How Taxes Impact Property Values

by Rob Viglione

Taxation is an unavoidable part of life. For real estate investors, taxation is a very important variable. Property markets are extremely sensitive and highly influenced by tax policy, so it is important to understand some of the basics. For instance, real estate taxes fall into two categories: transfer taxes (% of sale) and property taxes (% of assessed value charged annually). Changes to either of these two categories will influence broad market valuations.

Higher taxes mean lower property values. Simple, right? The National Association of Realtors (NAR) released a study this May quantifying the impacts of changes in both transfer and property taxes. It turns out that increasing transfer taxes increases the cost of buying and hence drives potential buyers out of the market. For instance, in California it is estimated that about 80,000 would-be buyers are crowded out of the market by every 1% increase in transfer taxes.

Property taxes are the largest recurring cost of home ownership, other than the cost of acquisition. These taxes are recurring and changes in rates can effectively render homeownership impossible for large parts of the population. As an example, consider that in LA County tax rates are 1.25% of property value. With median home prices of $435K and median incomes of $43K, this seemingly small 1.25% translates into roughly 18% of after-tax income! A small change in this rate can be devastating to a family living on the margin.

Financiers undrestand that as you increase the cost of ownership you decrease value. Using discounted cash flow methodologies NAR was able to estimate that for every $1,000 increase in taxes there is a $13K decrease in home values. For properties valued at the median, this means a 3% drop in value for every 0.23% increase in the property tax rate.

When times are good, the economy and asset values are soaring, no one seems to care about government spending hikes. All sorts of noble causes are championed by our noble politicians – everything from education at all costs, to healthcare for everyone – but when the economy turns sour and home prices plummet the inevitable consequence is government deficit. To cover deficits governments must increase taxes now or borrow and increase later. This only further hampers economic recovery. From an investor’s perspective, it’s imperative to understand how government cycles of spend, tax, fall-into-deficit, and tax more impact your bottom line. Keep up to date with your state’s and local municipality’s fiscal condition and anticipate changes to tax policies. Staying ahead of the tax game will give you a sharp advantage over your investor peers, and put you well in front of the pack as far as regular home buyers are concerned.

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