Changes California Can Make to Increase Housing Inventory

Since the pandemic began three years ago, our market and real estate markets nationwide have experienced unprecedentedly low levels of for sale and for rent inventory. Even with much-reduced demand due to interest rates doubling in less than a year, supply in most areas remains well below pre-pandemic levels. The “lock-in” effect of low interest rates and regressive, older property tax bases as well as lack of building new homes in the Los Angeles market over many years are the reasons for the extreme supply problem. The state and local governments have done very little to incentivize supply and instead have heaped taxes and controls that have only exacerbated these conditions. Here are some suggestions that could help accomplish the objective of increasing inventory.

End or Modify Prop 13

Proposition 13 was enacted in 1978 in California and sets the base tax assessment value of a property at the purchase price and a limit on property taxes of 1% of the assessed value (plus additional voter-approved taxes, normally up to around .25%). It also limits assessed value increases to no more than 2% per year. The 2% per year maximum increase, which is much less than average real estate appreciation, is problematic in that it discourages people from selling their properties because they would pay much more in taxes on a comparable home bought today. It also creates a regressive tax situation where a person who has owned their property for 30 years and whose home is now worth $5M pays less in property taxes than someone who purchased a $1.5M property last year. Of course, immediately ending this and increasing everyone’s assessment to the current value would be punitive and would have terrible consequences, but an idea to address this moving forward is that there should be a limit on how long the basis can increase only 2% per year and, after that time, it will increase more rapidly until it catches up with market value. This in itself would incentivize moving more frequently, but even more incentive could be created by homeowners being able to reset this clock on their lower tax basis if they move to another property, similar to the recently-passed Proposition 19 for seniors. This would not only increase turnover, which creates economic activity and tax revenue, it would increase supply. This suggestion will do a better job of incentivizing supply than the current model, however it would likely have a slight negative impact on home values.

Create a Bonus Mortgage Interest or Property Tax Deduction that Declines over Time

While there’s nothing we can do about current interest rates and the “lock-in effect” this is having on reducing supply of homes for sale by would-be sellers whose property has a much lower interest rate than what is currently available, we could create additional incentives to move by modifying tax deductions. Without getting into complex tax details that will vary depending on the person, the state could incentivize moving by increasing the amount of mortgage interest deductible amount for the first years of ownership with the percentage declining over time (e.g. 100% the first year, 90% in year 2, and have it sunset after 10 years). The same can be done with property taxes, which are not currently deductible in California. Make the full amount of property taxes paid deductible in year 1 with a 10% reduction in tax deductibility each year. This will incentivize people to move more frequently, increasing supply. What about all this tax savings cutting into the state budget? Well, the increase in transactions that result will increase income tax and transfer tax revenue. The modification of Prop 13 will increase property tax revenue. Also, the additional tax revenue received from reducing the amount of mortgage interest deduction after years of ownership will help fill in any budgetary holes created by allowing new or additional deductions. All of this being done in a way that encourages people to move, not to stay put forever.

End Rent Control

Economists are not generally proponents of rent control, and for good reason. Rent control limits supply, which drives prices higher for those not lucky enough to have signed a lease long enough ago to benefit. It reduces relocation, even in the event of employment changes, lowering potential economic activity and creating more traffic and pollution due to increased commutes. It also creates a moral hazard for landlords to not improve the quality of their product. Why bother updating or modernizing a property when you can’t get fair market rent and you probably would like your tenant to leave anyway? Additional rent control measures such as no-fault eviction protection and relocation fees to vacate a tenant for an owner to sell or move into their property, some of which have been recently imposed on single-family properties in Los Angeles, discourage investors from getting into the rental property business in the first place. This results in fewer available rentals and higher prices, despite what rent control intends to accomplish. Tax deductions and housing vouchers are better solutions to help affordability for renters and maybe making home ownership more attainable is a worthy goal as well.

Incentivize Development of Any Kind

To give an example of a systemic problem that discourages development, I will recall a personal experience. In 2016, I helped a developer purchase a triplex in Los Angeles. This developer intended to tear down the approximately 90 year-old building and redevelop the property into small lot single family homes. Five years later, in 2021, they finally completed the construction and were able to begin selling the homes. During this time, they were required to take part in various community meetings where the public got to weigh in on everything from the number of units to the architectural style to the location of the garages and the building department took all of this into consideration, requiring re-design and more meetings before ultimately approving the project. If it takes five years of carrying costs and opportunity costs to build a relatively small in-fill development in a non-historic preservation area, there’s no wonder why few have the stomach for development in LA. It appears that local government is now attempting to help fast track larger projects due to the housing shortage, however, new transfer taxes discussed in a previous post, have the effect of making larger developments potentially unaffordable and inflating costs. Tax incentives for developers that increase based on the number of units added and streamlined approvals for projects that are permitted “by right” based on zoning as well as more city planning staff and building department inspectors to deal with the increased capacity would help a great deal.

While change is slow and there will obviously be many opponents to these potential policies (as there are opponents to change of any kind), these can help alleviate supply shortages over time. The current situation has led to lack of affordability and, to some extent, an elite class holding onto their properties indefinitely, in fear of leaving them for financial reasons, with minimal opportunity for new buyers. It is true that while these suggestions aim to increase supply, there will be some increase in demand as well as people who are incentivized to move search for other properties. Even if demand goes up the same amount of supply, this is still good. The act of creating more mobility stimulates the economy and results in more options for sale at any given time, but in the aggregate, it should result in more supply locally. Yes, these suggestions will probably bring down values slightly, as more supply does, and the reduction of future tax benefits could do, but it could begin addressing the current incentives that lead to supply problems that rent controls and additional taxes will not.