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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.
Intuition suggests that the higher you tax something the lower its price becomes. The same is true of real estate. The National Association of Realtors (NAR) released a study in May of this year quantifying how much property values decline with discrete increases in tax rates. One example from their analysis is that for every 1% increase in the transfer tax rate there are 80,000 potential buyers driven from the market in California, alone.
Property taxes show a bleaker picture and tend to influence prices even more. In Los Angeles County property taxes are 1.25% of assessed value, charged every year. Consider that 1.25% of the mediate home price (of $425K in 3/08) is $5.4K, which ends up being about 18% of after-tax median income (taken from the U.S. Census Bureau's QuickFacts, 2004 median income for LA County). Increasing this tax rate even slightly can render home ownership impossible for a large segment of the population.
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.
These simple examples illustrate how important it is to understand the influence tax policy has on property values. This doesn't even touch on the signficance of depreciation or mortgage interest deduction, which have enormous implications for valuations. To at least understand these basics and to keep a watchful eye on policy developments will gives a tremendous long-term advantage to the serious real estate investor.
About the Author:
Rob Viglione is a writer, investment fund manager, and real estate broker. He has launched Viglione & Partners Assurance Group, L.P., SoCal Real Estate Advisors, Inc., and founded The Freedom Factory.
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