Depreciation change may raise housing prices

There has been quite a bit of discussion lately on how best to cure the ailing housing industry. Most economists predict that without a rebound in housing, the American economy will remain in its moribund state.

The FDIC recently offered a plan to bail out struggling homeowners, offering some combination of longer loan terms, lower rates and principal reduction. The rationale is that by helping homeowners avoid —- or even delay foreclosure —- home prices might be supported and the market stabilized.

This is a misguided attempt, destined for failure. Ultimately, there is only one legitimate reason a homeowner experiences foreclosure. He or she can’t sell the home for at least what they owe on the property.

In a thriving real estate market, homeowners who experience catastrophic illnesses, job losses and other personal difficulties are able to sell the home, pay off liens and salvage what remains of their credit rating as they move on with their lives.

Clearly, that thriving market does not exist today. Real estate operates on an extremely simple and timeworn principle —- the law of supply and demand.

When prospective buyers outnumber available properties, real estate values increase. Conversely, when the supply of homes on the market outnumbers qualified buyers, prices fall. Too much blame has been assessed to subprime and other high-risk mortgages for causing this mess.

While no one can argue that credit standards on many of those programs were too lax, eliminating the products altogether drove a significant population of potential buyers out of the market entirely. Many of those displaced buyers will find it difficult to re-enter the housing market for some time due to credit or income constraints.

Spending taxpayer dollars to supplement the mortgage obligations of distressed homeowners is not only extremely costly, it only addresses the supply side of the problem, and then only marginally. It also attempts to place an artificial floor on home prices, one that keeps many potential buyers out of the market.

One alternative, which specifically addresses the demand side of the equation, is to offer enhanced depreciation to investors buying real estate in a specific time frame, say through the end of 2009. Current tax law generally allows real estate to be depreciated over a period of twenty-seven and a half years. Temporarily lowering the allowable term of depreciation to 10 years would provide a substantial incentive for investors to enter the market and would encourage them to hold properties for several years in order to take full advantage of the tax benefits.

Distressed homeowners might become renters in their very own homes, salvaging their personal credit and stabilizing the neighborhoods in which they live. Further, as the supply of homes on the market dwindle, real estate prices would begin to rise and, like a rising tide, lift all boats.

Offering enhanced depreciation to real estate investors reduces revenue in the form of taxes to the federal government in the short term. But it is revenue neutral in the long term as these paper losses are recouped when the owner eventually sells the property.

There is a far better chance the federal government sees a return of its investment under this scenario than under the one currently proposed by the FDIC. The effect on the housing market —- and the economy as a whole —- would have a much greater impact as well.

> Kirk Smith, a retired mortgage lender, lives in Dunwoody.