EC Home Builders Buckle Under Tax Reform – Reviewing The Damage

In my last review of the housing market, I ran out of time to comment on an emphatic statement from the National Association of Home Builders (NAHB) regarding its failure to influence the Republican plan for tax reform. The tax plan coming out of the GOP side of the House of Representatives includes a provision to cut in half the cap on mortgages eligible for the interest rate deduction and also caps the deduction for state and local property taxes at $10,000. At the same time, the standard deduction is doubled so the number of people who will itemize should significantly drop. The NAHB has serious concerns about the potential negative impact on home ownership, and it delivered a clear warning that turned into a precursor of the steep sell-off in housing related stocks. From NAHB Chairman Granger MacDonald on the GOP tax plan:

“This plan is particularly disappointing, given that the nation’s home builders warned that the proposal would severely diminish the effectiveness of the mortgage interest deduction and presented alternative policies that would retain an effective housing tax incentive in the tax code…

By sharply reducing the number of taxpayers who would itemize, what’s left is a tax bill that essentially eviscerates the mortgage interest deduction and strips the tax code of its most vital homeownership tax benefit. This tax blueprint will harm home values, act as a tax on existing home owners and force many younger, aspiring home buyers out of the market.”

While the responses in the stock market varied roughly according to the concentration of high-end and expensive housing for a given home builder, the net impact on iShares US Home Construction ETF (ITB) and SPDR S&P Homebuilders ETF (XHB), which includes Home Depot (HD) and Lowe’s (LOW), was immediate and steep. ITB lost 2.4% and XHB lost 2.8%. LOW dropped 4.1%, and HD dropped 1.6%. I cannot explain why the two home improvement stores had such different impacts (I believe they have similar national coverage?), but the selling is likely from the theory that home sales will drop as richer home owners will be more reluctant to move in the face of dramatically worse tax situations; current homeowners are grandfathered into the existing tax scheme. I provide select charts at the end of this post along with brief commentary.

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Disclosure: Long INVH.

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