As I have stated in several recent interviews and articles, we believe that the reduction in sales volume in the under $100 million category of property sales in New York City has been the result of supply constraint as opposed to weak demand. Property owners are bombarded with negative news about the market and are opting not to put their properties up for sale rather than to sell into a disastrous market. The fact is that the market is not disastrous, far from it. Prices are remaining healthy and debt is plentiful from numerous portfolio lenders who are looking at present loans as cherries which are more profitable than they have been in recent memory with spreads of 250 to 300 bps over LIBOR and with much less risk as loan to value ratios have declined from 75-80% to 60-65%. We believe this supply constraint will start to abate for two reasons: the first is that word is spreading that achievable prices are still near record levels and the second is that the reality of capital gains tax increases next year are starting to get some play.
We have been advising clients that it is likely capital gains tax increases will be approved next year. No one believes the capital gains rates will go down and a growing majority agrees that these rates will increase. The reason for our perspective is the massive shortfalls faced by state governments and the federal government. Many states are hurting with projected shortfalls in tax collections approaching $40 billion. This is more than three times the totals experience in 2007. Moreover, the federal government is facing massive shortfalls in its budget. The culprit: the national housing slump which is well into its second year. This slump has had a multiplier effect in tax collections across the nation.
The obvious tax collection problem is real estate taxes as payments are not made on houses which are in foreclosure. While these taxes will be paid eventually, it takes time for the property to work its way through the system and taxes are not paid as the house is digested and recapitalized.
Personal income tax collections are off significantly as our unemployment rate continues to grow. Unemployment is currently at 5.5% and is expected to continue to grow. The next unemployment report is due out this Friday and it will be interesting to see how the labor market is performing.
Corporate income tax collections continue to recede as the result of falling profits. Losses in the financial services sector alone will result in hundreds of billions of dollars of evaporating corporate taxes.
Lastly, sales taxes have been greatly affected by the housing slump as well as high gas prices. Fewer home sales means less money is spent on home renovation materials, home furnishings and appliances. Higher gas prices are prompting cutbacks in consumer spending as families continue to try to figure out how to make ends meet. The inability of homeowners to access mortgage equity withdrawal has also had a debilitating effect on spending. The Fed’s beige book is, by all accounts, underestimating current conditions as it presently characterizes consumer spending as “slowing”. Moreover, consumer confidence is as low as it has been in 40 years as more than half of employed Americans believe their income will be less this year than it was last year.
Given these conditions, governments are going to have to come up with additional revenue to meet these tax collection reductions. Unlike the federal government, most state governments are required to balance their budgets. Capital gains taxes are vulnerable as they are viewed as a tax on the affluent. We have many clients that are presently putting properties on the market with the condition that a closing must occur before the end of the year. The next administration is likely to raise the tax which, on a federal level, is normally retroactive to the beginning of the year. We expect this wave to continue as sellers who do not want to effectuate a 1031 exchange take advantage of historically low capital gains rates.