Foreclosure and Taxes…How They Relate
Tanya Marsh from the Huffington Post reports on yet another side effect of the foreclosure debacle. While most people, including myself, hate paying taxes, taxes do have a purpose. They help pay for our roads, our police officers, our firemen, our teachers, our sanitation works, our….well, you get the point.
As a result of this foreclosure mess, property values continue to fall. Because property values continue to fall, tax rolls fall. When tax revenue decreases something must give. Typically they are jobs. When jobs are cut, guess what? You got it…People can’t afford their houses so they go into foreclosure…starting the cycle all over again.
The longer our government allows this cycle to continue, the longer we will stay in this cycle.
One More Casualty of the Foreclosure Crisis: Property Tax Revenues
The Home Defenders League, a community activist organization in California, released a report last week with the provocative title of “Home Wreckers: How Wall Street Foreclosure are Devastating Communities.” The report makes a simple but powerful point that has not been widely appreciated. Property tax revenues, which many municipalities use as a primary source of funding for education, police, fire, and other essential functions, are tied to real property values. Since the height of the market in 2007, on a national basis, it has been commonly reported that commercial real estate values have dropped at least 40% and residential real estate values have dropped at least 30%.
Of course, the concept of “real estate value” is pretty fuzzy. The fair market value of a thing is normally determined by a willing buyer and willing seller. But in the current market, there are a number of complications. First, there are a large number of unwilling sellers pricing their homes in light of a pending foreclosure, or because of a loss of employment or similar crisis. Second, both the residential and commercial real estate markets continue to be hampered by the unavailability of debt. Yes, the most credit worthy commercial and residential borrowers, with sufficient money for a healthy down payment, can obtain financing. But many other borrowers cannot. As a result, the market has way too many unwilling sellers and not nearly enough willing buyers (with adequate financing). So “real estate values” are significantly depressed. But if capital begins to flow more freely and employment rates rise, the number of willing, financeable buyers will increase and push values up.
That’s how markets work. If the market thinks that my house is worth 30% less today than it was three years ago, that makes me sad, but doesn’t actually hurt me until I’m forced to internalize that drop in value by selling the house at a reduced price. But one of the problems with the current crisis is that the policy response is forcing widespread internalization of depressed values, in both the commercial and residential real estate markets, by encouraging distressed sales and foreclosures. Many analysts in the commercial real estate world believe that this is a good thing, because the market can’t begin to improve until it hits bottom. But by capturing the temporarily depressed values and translating those into lower property tax assessments, this activity will have significant effects even after values begin to improve.
The property tax assessment method varies by state, but changes in value for a specific property are generally captured when a property is sold. In periods where significant changes are experienced in the larger market, an assessor may also increase or decrease the assessed value of a neighborhood or entire community by applying a particular formula. For a variety of reasons, assessed values normally lag “real time” values. For example, Maryland assesses real property every three years and recently issued a reassessment reflecting a 22% drop in value since 2008, the largest decline in the history of the Maryland Department of Assessments and Taxation. Other states may reassess on an annual basis, but use a prior year’s assessment in calculating current taxes. For example, in Washington State, 2011 property tax bills reflect 2009 assessments.
Many municipalities have reported that property tax assessments began to fall two years ago for the first time since the Great Depression, and have continued to fall since. These reduced assessments can have significant consequences for state and local government, particularly if there is a property tax cap in place. For example, the Home Defenders League estimates that California property tax revenues are expected to decline by $3.8 billion because of residential foreclosures.
There are no easy answers here. But it is clear that we shouldn’t compound the problem by forcing more homeowners, commercial real estate borrowers, and, by extension, taxing authorities, to internalize temporarily depressed values by encouraging sales into a distressed market or completing foreclosures. The real estate bubble burst and “value” was lost. Understood. But perhaps we should focus on trying to restore some of that value and mitigating the problems that will inevitably be caused by steep drops in property tax revenue.