You know what the most necessary ingredient is for capitalism to thrive?
I'll give you three guesses. No, it's not lower interest rates. It's not better management of the Phillips Curve by the (useless) Federal Reserve, and it's certainly not pouring more tax dollars into our useless education system.
Three strikes and you're out.
The most important element for capitalism to thrive is, well... capital.
That wasn't a trick question. The supply of capital creates innovation and, ultimately, increased wealth. Capitalism does not merely require capital; it requires capital velocity—the ability of capital to move quickly and efficiently from less productive uses to more productive ones.
Despite this, our society is often locked into paradigms that, if broken, would allow unproductive wealth to become productive investment capital. We want capital to be accessible and free to move to where it can be most productive. What good is capital if it is not put to good use?
Would you, Dear Reader, cash out of your biggest asset, stick all that money into a steel box, dig a six-foot hole in the backyard, and bury it? Of course not. Capital should be working for you, as well as others, flowing to where it can be most productive.
Yet, for reasons explained below, trillions of dollars are locked up in the real estate industry. If you listen carefully, you can almost hear it:
"Help me. Let me out of here. I want to be free!"
If capital is the fuel of capitalism, creative destruction is the engine that moves it. Your humble author submits that the real estate industry is overdue for a healthy dose of creative destruction. If done properly, we all benefit.
Let's start with the county courthouse.
The records in my home county go back to the 1640s. There's a certain romance and charm to these old places. But they are dinosaurs. They are expensive to operate and maintain.
The record room at every courthouse should eventually be replaced by blockchain technology. AI-driven smart contracts could research title and determine whether it is marketable in a fraction of the time currently required.
In Virginia, there is a grantor's tax, a grantee's tax, and a slew of other recording charges, including technology fees, open-space preservation fees, and deed processing fees. These taxes and fees can approach 0.7% of the property's value, and they are much higher (up to 6%) in places such as New York.
Virginia law states that many of these taxes are imposed for the privilege of using Virginia's recording system. If blockchain technology eventually eliminates much of the need for the traditional courthouse recording function, why shouldn't these taxes disappear as well?
With AI scrubbing title records on a blockchain, marketable title could be assessed almost instantly, eliminating much of the cost of title searches and reducing the need for title insurance.
Many law firms own title insurance agencies, and a buyer's HUD statement often reflects substantial title insurance charges, up to .07% of the purchase price, and lenders require that they be insured to, an additional cost. Every time property changes hands, new policies are issued, even though prior policies already insured everything up to the date of the last transfer.
Then there are mortgages.
Prior to the late 1970s, mortgage assumptions were common. Many states restricted the enforcement of due-on-sale clauses. Then, in 1982, after intense pressure from the banking industry and concerns over interest-rate risk, Congress passed the Garn-St. Germain Depository Institutions Act, which largely preempted those state laws.
Today, virtually every mortgage contains a due-on-sale clause.
Mortgage assumptions allow buyers and sellers to strike deals outside the expensive mandates imposed by the modern mortgage industry. Assumability can eliminate or reduce underwriting costs, title costs, appraisal costs, bank fees, mortgage broker fees, and a host of other add-ons.
In many cases, it could also reduce the need for Realtor commissions, often the largest expense associated with a real estate transaction. These costs help explain why so little housing inventory reaches the market and why real estate capital does not move with the same velocity as other assets.
Tokenization offers another opportunity.
My article last week explained what I believe will become the next great tokenization boom. In fact, it has already begun in parts of the commercial real estate market.
Allowing real estate interests to trade in tokenized form could democratize real estate finance, reduce costs, increase liquidity, and dramatically increase capital velocity.
Then there are local taxes.
My property taxes have increased nearly 100% over the past decade. Blue cities spend money like drunken sailors in the red-light district. Property owners are taxed not on their cost basis, but on whatever value a local assessor assigns to their property, before any costs of sale are considered. In Florida, there is a movement to do away with property taxes, partly as a way to curtail “drunken sailorism” in blue cities.
Federal tax policy is a much bigger problem.
The same politicians who constantly complain about housing affordability are often the same people making housing less affordable.
While principal residences enjoy a limited capital gains exclusion, gains above those thresholds remain taxable. A single man ( that’s me, ladies) gets a $250,000 exemption. A married couple gets $500,000. Everything else is gain and is taxed. Commercial property owners get no exemptions and face federal capital gains taxes of up to 20%, often coupled with an additional 3.8% Net Investment Income Tax.
If property is sold after being held for less than a year, gains are generally taxed at ordinary income rates, which can push the federal burden above 40% in some circumstances. Rental income is taxed as ordinary income. State taxes add to all this.
A vibrant economy demands capital velocity.
Yet capital gains taxes encourage owners to hold appreciated property rather than redeploy capital into potentially more productive investments. Some owners use tax-deferred exchanges, but that keeps capital trapped within the real estate sector when opportunities elsewhere may offer greater economic benefits.
Incentives drive economic behavior.
Progressive politicians routinely propose new schemes to make housing "more affordable," but they rarely support reducing the taxes, fees, and regulatory barriers that make housing expensive in the first place.
In Richmond, the morons on City Council require portions of some multifamily developments to be reserved for lower-income residents. Thus, violent criminals and drug dealers become neighbors of high rent apartment and condominium dwellers where they are known to be disruptive and stab high rent payers just for fun.
Real estate affordability is not a mystery.
DO AWAY WITH DISINCENTIVES.
Those longing for cheaper housing are caught in the vortex of classic Public Choice Theory and are being held hostage by government flunkies and concentrated lobbying groups like the National Association of Realtors, each intensely protecting its own turf at the expense of the whole. The NAR has been most strident in its efforts to keep real estate commissions high, much higher than other countries through MLS restrictive brokerage systems. It is really good at putting spouses and family members of Washington insiders on their payroll, often at exorbitant salaries.
Every 1% of commission acts much like an additional transfer tax on a sale. It reduces housing mobility, limits consumer choice, and slows the velocity of capital throughout the economy.
America's real estate market contains tens of trillions of dollars in wealth, yet transfer taxes, capital gains taxes, refinancing requirements, title costs, brokerage commissions, and regulatory barriers keep much of that capital moving far more slowly than it should.
Capitalism thrives when capital is free to move.
Can you hear it? I can. “Help me. Help me. Get me out of here” says the poor underutilized capital rotting away in unproductive assets, a political prisoner of economic ignorance.
