Are property taxes rising too quickly?

The National Association of Home Builders (NAHB) is out with a new study and at first glance the news is concerning.

“State and local property tax revenues increased nearly 20 percent over the past four years,” said the NAHB headline.

Property taxes are a big deal. If too high they can result in gentrification. If too low then local services may be inadequate. The Washington association says real estate owners paid $633.9 billion in property taxes during the four quarters ending Q3 2020.

“Four-quarter property tax revenues,” says NAHB, “have declined just once over the last eight years and are more than $100 billion (19.2%) higher than they were four years ago.”

Inflation

Everyone prefers lower taxes. Alternatively – and grudgingly – we know that taxes are measured in dollar amounts and with inflation it takes more dollars to make given purchases.

One inflation result is that a quart of milk today costs more than a quart from ten years ago, even though the amount purchased has not changed. This happens because inflation is really a measure of buying power. With inflation the buying power of cash declines so it takes more dollars to purchase something.

Metro Home Prices

The more one looks at those fearsome property tax increase numbers the more it appears that such increases have actually been pretty reasonable.  As it happens the National Association of Realtors (NAR) publishes metro home prices on a quarterly basis. We can readily compare quarters and when we do this is what the numbers show.

  • In the third quarter of 2020 the typical sales price for an existing home in 181 metro areas averaged $313,500.
  • Four years earlier, in the third quarter of 2016, the typical metro asking price in 178 metro areas was $240,900.
  • That’s a difference of $72,600 or 30.14%.

So yes, property taxes during the four-year period rose 19.2%. But property values increased faster, up 30.14% in the same time frame.

“Property taxes rise with property values but not exactly,” explained Rick Sharga, Executive Vice President with RealtyTrac a leading source of real estate data. “For instance, in many jurisdictions property values are assessed every few years rather than annually. In a sense, property taxes are a lagging indicator and sometimes they never catch up. There can be annual assessment caps to hold down tax bills and homestead exemptions. In many cases there’s a healthy dose of compassion built into the system with special rules for widows and widowers, the disabled, veterans, the elderly, first responders, deployed military, and portability when moving in-state.”

The reason for so many exceptions is that property taxes are the end result of the political process. If people are widely concerned about the cost of property taxes or how they’re applied they can vote for state and local candidates with a different approach. 

Mortgage Rates

One of the reasons for rising property values has been falling mortgage rates. Lower rates make real estate more affordable. Better affordability enlarges the pool of potential buyers and that leads to more competition for a relatively limited supply of properties.

The annual mortgage rate in 2016 was 3.65% according to Freddie Mac, an average that fell to 3.11% in 2020. For a fixed-rate, $200,000 mortgage the monthly payment declined from $914.92 in 2016 to $855.12 in 2020, a difference of $59.80 a month for principal and interest or $718 a year.

In January the average mortgage rate was 2.74%. Finance or refinance $200,000 at the January rate and the monthly payment falls to $815.42 – $99.50 less per month than paid by the 2016 borrower.

Income taxes

One way to off-set property tax costs is to make them a deductible expense when figuring federal income taxes. However, as a result of the Tax Cuts and Jobs Act of 2017 (TCJA) the ability of residential borrowers to deduct property taxes has been restricted to the point where millions of taxpayer no longer bother to itemize deductions. Instead, they take the newer and larger standard deduction created under the new rules.

Is this a good trade for taxpayers? Some will have bigger write-offs under the 2017 changes but many will not. According to the legislation itself, the TCJA was designed to increase government revenues by more than $665 billion by restricting real estate write-offs,

What about the future?

In mid-February mortgage rates began to rise in part because of inflation worries. The increase has been visible, with mortgage rates hitting 2.81% in mid-February according to Freddie Mac. That’s just .07% higher than the January average, not a serious worry.

Going forward, however, inflation and higher rates could – could – be a more serious issue. The concern is that pent-up demand and supply-chain shortages will set off a spending flurry thus forcing prices higher for a wide range of goods and services.

But an equally-serious worry is simple speculation, people bidding up prices because they think out-sized inflation levels are coming, and then more people bidding up prices in response to speculation. In effect, inflation can be a self-fulfilling prophecy.

The reality is that a little inflation is a good thing. The Fed would ideally like to see prices rise 2% or so per year. That’s enough to push more spending, to encourage people to buy now before prices again rise. Buying now puts more people to work and that’s good for any economic system.

In terms of real estate, a little inflation means higher prices as well as higher property taxes. Does it also mean higher mortgage rates? That’s not so clear. Right now the country has trillions of dollars in excess savings, a cash hoard that’s holding down interest rates from where they might otherwise stand.

So – like the price of milk – property taxes will inevitably go up over time. It’s no surprise, it’s just the way the world works when home values increase.


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