Three Policy Moves That Could Revive the Residential Housing Market

The housing market has long been the engine of the American economy, yet recovery cycles often leave builders, buyers, and policymakers searching for effective levers to pull. John K. McIlwain of the Urban Land Institute has outlined three specific policy steps that could meaningfully accelerate housing market recovery. For residential builders and developers, understanding these proposals is not just an academic exercise. Whether you are navigating a housing market slowdown or planning ahead for the next upswing, these strategies directly affect land acquisition, product mix, and financial planning. Each proposal addresses a specific structural weakness in the current system, and together they form a coherent framework for reviving a market that has struggled to find its footing.

Converting Federally Held REO Properties into Rental Housing

With foreclosed homes numbering more than 250,000 nationwide at the time of McIlwain’s analysis, the sheer volume of real-estate owned (REO) property held by the federal government represents both a challenge and an opportunity. McIlwain supports converting a portion of this REO inventory into rental units, a strategy that addresses two problems at once: it removes distressed properties from a market that cannot absorb them and adds much-needed supply to the rental sector.

The Operational Hurdles of Bulk REO Conversion

The Federal Reserve’s white paper on REO-to-rental conversion identified three structural difficulties that any large-scale program must overcome:

• Geographic clustering — Homes must be grouped closely enough to permit economical property management. Scattered single-family homes in different neighborhoods drive up maintenance and oversight costs.
• Pricing discipline — Bulk sale prices must be attractive enough to bring private investors into the market, but not so low that they distort local comps or invite speculative flipping.
• Financing mechanisms — A dedicated funding source for bulk REO purchases must be established. Traditional mortgage financing does not cover portfolios of distressed properties.

Unaddressed Risks in the REO-to-Rental Model

McIlwain notes two issues the Federal Reserve white paper did not fully address. The first is the potential creation of slums. If REO properties are sold to investors who defer maintenance or fail to screen tenants, whole neighborhoods could deteriorate rather than recover. Investors who prioritize yield over property stewardship can turn what was once a stable block of owner-occupied homes into a transient zone of neglected rentals. The second is the hold-period requirement: renters may be locked into properties for extended durations, limiting their mobility and financial flexibility. A household that wants to relocate for a job opportunity may find itself bound by lease structures designed for institutional portfolio stability rather than tenant needs.

There is also the question of property management at scale. A single institutional landlord managing thousands of scattered single-family homes faces per-unit costs far higher than a multifamily apartment operator managing a single building. Routine maintenance, lawn care, trash collection, and emergency repairs all become logistically complex when inventory is spread across multiple zip codes. These operational realities mean that the financial returns on REO-to-rental conversion are often thinner than anticipated, which in turn affects the price the federal government can command in bulk sales.

For home builders, the REO-to-rental trend has a direct implication. The build-to-rent housing market has gained real momentum as an alternative institutional product type. Builders who can deliver purpose-built rental single-family homes at scale are positioned to capture demand that might otherwise flow into converted REO stock.

Replacing the Mortgage Interest Deduction with a Home Credit

McIlwain identifies a mortgage interest credit as the single most impactful step the federal government could take. Rather than tweaking the existing mortgage interest deduction, he proposes replacing it with a Home Credit modeled on recommendations from the Advisory Panel on Federal Tax Reform under President George W. Bush in 2005.

How the Home Credit Would Work

The proposed credit differs fundamentally from the current deduction in three ways:

1. Universal eligibility — The credit would be available to all taxpayers, not just those who itemize deductions. This extends the benefit to younger, lower-income households who currently receive no tax benefit from homeownership.
2. Regional cost adjustment — The amount of mortgage interest eligible for the credit would be pegged to average regional housing costs, acknowledging that a $300,000 mortgage in the Midwest and a $800,000 mortgage in coastal California serve the same purpose.
3. Ownership duration requirement — Taxpayers would need to own and occupy a home for a longer period before capital gains from a sale could be exempt from taxation, discouraging short-term speculative ownership.

Why This Matters for Builders

A mortgage interest credit would put more purchasing power in the hands of first-time buyers, the demographic that has struggled most to enter the market. Builders who understand these shifts in expanding homeownership policies can adjust their product mix accordingly. Entry-level and move-up homes are likely to see increased demand if a credit makes monthly carrying costs more affordable for a broader pool of buyers.

There is also a regional dimension worth examining. In high-cost markets where the gap between local wages and home prices is widest, a regional cost adjustment would have its greatest impact. A builder working in the Bay Area or the Northeast corridor would see a meaningfully different credit calculation than one building in the Midwest or the Sun Belt. This geographic nuance matters because it aligns policy incentives with actual market conditions rather than imposing a one-size-fits-all threshold.

Restructuring Underwater Mortgages into a Two-Tier System

McIlwain’s third proposal addresses the millions of homeowners trapped in mortgages that exceed their property’s current value. Rather than principal forgiveness or government bailouts, he proposes splitting each underwater mortgage into two tranches.

The Two-Mortgage Structure

The first mortgage would cover no more than 80 to 90 percent of the home’s current value. Homeowners could refinance this portion, but only to reduce their interest rate, not to extract equity or extend terms. This first lien would be the paying mortgage, structured to be affordable and sustainable.

The second mortgage would cover the remaining balance. Crucially, it would not require any monthly payments. Instead, it would be repaid only when the property is sold, and only from a percentage of the net sales proceeds that exceed what is owed on the first mortgage.

Why This Approach Works

This two-tier framework solves several problems at once:

• Prevents default — Homeowners can afford the first mortgage because it is capped at a reasonable percentage of current value.
• Preserves lender recovery — The second mortgage ensures lenders eventually recover some portion of the underwater balance.
• Avoids moral hazard — Homeowners do not receive free principal forgiveness; the deferred balance remains a legal obligation.
• Maintains neighborhood stability — Fewer foreclosures mean fewer vacant properties dragging down surrounding home values.

Builders who can navigate housing market cycles with confidence understand that distressed inventory is a double-edged sword. On one hand, foreclosed homes compete with new construction at the low end. On the other, a functioning solution for underwater homeowners stabilizes the broader market, making it easier for builders to plan and price new communities.

The two-mortgage structure also has implications for the mortgage servicing industry. Servicers would need to track two liens with different repayment triggers, requiring systems and processes that do not currently exist at scale. This administrative burden could slow adoption unless paired with clear regulatory guidance and standardized documentation. Nonetheless, the basic concept of deferring a portion of the principal until sale is sound and has been implemented successfully in shared-appreciation mortgage programs in other countries.

What These Proposals Mean for Residential Builders

Each of McIlwain’s three steps has practical implications for how builders should think about the next five to ten years. Taken together, they point toward a housing market that is more institutionally driven, more diverse in its product types, and more dependent on federal policy structuring than at any point in recent history.

Rethinking Product Mix and Land Strategy

If REO-to-rental conversion becomes a scalable policy, builders should evaluate whether their land pipeline supports build-to-rent products. Institutional capital is already flowing into single-family rentals, and purpose-built rental communities offer faster absorption than for-sale product in uncertain markets.

Preparing for Demand Shifts from Tax Reform

A Home Credit that reaches first-time and moderate-income buyers would expand the addressable market for entry-level and mid-priced homes. Builders who have shifted entirely to luxury or move-up product may want to reconsider. The demographic tailwind of millennial and Gen Z households entering their peak home-buying years aligns with a policy that makes ownership more affordable.

Managing Risk Through Market Cycles

The two-mortgage restructuring proposal highlights a broader lesson: markets that clear distressed inventory efficiently recover faster. Builders who maintain strong balance sheets and flexible business models can acquire finished lots and attract trade partners when weaker competitors contract. Understanding how to navigate a housing market slowdown is not just about survival, it is about positioning for the rebound.

A Practical Checklist for Builders

• Review land holdings for build-to-rent suitability in markets with high REO concentrations.
• Model pro formas under both current and proposed tax treatments to test sensitivity.
• Maintain strong lender relationships to access capital when distressed assets become available.
• Monitor policy developments at the federal and state level, particularly around tax reform and GSE reform.
• Diversify product types across price points to capture demand from first-time buyers and institutional rental investors alike.

The housing market does not recover in a straight line, but well-designed policy can shorten the cycle and broaden the recovery. McIlwain’s three proposals represent concrete steps that address structural weaknesses in the current system. For builders who track these developments closely, the payoff is the ability to invest with confidence when the market turns.