Steady as she goes through the inter-cycle strait 

Once every four years, the world buckles into an emotional rollercoaster to watch the summer media eclipse of the US Presidential Elections, the Summer Olympics, and the Euro Cup.

For the adrenaline news junkie, this quadrennial super news cycle is already an unusually potent batch, with an assassination attempt, a presidential nominee hot swap, and global division not seen since the 1930’s. While political headlines and campaign advertisements implore “the end is nigh”, they have had little impact on the private markets as the U.S. economy appears to coast towards Captain Powell’s elusive soft landing. In the words of the late right-hand man of the Sage of Omaha:

"The idea that you can make macroeconomic predictions and invest accordingly is one of the most destructive ideas that has come into economics." – CharlieMunger

However, there is an exception when it comes to headlines surrounding changes in U.S.fiscal policy, particularly taxes on investments, that change the rules of how the game is played.

Let Them Eat Caps

A recent election headline that generated questions for RRA’s investors wasPresident Biden’s announcement that he intends to address the affordable housing crisis by implementing a 5% cap on rent increases. Failure to comply could result in losing beneficial tax treatment or even an automatic default on Fannie/Freddie loans.¹

This cap would target “corporate landlords” (defined as any landlord owning more than 50 units across all holdings) and create something akin to a sin tax on profits enforced by the IRS and GSE lenders. The notion that any landlord seeking optimal rental rates is unjust or exploitive and thus should be restricted has tinges of Riba (a sin to profit on loans), and Bolivarian socialism. Never mind that the largest investors in multifamily are public pensions and 401k managers like Vanguard.

That being said, all affordable housing crises are a function of supply shortages. These shortages are often exacerbated by rent controls as seen in San Francisco, New York City, and many European cities, because rent control hurts housing inventory by discouraging new investments in building improvement sand developing more supply. This type of political rhetoric adds uncertainty to the real estate market and signals to private investors to reduce exposure to housing and throttle back new development.

Even during the apartment boom of the last cycle, the U.S. was unable to create enough housing supply to moderate pricing. Take, for example, a market like AustinTX, that once led the nation in multifamily development over the last cycle, and now leads the nation in multifamily rent declines (–8.1% since 2022)despite occurring during a period of historic inflation.²

Now, with the Fed’s monetary tightening, new residential construction across theU.S. is already down 21.8% year-over-year according to CoStar, and federal dis-incentivization via rent caps would compound the housing crisis.

WithBiden stepping down, it's unclear if a Harris Administration would continue to pursue other punitive actions against real estate investors; but further pursuit of such a policy demonstrates our politicians' ignorance of supply/demand economics at best, or their desire to buy votes through socialist policies that transition away from capitalism at worst.

But Often Rhyme

The last time the tax code was significantly revised to the detriment of real estate investors was during the Reagan Tax Reform Act of 1986. This reform eliminated passive activity losses and accelerated depreciation, which had previously attracted investments in commercial real estate as a tax shelter to offset other income. As a result, capital flows into commercial real estate were abruptly curtailed, leading to a negative impact on property values. This chain reaction ultimately contributed to the Savings and LoansCrisis of the late 1980s and early 1990s when 2,443 lending institutions failed and over $300 billion of value, in today's dollars, was lost.³

In the 1960s, 70s, and early 80s, when these tax incentives existed to promote investment in commercial real estate, the US had an average housing shortage of 10.05%. In comparison, the following period (late 1980’s until today), averaged at 16.63% and is currently 19.23%, the highest since the post WWII housing shortage.⁴

The tax code change in 1986 (and subsequentS&L Crisis) was a particularly painful memory for real estate developers like my father, Charlie Dunlap, who built and managed over 10,000 units in the1980’s.

Having worked in real estate through the S&L crisis, my father has imbued RRA with a keen sensitivity to government market manipulation and a stubbornly strong bias against anything rent controlled.

‍ 

Footnotes:

¹ White House (President Biden Announces Major New Actions to Lower HousingCosts by Limiting Rent Increases and Building More Homes)

² CoStar (Change in Average of Market Effective Rent/SF from 2022 to2024)

³ FDIC Historical Analysis in today’s dollars

⁴U.S. Census Bureau and Department of Housing and Urban Development (HUD)