The New Republic, April 13, 1974
LIKE SOME 25 MILLION other heads of households in the United States, I must pay monthly tribute to an absentee landlord for the privilege of having a roof over my head. That tribute is no trifling sum: it amounts to about one quarter of my income. Part of it covers the legitimate cost of constructing and maintaining the building I live in, and I have no complaint about that. But a good-sized portion is profit for banks, insurance companies, real estate agents and present and past landlords.
My fellow renters are disproportionately poor, young and dark-skinned. In 1969, according to the US Census, the median household income for renters was $6,300; for homeowners it was $9,700. Three out of four married couples under 25 years of age are renters, as are nearly 60 percent of nonwhites (compared to 35 percent of whites of all ages). The renters’ handicap is that they haven’t inherited or amassed enough capital to lift themselves out of the status of tenancy. For this they are doubly punished: their housing is generally older and of poorer quality than that of non-renters, and they must disproportionately subsidize the income of landlords, bankers, brokers and insurers — those whom I call real estate parasites.
By contrast to the renter the homeowner is able to cut down his losses to the parasites. True, he generally pays for his house twice over, once for the property itself and again for the money to buy the property. In this sense banks are really landlords to us all: everyone must pay a tithe to the money-lenders for a roof over his head. The homeowner is also absurdly socked by title insurance companies, which collect several hundred dollars for reinsuring the same title they verified for a string of previous owners. But the homeowner gets some breaks that the renter doesn’t. He can deduct from his federal and state income taxes the tithe paid to money-lenders. And he can recoup a good part of the tithe when he sells his house later, just as the person who buys from him can recoup from the next buyer, and so on until and even after the building crumbles.
The people who fare best of all are not those who own their homes, but who own the homes of others. They too must pay a tithe to the money-lenders, but unlike the home-owner they are able to recoup the entire amount of the tithe — and then some not at some future date but every month when the rent checks come in. Typically about forty percent of a tenant’s rent goes to pay the landlord’s financing costs. Another one-fifth to one-fourth goes for property taxes, and about one-third covers upkeep, management and other costs. The rest is the landlord’s monthly profit, which is not to be confused with the gain he collects when he sells or refinances the building, or with the tax shelter benefits he receives from depreciation and interest write-offs. If inflation starts to gallop it doesn’t hurt the landlord: he can raise rents and cut back services while his financing costs remain constant, and he reaps a larger capital gain in the end.
The renters’ burden is increased when buildings are resold or refinanced. For reasons that will be explained in a moment, landlords generally don’t like to hold a property for too long; they prefer to sell old holdings and acquire others. Each time a new landlord buys a building, he borrows money to pay off the previous landlord. Since the price of the building will have risen, and interest rates most likely will have risen too, the financing costs of the new landlord will be higher than those of the old landlord. Each sale also means a six or seven percent commission for a real estate agent and another round of closing costs and title insurance fees. All these added costs are no problem for the new landlord: he raises rents, which accounts for the seemingly illogical fact that rents in old buildings don’t decrease after construction costs are paid off. Rents increase because the same old building can be resold a dozen times, providing succor for generation after generation of parasites.
Much the same result comes about when a landlord refinances rather than sells a building. Refinancing works like this. Suppose a landlord buys a building for $100,000 with $20,000 down and an $80,000 loan. After several years the building is worth $120,000 and the principal outstanding on the loan has been reduced to $60,000 thanks to the tenants’ monthly rent checks. The landlord then refinances the building by taking out a new mortgage, say, for $100,000. He pays off the $60,000 still left on the old loan and pockets the $40,000, in effect cashing in the equity his tenants built up for him, plus part of the gain from the building’s rise in value. Wondrously, he pays no capital gains tax on the $40,000 because it is in the form of a loan rather than the proceeds from a sale. And because he still owns the building, he continues to receive his month-to-month profits and retains title to future appreciations in value. The only problem is that he must make higher payments on his new, larger loan, but again this is easily solved by raising rents.
THE GOVERNMENT ADDS injury to insult through its lopsided tax laws. Consider first the local property tax, which is largely passed on to renters by landlords. A family paying $200 a month to its landlord is probably paying $40 or more in property taxes. So the actual rent is $160, with a “sales tax” of $40, or 25 percent, tacked on. No other commodity sold in the United States, with the possible exception of cigarettes, liquor and gasoline, carries such a heavy tax add-on. It’s regressive since low-income people spend a higher proportion of their incomes on housing than the well-to-do. Several states have tried to lessen the regressivity of the property tax as it affects homeowners by granting partial exemptions or “circuit-breaker” relief in the form of income tax reduction or rebates. But only California, Michigan and Vermont give similar property tax relief to non-elderly renters, and even in these states the renters’ relief is small compared to homeowners’.
The federal income tax discriminates against tenants by allowing homeowners, but not renters, to deduct that portion of their housing costs attributable to mortgage interest and local property taxes. This is an enormous subsidy and increases with the owner’s income. According to the Tax Reform Research Group, the average $7,000-a-year homeowner in 1972 saved $20 thanks to these deductions; the average $100,000-a-year homeowner saved $2,500.
Another tax subsidy for owners is the low rate at which profits from the sale of housing are taxed. Landlords pay the capital gains rate — half that at which renters’ wages are taxed. Homeowners pay no capital gains tax if they buy a new house within one year. The renter’s effective income tax rate is several percentage points higher because of these preferences to owners.
Perhaps the juiciest break for absentee landlords is the deductibility of depreciation on properties that don’t depreciate. Most apartment houses appreciate in value over time because the land beneath them rises, as does the cost of constructing new housing. The tax laws nevertheless permit landlords to deduct from taxable income a fictitious and, in the early years of ownership, substantial amount of depreciation. What’s more, a non-depreciating property can be depreciated not just once but several times, with each successive landlord getting his chance to play the game. This is one reason real estate is such an attractive tax shelter for the wealthy. It’s also a major cause of housing resales, and thus of rising rents.
Consider what happens after Landlord A buys a large apartment house and enjoys its hefty depreciation and interest deductions for several years. (Like depreciation deductions, interest deductions are concentrated in the early years of ownership because loan repayments contain more interest than principal at first.) When Landlord A’s tax deductions drop too low, he sells, the building for a capital gain to Landlord B, who begins his own top-heavy sequence of depreciation and interest deductions. Landlord A in turn uses his profits to buy another building on which he can get those juicy front-end deductions once again, and both landlords raise rents to cover the higher financing costs of their new loans. About half the annual investment in real estate goes into buying or refinancing existing buildings, rather than into putting up new ones. If resale and refinancing were discouraged instead of encouraged by the tax laws, there’d be more new housing built, and rents would be lower.
The federal government has made several efforts to aid renters. Loan guarantee programs of the Federal Housing Administration and the Veterans Administration have reduced the amount of savings needed to escape from tenancy. Low-rent public housing and public subsidized private housing have provided shelter for many, and direct rent subsidies have helped others to live in landlord-owned units that they otherwise could not afford. But contrast these federal approaches with housing policy in Scandinavia and other western European countries. There, the effort has been to reduce the subsidies renters pay to real estate parasites, rather than to subsidize those subsidies with government handouts. It has been done by rent control, municipal ownership of land, cooperative nonprofit ownership of housing, and so-called index loans in which financing costs, instead of being fixed for the entire term of a mortgage, are low initially and rise only at the rate of the cost of living or other price indices.
EDWARD M. KIRSHNER, an urban economist in Oakland, California, has drawn up a plan that would apply Scandinavian principles to American tax laws, and the results are astounding. Suppose a city acquired land at current market prices by floating low-interest tax-exempt bonds or by borrowing from local public employee pension funds. Suppose the city then leased the land to a nonprofit housing cooperatives with the proviso that payment for the land could be deferred until the co-ops finished paying for the housing they would build, rehabilitate or simply purchase. The co-ops would get 100 percent index loans from a municipal revolving fund generated through tax-exempt bonds or pension fund loans. Members of each co-op would make nominal down-payments followed by monthly payments to cover upkeep and management, retirement of the index loan, and payments to the city in lieu of property taxes. After the mortgage on the housing was paid off, that portion of the members’ monthly payments would go to reimburse the city for its land.
Note that co-op members in this model are better off than renters. As co-owners of their housing they can reap the mortgage interest and property tax deductions; they also get the homeowner exemption or circuit-breaker kickback if their state has one. Because the co-op is paying for housing and land in seriatim, rather than both at once, and because it has a low-interest index loan from the city, the members’ monthly payments are quite low. And because the land and housing are forever off the resale market, neither present nor future co-op members will ever be saddled with some new landlord’s refinancing costs.
The result of all these savings, according to Kirshner, is that the same housing affordable today only by families earning $14,000 could be available to families earning $7,500 (assuming 25 percent of income goes to housing). And this could be achieved without a penny of direct federal subsidies — indeed, without any additional federal legislation.
To put the model fully into effect would require municipal governments that aren’t afraid to step on the toes of real estate parasites (who tend to be powerful at city hall). Still, housing co-ops can be and have been developed without municipal support, bringing substantial savings to moderate income families. According to Paul Golz of the Mutual Ownership Development Fund, there are some 160,000 cooperative housing units in the United States, mostly labor-sponsored and mostly in New York City. Co-op City in the east Bronx, one of the largest housing complexes in the world, was aided by a $234 million loan from New York State; monthly payments there are well below the prevailing rates in New York City.
For the moment, however, true co-ops — not to be confused with condominiums—are a rarity, as are rent control, index loans and other arrangements that might reduce the profits made by landlords and bankers. Unless things change, my fellow renters and I will keep forking over those maddening monthly tributes. We may join tenant unions and otherwise protest, but the laws of the market and the state are stacked against us.