Gyroscopic Investing

There's several states in the US that provide ridiculously generous lifetime pensions to government employees such as police officers, firefighters and teachers. These pension plans are hugely underfunded and will require raising taxes over time as people's life expectancy rise. This is already happening, and I believe it will happen to a greater extent in the future.

As property taxes rise, in theory, housing prices must drop. This is because houses are sold on the free market where buyers will buy homes based on their ability to pay a monthly mortgage. If the tax bill rises, then a person cannot pay as much for a house as they did before, because they are still capped at what they can afford monthly. The same goes for interest rates. As mortgage interest rates rise, in theory, housing prices should fall, as more of the "total monthly payment" is going towards paying interest so the person can't afford as expensive of a home.

Since sellers must be paired up with buyers, the value that buyers will pay must decrease ALL ELSE EQUAL if property taxes rise.

Here's the problem I forsee. While home sellers have the flexibiliy to sell their home at a lower price (because the market forces require them to), there is no similar requirement for local governments to reduce property taxes.

To use real numbers, suppose you have a City and the taxes amount to about $2,400 per year on the median family home. That's $200 per month. Suppose the median monthly mortgage that a person in this city can make is $1,500. That leaves $1,300 to pay the mortgage principal/interest (ignoring insurance for now). If property taxes rose to $3,000 per year, that would drop the monthly allowable mortgage payment to $1,450 per month. Thus, the person must offer a lower price on the home he intends to buy, in order to stay within his budget (that is determined by the bank, and if it exceeds the budget, the bank will not extend the mortgage).

The city can raise taxes forever, and this in theory will drop property values ALL ELSE EQUAL due to the situation above. The problem is that if housing prices drop, people who currently live in the city will either:

1) Be forced to stay there and pay higher taxes
2) Be unable to pay the taxes, the city seizes the home and auctions it
3) Be forced to sell their house at a lower price

As far as the city is concerned, regardless of what action the homeowners take, they are getting paid so the city doesn't really see the negative effects of raising taxes.

I predict that this will be a minor contributor to long-term soft-housing prices going forward in the US for the forseeable future.

TripleB wrote:As far as the city is concerned, regardless of what action the homeowners take, they are getting paid so the city doesn't really see the negative effects of raising taxes.

Right up to the point you have a Prop-13 type tax revolt.  I am not a huge Prop-13 fan (it is unfair to new/young home buyers), but ultimately voters can set limits on what the taxing authorities can do.

And it surprised the heck out of me when the local assessor (in CA) reduced the assessed value of my home several times since 2007.

Doesn't the Laffer curve apply to this situation? As the local government raises property taxes, property values will eventually start to decrease. And at a certain point, any further increase in property tax rates will cause an even larger decrease in property values, resulting in a net decrease in property tax revenue.

I suppose, however, that voter action is a far more important determinant of property tax rates than the Laffer curve is.

Tortoise wrote:I suppose, however, that voter action is a far more important determinant of property tax rates than the Laffer curve is.

One can only hope!

WildAboutHarry wrote:

Tortoise wrote:I suppose, however, that voter action is a far more important determinant of property tax rates than the Laffer curve is.

One can only hope!

Indeed!  While I certainly agree that the Laffer Curve always breaks into a negative slope at some level of taxation, I'd wager that in this case it'd likely be a punishingly high one!

I can only speak for Texas, but here it is school district property taxes that make up most of a homeowner's overall property tax bill, so I don't know if the premise in the OP is valid.

I agree that lots of public sector retirement plans are poorly funded, but when I think about the ways in which these funding issues would flow into a property tax statement when the overall property tax bill is only about 30% allocable to city and county taxes in the first place (the rest are for school taxes), I wonder how much impact it is actually going to have on property values.

To me, the prospect of rising mortgage rates and rising energy costs would potentially have a lot more effect on property values.

this thread is one of many reasons why I have no intention of owning property where I live (a major city, heavily unionized public sector...with labor troubles on the horizon)

Could you be talking about NYC?

This is the place where TripleB's theory could be tested.  There is a rule limiting the yearly tax increase on single family homes, but it doesn't apply to coop apartments.  So, to make up for the loss of pension funds, instead of fixing that broken system, the city has more than doubled coop taxes in the past few years.  Maintenance in my building has gone up over 25% in the past 3 years, and that's on the low side.  And the city just announced another big increase, yet again.

You can bet that this is having an effect on coop prices, which had otherwise survived the housing market collapse largely unscathed.  There were a few firesales but almost no foreclosures of Manhattan coops in 2009, thanks to strict board rules:  usually 25% or more down, no fancy mortgage products, and 2 years maintenance and mortgage payments in the bank.  Hard for me to judge exactly, but I think prices have softened about 10% over the last year.

murphy_p_t wrote: this thread is one of many reasons why I have no intention of owning property where I live (a major city, heavily unionized public sector...with labor troubles on the horizon)

A very wise decision speaking as someone who has "owned" a good number of homes through his lifetime.

I am now of the opinion that you don't really own the home, the home owns you. First, there is the mortgage, and second the property taxes and other government obligations. Much better to live a nomadic existence in my opinion.