancy in Manhattan was 15% recently, according to real estate investment firm CBRE. "The commute has crushed a lot of people's willingness to trudge into the office every day," said Jason Alderman, the head of real estate giant Hines' New York office. He said Hines' buildings within a half-mile of the major transit hubs Grand Central and Penn Station have higher occupancy rates than others. But, he added, "buildings that are catering to people — making it exciting to come back to the office or easy to come back to the office — are winning."

As demand for other office buildings decreases, Hines is considering office-to-apartment conversion projects. Alderman said the company is actively bidding on properties. Converting an office building into a residential space can be difficult, and that's when the building already has the right structure to work with. A lot of buildings don't — they're too wide, or have the wrong kind of windows, which makes conversion more expensive. But politics may be a greater factor in a project's success. Even as cities try to entice developers to turn office buildings into apartments, they've also installed obstacles. In New York, strict zoning rules already impact which buildings — and in some cases, how many floors — can be converted into housing. Rezoning a property for residential use can be timely and costly. Alderman said approval also requires support from politicians, who often add requirements for affordable housing a developer may be unable to afford. (Source: NPR)