California has anted up $200 million from the state’s treasury to pump up the housing market in yet another builder and lender tax subsidy based on prematurely bringing out what would be next year’s homebuyers. The state’s subsidies will grant $100 million in tax credits (prepaid taxes or refunds) toward the purchase of existing homes (primarily real estate owned properties [REOs]) and another $100 million to the purchase of homes in builder inventory. Both will accelerate the movement of tenants into homeownership and contribute to increasing vacancies in residential income properties.

Anyone who has not owned their principal place of residence during the past three years may purchase either a new or existing home and get the tax credit. But non-first-time homebuyers (those who owned their residence within the past three years) may only receive the tax credit by purchasing a new, never-before-occupied home. For the purchase of an existing home, homebuyers must close escrow during the period beginning May 1, 2010 and ending December 31, 2010. Purchasers of new homes have until Aug 1, 2011 to close escrow – builders are creating more inventory – but must enter into an enforceable purchase agreement and file for the credit between May 1, 2010 and December 31, 2010.

The amount of the credit is the lesser of 5% of the purchase price, $10,000 or the taxes due the state by the homeowner. The tax relief for the homebuyer is delivered in equal installments over three years – as a reduction in taxes they may owe.

first tuesday take: The new tax credit “for” homebuyers is nothing more than a subsidy for lenders, the building industry and brokers/agents handling their transactions. The subsidy for these gatekeepers is indirectly received, taken through the sale of property that would not occur until later years – the motivating purpose of the tax credit. To boot, it will only drive up sales volume, prices, demand and momentum temporarily, artificially and unsustainably.  As a result, 2011 sales volume and prices will be worse off because of the subsidy than they were going to be. Not good prior planning.

Instead of handing buyers money to purchase the leftovers of excess homebuilder construction and REO inventory from the mortgage lender debacle, California’s lawmakers should use this state money to pay California-based developers to refrain from building in much the same way as the federal government subsidizes landowners to leave farmland fallow to avoid agricultural overproduction (a more forward-looking event). The logic behind doing so is maintenance of the market: control supply until a full-bodied housing demand develops. Otherwise, the government subsidy undermines the market by creating an artificial, unsustainable demand to eat up housing inventory when it is clear an increase in sales will be a flash in the pan when much more inventory is either in the pipeline (as REOs) or will be created by builders.

Here, the tax credit depletes the market of future buyers. Once the subsidies run out, there will be an insufficient reservoir of prospective buyers to keep the market going. It’s simply demographics – retiring Baby Boomers and a cyclically low number of the population in the age bracket for first-time homebuyers. Lawmakers are essentially pre-selling to those who won’t be here later to buy in 2011 and 2012 when they are needed – unlike what occurred with the last housing tax subsidies in 1975, which were also unnecessary, but for an entirely different reason: the recovery was already underway. [For more information on how generational demographics affect housing, see the February 2010 first tuesday chart, First-time homebuyers and new housing.]

Furthermore, granting $200 million in tax credits to homebuyers is a serious misappropriation of taxpayer money. California has an educational system that is third from the bottom nationally, and we are spending precious tax dollars on builders and lenders to get next year’s buyers to buy now!

Thus, it’s little wonder the interference with government spending by powerful trade unions for conservative builders and brokers herald these government give-aways as top-draw action. Lenders have prudently remained silent so as not to taint the relief with their presence. Sacramento, it seems, always finds reason to throw a bone to the developers and lenders – the very people who single-handedly built the bubble. [For more information on the past and present of tax subsidies in the housing market and how they affect housing inventories, see the March 2010 first tuesday article, Prices will fall as the supply of housing soars above demand.]

Re: “Some home buyers get new state tax credit,” from the San Francisco Chronicle