Yet Another Issue Affecting the Residential Real Estate Market

It’s common for households comprised of elderly parents to hang onto valuable stock portfolios for reasons beyond need as they age. It makes practical tax planning sense not to sell before death to avoid paying tax on long-term gains accumulated on aging portfolios. Such sales would eliminate the step-up basis that their children would enjoy under current tax law. A similar kind of tax planning is a growing factor in the residential housing market. In other words, what was common in the world of paper investments is increasingly a factor in the availability of homes for resale.

Boomer-nomics

A quick review of the Federal Reserve Chart (below) shows that the bottom 90% of households own barely 13% of the stock market. However, those same households own 56% of the housing market. By comparison, the top 1% of households own 50% of the stock market but less than 14% of the housing market.

The glaring point here is that for the majority of middle-class families, their homes are the most valuable financial asset. And buying a home by this young crowd in today’s market is a tall order. Older individuals, who often have substantial equity in their homes, are less affected by recent soaring prices and higher mortgage rates. Not surprisingly, they are responsible for over half of all housing sales and almost half of purchases. So how does today’s young middle class keep up? 

No Housing Boom Here

According to the National Association of Realtors, first-time buyers are having trouble finding homes they can afford. A couple of reasons are apparent.

• They don’t earn enough money to purchase their first home due to inventory shortages, particularly in the resale market. 

• Some in the Boomer crowd are trading up or downsizing into retirement. Still, many are locked into their current abodes due to the not-so-low mortgage rates or the current sky-high valuations of homes bought years ago in a totally different price environment. In short, many aging Baby Boomers are just not selling.

To make a point, let me construct an example of home ownership in America’s regions with inflated cost of living, many of which are located on the East and West coasts. An older couple, not wealthy except for their home ownership, bought a home forty years ago for $40,000, which is now paid for and worth well over $2.5 million. It sounds crazy, but my example is not that extreme. The couple has since aged into their eighties and would like to sell, but won’t. Why not? Just like those highly appreciated paper investments many older couples own, if they sell, they will create a huge tax burden for the family by eliminating the “step-up basis” their children would enjoy under current tax law once the parents pass to their reward.

Generational Impacts

This aging population is not selling for good reasons, as they are locked in place by favorable tax treatment and/or low mortgage rates. The resulting inventory impact on the residential real estate market is real. In short, the step-up basis of family homes to current value is too financially advantageous to ignore. Instead of the parents paying a significant capital gain on a pre-death sale, if the children sold the property immediately after inheriting it, they would pay no capital gains taxes at all.

What a significant benefit this allows some parents to pass on to the next generation. But not so much to those born in less favorable situations. Lower mortgage rates will help if and when that finally happens. But a lot of young folks are casualties of today’s “unaffordability” when it comes to buying a home.

This makes the stock market increasingly crucial as a wealth-building vehicle.