Is the 1031 Exchange at Risk? Inside the Court's Chevron Decision.

[Andreas Mueller]

Welcome to A Skeptical Dude’s Take on Real Estate: a frank, hopefully insightful, dive into real estate and financial markets. From one real estate investor to another.

Coming at you live from Nashville, TN.

Fuel for the day: I realized one thing I should be buying in bulk is coffee, I sure have enough. So I picked up a 5lb bag from Black Rifle. Highly recommend if you want to save a few shekels.

Today We’re Talkin:

• - The Weekly 3 - News, Data and Education.
• - Fed Comments by Jerome Powell
• - A Skeptical Look: The Chevron Decision Could be a Big F*$%*%g Deal!
• - The Skeptics Take.

The Weekly 3: News, Data and Education to Keep You Informed

1. - The mortgage market is experiencing a severe recession. It's one of the worst mortgage downturns in history. Mortgage purchase apps are at the lowest levels of the post 1995 era (Lambert).
2. - Love high-speed rail AND Taylor Swift? Well you are in luck. The high-speed rail ride to Miami will have sign along trains to her next concert. (Trains)
3. - Are Homebuyers OK with Small Lots? A record 65% of new single-family detached homes sold in 2023 were built on lots under 9,000 square feet, per the latest Survey of Construction (SOC). Unclear how many home buyers want/will accept lots that small. Or just keep renting/waiting (mortgagetruth).

Today’s Interest Rate: 6.99%

(👇 .09%, from this time last week, 30-yr mortgage)

Briefly, because I want to get right to our main topic of today’s newsletter, a few comments on what Jerome Powell said on inflation this week.

Speaking in front of the Senate Banking Committee yesterday, Powell was questioned about everything from inflation to odd political issues and grandstanding. The takeaway?

In short,

1. - Powell is serious about smashing inflation, saying of the inflation in the 1970’s: “People [the Fed] didnt get in there and get it done, so inflation kept coming back.”
2. - Powell is not going to come to the rescue of the housing market. When asked about it and if in his opinion we should build more “affordable / workforce housing.” He responded: “This is a job for you. But let me say this, I am aware that housing is in short supply.”

Powell also reiterated that:

• - unemployment while still low is steadily notching higher;
• - job and wage growth while still strong are steadily moderating;
• - inflation is moderating, on trend, and the Fed’s target of 2% is on the horizon.

The Bottom like: I still think we get interest rate cuts in September, and a second one after the election. It is becoming harder to justify a restrictive 5.5% federal funds rate.

The Chevron and Loper Decision

A new Supreme Court Decision may Hopefully Bring Clarity and Efficiency to the Mortgage and Housing Market.

A recent Supreme Court ruling may bring impactful regulatory changes to the housing market, and people aren’t talking about it.

So, let us.

First, what’s the Chevron doctrine?

For nearly 40 years the courts have been of the opinion that they should defer to a federal agency / regulator and rely on their interpretation of a law, if it is ambiguous or unclear.

No longer.

Now, courts will provide a check on federal regulators. From the decision: "Courts must exercise their independent judgment in deciding whether an agency has acted within its statutory authority. " More specifically, on June 28, 2024, the Supreme Court overruled the previous Chevron framework in the Loper decision (H.K. Law). Previously, under the Chevron doctrine, when a court determined that a statute was ambiguous or that Congress had not directly addressed the precise issue in writing a given law, the Court, rather than applying their interpretation of the law, would instead defer to the regulatory agency’s interpretation.

In other words, the courts will now interpret whether regulators are acting lawfully in applying new regulations instead of allowing them decide themselves, again when the law is reasonably unclear. The Supreme Court has now made clear that it "remains the responsibility of the court to decide whether the law means what the agency says (H.K. Law)."

A Double-Edged Sword?

Thinking objectively and trying to remain intellectually honest, the Chevron decision likely cuts both ways. Although I do on the whole, today, think this was the right decision. However, the original ruling allowed federal regulators to function efficiently, which they cannot if every interpretative gray area in the law requires a court decision.

But, Chevron also allows federal regulators to be judge, jury and executioner in matters of law. So, IF the agency is working in the public interest, we would want them to exercise broad interpretations of a given law. For instance, in regulating chemical companies to not pollute with new novel chemicals in our rivers and oceans, without needing a new law from Congress.

But when corporate interests or lobbyists (trying to stay a-political!), or frankly just well-intentioned government regulators looking to stay active in their bureaucracy (I have personally seen this) get involved, then that same interpretive leeway gives the regulator even more power at the expense of the public interest. Think, the USDA brining armed feds to shut down Amish farmers for selling their unpasteurized milk, or the FDA allowing harmful chemical additives in our food that are banned in hundreds of other countries.

And too often, businesses complain about a lack of clarity in a given regulator or lack of regulation. For example, in many instances, the regulator does not reveal how to stay within the law. The federal agencies don't have to do that. They just have to say that you broke the law, and no explanation is really needed. Think the Crypto industry, who is literally begging for clear regulations.

One example: Coinbase just sued the SEC for a lack of transparency in their regulatory policy, saying that “Financial regulators have used multiple tools at their disposal to try to cripple the digital-asset industry.” And noting that the SEC “has claimed sweeping authority, but refuses to provide any rules, let alone consistent or coherent ones.”

Got it?

Ok, So what’s the big deal with overturning Chevron for Real Estate?

The Court's decision in Loper will create a sea change in administrative law with wide-ranging implications and potential opportunities for highly regulated industries, like the real estate.

This will create an opportunity for more efficiency and lower costs in the real estate economy. It also means more time is needed to see how new challenges in the Courts will affect things like Fair Housing, HUD and FHA regulations / costs.

In short, if you are operating in a business that touches any part of the housing economy, this likely will affect you. Startups, bankers, mortgage lenders, home builders, technology companies, new finance / fintech, estate planners, CPAs, wealth managers….. all will be highly affected.

But don’t take my word for it, let’s see what a few industry professionals are saying of the Loper decision:

• Mortgage bankers - “The [Loper] decision… will be welcome news to the mortgage industry. One of the principal industry concerns about the vast power granted to the Consumer Financial Protection Bureau was that these powers were too insulated from review….The ruling sends a crystal-clear message to federal agencies that their powers are not unlimited…We would not be at this point today if government agencies were more prudent and consistent about staying within their statutory authorities, grounding their rulemakings in empirical facts, and heeding appropriate procedural safeguards…Instead, too frequently, our regulators appear to be chasing headlines and short-term political wins.”
• National Association of Homebuilders - “Today’s Supreme Court ruling is an important step forward to advance meaningful regulatory reform because it means that federal agencies can no longer continuously change the law – and the intent of Congress – by implementing their own interpretation of statutes as long as the interpretation is viewed as being ‘reasonable.’…Today’s ruling that overturns Chevron means that federal agencies will now have less discretion to impose new regulations that Congress did not clearly authorize.”
• Real estate attorneys - "The most specific [impact] is in the multifamily context because they're living under the Fair Housing Act, and that statue is very broad and ambiguous, and HUD in particular has had a great deal of latitude in setting guidance and bringing enforcement as to what they believe should be the law even though it's not congressionally written as such."
• And here is an anecdote from a mortgage lender: “I work in mortgage and I think this is huge for us. We would call the CFPB for clarification on what was/wasn’t allowed for advertising and they would refuse to answer, but would give us $10,000+ dollar fines if we guessed it wrong (@mortgagenmore).”

On Taxes, is the 1031 Exchange still Legal?

The Loper decision will likely lead to a surge in challenges to IRS authority / rule making. The IRS has made thousands of interpretations of tax policy. Heck, my CPA and I regularly discuss and are forced to make our own assumptions on how the IRS may interpret something in our real estate taxes, if we were to get audited. It’s super unclear. And there are so many small carveouts for special interests in IRS interpretations. For example: Is the 1031 exchange at risk? Should we even allow it and does it help or hurt consumers? According to the IRS, “Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.” However, in practice it often is a tax-free exchange when applied to real estate. Will this change?

On Real Estate Transactions Costs

Why is it so expensive to even do a real estate transaction? What are all these fees and why are they continually going up? Why am I forced to buy title insurance that insures the lender, not me? Will the CFPB install new regulations or fewer? Will those lower costs or increase the burden on lenders, which I have to pay for? Why is recording the deed with the county so expensive, can we use technology (like crypto) to make this process more efficient? Why does it often take 3-4 years to build something?

You can see how this gets complex quick.

On Building Big Infrastructure in the USA

And, if I may be so bold, a note on larger infrastructure that obviously affects the real estate economy: What about large infrastructure project that get bogged down in litigation? Can we start building bridges, roads, electric infrastructure, high-speed rail, and large impressive buildings in this country again?…

It took 13.5 months to build this in 1930. Let that sink in.

Empire State Building

…These are just a few of my thoughts bouncing around in my noggin. And there are probably hundreds of positive use cases we aren’t even thinking about today. We need more startups in the industry!

The Skeptics Take:

Business craves clarity, and there is a hope across industries that allowing the courts back in to check the Executive Branch will help ease the perceived burden of overregulation.

But time will tell.

Anecdotally, I witness much frustration in the mortgage industry. I hear often that lenders often don’t know why a regulator interprets the law this or that way. Nor do they always provide explanation for their decisions. One can imagine this makes it difficult (ie more costly) when adequate guidance is not given. Businesses don’t operate well with uncertainty, in this case mortgage lenders. So one would hope that this provides certainty of what regulations are and are not lawful.

Technology in banking, particularly at “FinTech” finance / bank companies that do not have a physical presence has been often difficult to start / operate. This ruling may be helpful in allowing more alternative lending institutions participating in the housing market. Using Bitcoin and cryptocurrencies to purchase real estate and, perhaps even more importantly, creating Smart Contracts or Tokenization to record real estate ownership etc… comes to mind. These ideas would create efficiencies in the real estate transaction, lowering costs to purchase real estate, and also to democratize its ownership. To date the regulators have not given adequate guidance, or just flat out banned, many technologies.

Objectively, and on the whole, it seems quite odd that the Chevron doctrine was in place for so long. And I get that in the 1980s the worry was that the courts would be activist so the Supreme Court decided to instill the power of deference in the Federal regulator. But, isn’t this how checks and balances work? Isn’t this why we have 3 branches of government who have equal power to check the other? Seems crazy that we have allowed regulators for 40 years to ostensibly be judge jury and executioner.

Lastly, it is important to note that the previous Chevron regime only applies when a regulator acts in the void, when they make a rule that the law does not reasonably address. As the third branch of government, Congress can always act to change / clarify for businesses and regulators the law they originally wrote.

But on the whole, is Loper as a positive opportunity for decreasing regulatory burden on businesses and consumers alike.

But, Congress, please keep a watchful eye, ok?

Until next time. Stay curious. Stay skeptical.

Herzliche Grüße,

-Andreas

P.S. Just a lovely scene. (And where I wish I was typing this from).

@valentynedreams

* I write this myself and get it out for you all in the same day. Apologize in advance for any typos / syntax errors. Don’t have a team of editors, yet :).

** The preceding has been my opinion only, the views are my own, and are intended for educational and entertainment purposes only and does not constitute financial advice.