For several decades it’s been a common understanding and an unwritten rule: “As California goes, so goes the nation.” It’s because the state is very often on the cutting edge of legislation and regulation on matters of importance to a broad swath of the American public. That’s why all eyes are on AB 1771, The California Housing Speculation Act. Otherwise known as the California “flip” tax.
What Is the ‘Flip’ Tax and What Does It Propose to Do?
The central issue is California’s rising real estate values. The bill refers to figures cited in the California Association of Realtors quarterly index, which states that single-family home values increased 17 percent in the third quarter of 2021 while a record low of potential home buyers met minimum home-buying qualification standards. On top of that, condominiums and townhomes were at an all-time high.
The bill also asserts that investor-buyer sales growth during the same period was 51 percent. To curb investor-buyer activity, legislators are being asked to charge additional taxes for homes not sold within a three-year period.
If the bill makes it out of committee unscathed, investors could face a 25 percent tax over and above any other taxes currently relevant for any property held less than three years beginning January 1, 2023. That tax can be reduced by 20 percent for each year a property is held for up to seven years or longer.
Obviously, this bill targets real estate investors operating in California where it’s not unheard of for a cash buyer to walk in with $1 million within days of a property being listed. The million-dollar question is: Will this piece of legislation curb investor-buyer activity in California?
Who Will the California Flip Tax Benefit the Most?
Any legislation can be judged on two things: Who it benefits and who it hinders.
At face value, the California flip tax may take aim at house flippers across the board. On closer scrutiny, however, the way it’s designed, it will benefit wealthy and institutional investors a lot more than it will help potential homeowners.
It’s clear that house flippers that hold inventory for less than three years are the primary target. What the legislation, as written, encourages is for homebuyers to hold onto properties for longers durations. Instead of discouraging flippers from buying properties at all, it’s likely to entice them to switch from a fix-and-flip strategy to a buy-and-hold strategy, a strategy often employed by landlords and rental property companies.
Property values in some parts of California are already at record highs. AB 1771 isn’t likely to change that. If an investor is committed to the fix-and-flip strategy, they’ll have to think hard about whether they’re willing to pay the extra tax or not. If it’s profitable, many of them will. On the other hand, if an investor holds property for a longer duration of time, they’ll pay fewer taxes, incentivizing those investors to rent their properties in an already hot rental market. Were the rental market not as hot as the seller’s market, the legislation could do as intended and curb investor buying. However, as is, investors likely to hold their properties longer are investors with a lot of cash and strong portfolios.
Investors who will benefit the most from California’s proposed “flip” tax legislation are large institutional investors who can rotate their inventory and sell older properties in their inventory while holding onto newer properties until they are advantageous to sell.
Who Will the Flip Tax Hinder the Most?
The California “flip” tax, if adopted, will likely not help potential homeowners as much as it will hinder smaller, mom-and-pop real estate investors.
For one thing, home prices are not rising because of increased investor activity. That is not to say that investor activity hasn’t increased. It has. But the rising home prices are caused by low supply and high demand for housing, a climate that would still exist if there were no investor-buyers. It would be truer to say that the increase in investor activity is due, at least in part, to the rising prices of real estate. Fix-and-flip investors are attracted to the quick gains that a rising market offers; they didn’t create the market.
Investors who are least likely to afford to pay the “flip” tax are mom-and-pop investors, newer investors who must borrow money for the acquisition, and small investors who work on no more than two or three flip-and-fix projects at one time. These are the investors who must watch every penny of outflow to justify a dollar of inflow.
Given the realities of the current real estate market in California, small investors will get the shunt while larger investors will pick up the slack.
Are House Flippers Hurting the Market in California?
The bigger question is whether house flippers in California are hurting the market or helping it. Considering that they generally take houses that will not qualify for home loans, rehabilitate them, and put them back on the market, it should be obvious that flipping activity is helpful to the California housing market. Many potential homeowners can buy a property that is ready to be lived in because a house flipper sold it to them. Sure, they’ll pay more for the property, but many homeowners don’t want to hassle with making improvements to a property they just purchased. Housing flipping creates a win-win situation that benefits both investors and potential homeowners.
The proposed legislation does include exceptions to the 25 percent “flip” tax. These include:
- The property has more than one residential unit;
- A deed restriction requiring at least 15 percent of the residential units to be affordable housing;
- Property is a part of a subdivided property where the qualified taxpayer is the recorded owner and the other parts of the property have not been sold;
- And non-residential properties.
These are just a few of the listed exceptions. While most of the exceptions make sense, savvy real estate investors will quickly realize a market for duplexes, fourplexes, and small apartment complexes. Plus, as written, AB 1771 seems to encourage investors to buy a single-family residence and turn it into a multi-unit property. Nothing in the proposed legislation seems to prohibit that.
Commercial real estate flippers would also not be affected by the legislation.
As currently written, AB 1771 is not likely to prohibit enough residential fix-and-flips to make a difference in California’s real estate market. However, if house flippers do retreat from the market in scale, that could hinder the number of viable properties on the market, which would only hurt potential home buyers even more and leave more room for large institutional investors to do the work.
Everyone is watching California’s AB 1771. If it passes, will other states follow?
For more information, call Nick Roberson.
