Pricey U.S. housing markets, from the New York suburbs to California’s coastal cities, could take a direct hit under the tax-reform bill released by House Republicans.

Under the bill, mortgage interest would be deductible on loans up to $500,000 instead of the current $1 million for couples filing jointly — weakening the incentive in high-cost markets where property deals often require large mortgages. The deduction would be rendered useless for many others as the standard deduction is doubled and state and local tax deductions are substantially downsized, diminishing the need to itemize.

The plan — touted by President Donald Trump, a billionaire who made his fortune in real estate — is sending the housing industry reeling, with some trade groups treating the bill as the most serious threat in decades. The National Association of Realtors said the initial memo released “appears to confirm many of our biggest concerns,” while homebuilder shares tumbled the most in almost a year.

In expensive markets such as the San Francisco Bay area, where home prices have soared in recent years and stretched affordability for many buyers, capping mortgage deductions would diminish an incentive used by purchasers to offset costs. A limit to state and local property tax deductions at $10,000 may particularly hurt states with high rates like New York and New Jersey, leading to pushback from congressional leaders from those areas, which tend to be Democratic leaning.

Mark Zandi, chief economist at Moody’s Analytics, said the tax changes could initially cut prices by 10 percent in expensive markets and 3 percent to 5 percent across the U.S.

“You can see why the industry is not too excited by all this,” Zandi said. “It’s not good for home sales, house prices or new housing construction.”

Fewer Itemizing

About 7 million homes, including a third of homes in California and 19 percent in New York, would be affected by the mortgage-interest deduction cap if they were put on the market, according to a preliminary analysis by the National Association of Home Builders. The number of households that itemize to take advantage of the housing deduction would drop to less than 11 million from 34 million currently, according to the group.

The plan could also limit home sales in other ways. Under current law, a couple who sells their home is able to exclude up to $500,000 in capital gains from their gross income, as long as they used the home as their principal residence for two of the past five years. Under the new plan, they’d need to use it as their principal residence for five of the past eight years to qualify. Instead of being able to use that exclusion every two years, they’d only be able to use it every five years.

High-income homeowners might not be able to use the exclusion at all. Under the bill, the exclusion would be phased out by a dollar for every dollar a joint tax filer’s adjusted gross income exceeds $500,000.

The NAHB, which represents small home builders, has vowed to fight the bill after initially expressing support for the GOP plan before it was released, under the hope that other homeownership incentives could be added to the plan. The National Association of Realtors, Washington’s second-largest lobbying group, opposed the plan from the start.

Builders Hit

An S&P index of homebuilders tumbled 2.7 percent, the biggest loss since November 2016. Toll Brothers Inc., the largest U.S. luxury-home builder, sank 6.1 percent. The Horsham, Pennsylvania-based company’s average price of home contracts in its fiscal third quarter was $837,300.

The market may be overreacting, according to Jack Micenko, an analyst at Susquehanna International Group LLP. The proposal doesn’t eliminate the mortgage-interest deduction entirely, and the trend of trading up for larger houses is slowing, he said. Homebuilders have been pivoting toward first-time buyers, most of which would fall below the $500,000 threshold, he said.

“People are shooting first and asking questions later,” Micenko said. “There is some good news in here.”

Mark Calabria, chief economist for Vice President Mike Pence, said on Wednesday that the benefits of the mortgage-interest deduction to homeownership were overblown and that other aspects of the GOP tax plan would promote housing. He said the state and local tax deductions and mortgage-interest deductions predominately benefit the wealthy.

“I want to make the radical suggestion that, even without the state and local tax deduction, that millionaires are probably still going to buy homes,” Calabria said at a conference hosted by the Urban Institute Housing Finance Policy Center and CoreLogic. “Likely when you do the real analysis, the full analysis, a holistic analysis, the changes on the individual side will be pro-homeownership and pro-housing rather than claims to the contrary.”

‘Think Twice’

Buyers already struggling to afford homes in pricey New York-area markets may think twice about purchases, said Jonathan Miller, president of appraiser Miller Samuel in New York.

About 3.7 million U.S. households pay more than $10,000 in property tax, and about 1.35 million of them are in New York and New Jersey, according to the National Association of Home Builders. In New Jersey, almost 31 percent of homes have property-tax bills higher than $10,000, the group’s data show.

“It exacerbates the cost problem further,” Miller said.

The mortgage-deduction limits may also worsen one of the housing market’s most vexing issues right now: a severe shortage of inventory in many areas. Homeowners with high-balance mortgages will be reluctant to sell and lose the deduction that would be grandfathered in for current owners, said Zandi of Moody’s.

California, Connecticut

Silicon Valley, one of the most expensive U.S. housing markets, would face a “triple whammy” from the proposed legislation, said Ken DeLeon of DeLeon Realty in Palo Alto.

“The average price is right around $3.4 million in this area,” DeLeon said. “These aren’t really rich people, they’re just people trying to buy a somewhat nice home for their family. Even condos are at least a million.”

Halving the mortgage interest deduction, capping the state and local tax deduction, and the capital gains changes will likely make Silicon Valley’s housing market even more short on inventory and more expensive, DeLeon said. And even as Congress debates the legislation, the uncertainty will turn many potential buyers into renters.

“It feels very political,” DeLeon said. “It’s like they’re saying, ‘Let’s just please our base and strike back at those who voted against us.’ Which is short-sighted because Silicon Valley is the best thing America has going for it. This is going to prompt companies to go offshore or look at tax-haven states.”

In Greenwich, Connecticut, where the median single-family house sold for $1.8 million in the third quarter, the tax bill could damage both the “fragile” recovery in the luxury market and sales of starter homes, said Robin Kencel, an agent with the Stevens Kencel Group at Douglas Elliman Real Estate. Buyers in the tony town have been moving toward smaller homes while lavish estates on several acres have languished on the market, data from Miller Samuel and Douglas Elliman show.

“At the $1 million level, which is first-time buyers in a market like ours, every dollar matters,” Kencel said. “One of the nice things we’ve been seeing is more millennials starting to come out to Greenwich from Manhattan and take the home-buying plunge. This is the buyer pool, I think, that would be particularly sensitive to any changes like this.”

For the ultra-rich, caps to property taxes are a bigger blow than the limited mortgage-interest deduction, said Stephen Shapiro, chairman of brokerage Westside Estate Agency in Beverly Hills, California. The firm’s average sale this year was about $9.5 million.

“When we’re dealing with a sale for $25 million, most of those high-end deals are all cash,” Shapiro said. But “if the property tax deduction is limited to $10,000 and you’ve just bought a house for $25 million, and your property tax is $275,000 a year, then you’re losing $265,000 of tax offset under that. That’s a big hit.”

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