Bacon's Rebellion

Democracy Thrives in Sunlight

Waiting for the Crash…

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by

James A. Bacon
in

I’ve long maintained that real estate prices in Virginia are out of control and headed for a bust. Nothing makes my point clearer than this chart, created by Chmura Economics & Analytics and scheduled for publication tomorrow in VA Newswire.

The image is fuzzy because I had to shrink it to fit this blog format, but the divergence since 2001 between the green line (change in Virginia housing prices) and the blue line (change in U.S. housing prices) comes through clearly. The increase in Virginia housing prices has outpaced the increase for the U.S. by a wide and growing margin. The strongest price increases, according to Chmura, have been concentrated in Winchester, Northern Virginia and Hampton Roads.

What goes up must come down. When mortgage rates are rising and income is increasing at only five percent per year, it is impossible to sustain price increases of 20 percent or more per year, no matter how severe the local housing shortage. Inevitably, as speculative excess is wrung from the market, price increases will cool. The first big question is whether there is sufficient froth in the market to lead to an outright retreat in prices. The second big question is what will happen to local tax revenues and tax rates when property values fall and reassessments roll around. It won’t be pretty.

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16 responses to “Waiting for the Crash…”

  1. NoVA Scout Avatar
    NoVA Scout

    It may just be my naturally sunny disposition, but I assume a very grim day awaits local governments and property holders in the coming years, at least in some of the areas of dramatic appreciation in residential property values. A few homeowners lament the arithmetic effect of meteoric value increases on taxes (even where tax rates have been cut substantially). They will have a real problem, one that will be far more explosive for local governments, if values actually fall and require rate increases to offset lost tax revenues. No doubt savings here and there can be extracted from even the best of municipal and county budgets, but the cost drivers (population, traffic, schools etc) will remain even if housing values fall. All this bespeaks a need to get away from this confounded system of using home values as the base for local tax collection. Income taxes make far more sense, but I doubt that either party (particularly my own beloved GOP) has the gumption to do what needs to be done to put all levels of government on an entirely different tax system, one which would require either direct local taxing authority or a slick, timely jim-dandy system of revenue sharing between state and local governments. given that the General Assembly republicans can’t even get out of their own way this year on fairly standard budget issues, I view any true structural reform of this problem as something that is absolutely beyond the capabilities of our elected officials. A general fiscal disaster might clear the decks and stop the paralytic bickering over issues that are, by comparison, relatively trivial.

  2. James Atticus Bowden Avatar
    James Atticus Bowden

    Why can’t the prices flatten out a bit and not fall? Demand is going to continue to grow – based on population estimates – and the far right of the bell curve can handle modest increases (not the sustained 20%) on expensive property.

    I’ve proposed for some time to legislators – and on the Rebellion – that the GA should devise a formula for some of the income tax to go to Cities and Counties. Concur with NoVa Scout.

    The reforms or studies for reform in the past 7 years have been farces because they maintain revenue neutrality and fail to look at principles of why-what-how-how much should be taxed.

    If I am wrong and someone has the url to a super piece of tax analysis (especially since there is NO macro-economic model built for the Commonwealth), please advise.

  3. Jim Bacon Avatar
    Jim Bacon

    It’s possible that prices will flatten out and not fall. I’m just pointing out that there’s a significant risk, which everyone should protect against, that prices might actually tumble.

  4. Ray Hyde Avatar
    Ray Hyde

    I’m not sure how much people really care whether they go up or down: except for the true speculators, most people want a home and a place to live comfortably more than they want an investment.

    No matter how the tax is assessed, the tax is an income tax. If home values go up and rates don’t come down enough to match, then you have just had an income tax increase. If home values are now overpriced then the county is getting awindfall based on the current rates, but when the net assessment rolls around they my have to jack the rates up more than valuations have fallen. In that case you will have had yet another income tax increase.

    Where the first problem lies is with the politicians who are lying to us by calling this farce a real estate tax. Call it whatever you want, when I pay it, it comes out of my income. The second problem is that there is no nexus whatsoever between the assessment and the ability to pay. This means that fixed income people or those with small ability to improve their icome situation get forced out in favor of those who are willing to pay more for the same space. In turn, this decreases stability and increases churn in the neighborhood.

    While NOVA won’t dry up and blow away, its most vulnerable residents will.

    On the other hand, both income and assessments are subject to fluctuation which results in fluctuation in revenues, and that is an anathema to the state or county. Using both methods helps offset the fluctuations and makes the government revenue stream more stable.

    Individuals are expected to re-assess their priorities and reduce unnecessary or less necessary expenditures in order tht the government can avoid having to make the same difficult choices.

    I don’t think that the property tax is going away, but I do think there ought to be some way to tie it to ability to pay, such as that the tax may not increase above 15% of household net income, or some such figure. For most people it wold never be an issue but it would provide some protection to existing residents in cases where assessments have gone out of control.

    The whole real estate tax situation relates to the proffer situation, too. By demanding high proffers existing residents are really demanding some protection from the newcomers and their associated expenses. Some areas base the assessment on the original sales price plus re-assessments. The assessment may increase but the total tax may not increas above some set rate like 3 or 5%.

    Under that scenario, if asessments stay the same or go down, those older residents would continue to see their taxes go up modestly untile they eventually match the current rate. That would only happen when the area stops growing, in which case residents would be protected from new higher taxes caused by newcomers. If the area continues to grow, the tax rate would be set to meet the revenue needs of the area, but becuse of the (temporary, or annual) cap in terms of %dollars paid, newcomers would continue to pay more of their own costs.

    The problem with the proffer system is that those higher new costs are immediately reflected in home assessments across the board and the older existing residents get no protection rather than the kind of sliding scale increase that a %$ cap provides, at least for a few years.

    But however you do it, its an income tax, I don’t care what you callit.

  5. RedBull Avatar
    RedBull

    I totally agree.

    Not trying to crash the party, but check out my post at http://www.morgansriflemen.blogspot.com/

    Like I said, I work in real estate and the situation is going to get worse before it gets better.

  6. Toomanytaxes Avatar
    Toomanytaxes

    A couple other points for the mix. One, there is growing evidence that Fairfax County grossly under-assesses high-end homes — those above $1.5 M. There’s at least anecdotal evidence that these properties are valued at substantially less than their sales price and market value, whereas more modestly priced homes (such as they are) are assessed much closer to market value.

    The response from the county is: they lack comparables. A friend of mine suggested that, for the high-end homes, the county ought to spend a few hundred dollars for individual appraisals. Good idea. This under-assessment problem is serious, undermines fairness in taxation and needs to be addressed.

    A second item is that, unlike most other NoVA jurisdictions, Fairfax County seeks and collects little in cash proffers. Right, wrong or indifferent, cash proffers are the Virginia system.

    Prince William County recently adopted higher target proffers based on its actual capital costs for schools, roads, parks, police, etc. Moreover, PWC set forth its entire cost study. Meanwhile Fairfax County Schools, which have been complaining about the need for capital for construction and reconstruction of schools, has asked for a fraction of what PWC requests and Fairfax County fails to set forth its cost study. Sweetheart deal? Moreover, Fairfax County has no target proffers for transportation. Gerry Connolly runs to Richmond and demands higher transportation taxes, while he fails to seek cash proffers for transportation in a manner similar to everyone else in NoVA. We may still need more money, but why not use the tools one has?

    Connolly argues that the County receives valuable land as proffers. But, at the very same time, Fairfax County has determined that much of the land it was proffered for schools cannot be used for schools. Some of the lots are simply too small for schools and a few are even unbuildable land. The origination of this problem came well before Connolly, but he should stop playing the game. Fairfax County needs cash for infrastructure, but seeks virtually nothing from developers, who are making those payments elsewhere.

    Finally, I agree with Ray Hyde that the real estate tax is an income tax that does not necessarily relate to the property owner’s income. While high housing prices are keeping many people from being able to live in Fairfax County, the sky-rocketing real estate taxes are starting to force out older residents who may well own their homes free and clear, but cannot afford the real estate tax increases. The county offers some tax relief, but not enough for many people. The situation will probably get worse.

  7. Larry Gross Avatar
    Larry Gross

    Can one make the argument that homes/property are … capital in terms of taxing them?

    We actually do treat the “gains” as such when they are sold except we exempt those “gains”
    if you roll them up into the next purchase.

    So… when folks get interest-only mortgages or even when they obtain equity loans on their
    properties – they retain that exemption … get interest credits at tax time – right?

    There’s another interesting dynamic here. The Feds and States essentially rebate taxes if you are paying interest on a mortgage while the localities do not – and, in fact, take money from you if you own property.

    What if the Fed/State deductions went away – or HORRORS – the State and Feds started taxing your property also?

    It would seem that depending on one’s political and/or capitalistic “tilt” that taxes on what people own is what?

    … wrong at the Fed/State level but okay at the local level?

    I think what we have is a very complicated, convoluted system that rewards folks who know how to game the system and penalizes those who cannot afford to pay someone to tell them how to properly game the system.

    This works just fine.. until stocks, bonds, or homes go belly up.. then we have problems.

  8. Ray Hyde Avatar
    Ray Hyde

    Larry: I don’t know what to think about this: it is either an entirely new spin or you really are subversive. Maybe I’ll have some ideas later, right now I’m trying to think, but nothing happens.

    I have argued strongly against proffers. I think they unduly penalize newcomers and those trying to become established, and at the same time they work against the oldtimers by artificially inflating assessments. I think that some kind of time delay in assessments or the effects thereof wopuld alleviate some of the problem.

    I recall a case of an acquaintance on Martha’s Vineyard. He had a good stable job and a nice home, waterfront, but nothing special by Vineyard Standards at the time.

    An outsider from NY came down and rented the adjacent property for the summer. He liked it so much he proceeded to buy it from the owner. The owner did not want to sell. particularly, but the visitor kept raising the price all out of proportion to what was common at the time. He eventually got it for $3.5 MM, an unheard of sum at the time, but chicken feed to him.

    My friend was immediately reassessed and as a result he lost the home his family had lived in for over 300 years.

    That is an extreme case, but it shows how wrong the reassessment scheme can be.

  9. Ray Hyde Avatar
    Ray Hyde

    TMT is right. Bad as they are, proffers are all we have. Time for Fundamental Change.

    Let’s look at capital. If I have a half million invested, I pay tax on it when I earn the money, and nothing until it is sold. then I pay tax on the gain (income or capital gains, call it what you want).

    If I invest in a house, I pay tax on the money I save for the downpayment, and I payan annual tax again for holding that capital in the form of property tax. I also pay property tax tax on the imputed capital gain, even though I don’t “have” the money yet. Some of that capital gain is taxed against money that isn’t even mine: it is borrowed. Therefore the (Fed) government allows me to reduce the cost of that tax by virtue of the interest deduction.

    Later, when the property is sold, I pay tax yet again on the true value of the capital gain (income) resulting from holding my investment. In this respect, it is no different from investing in equities. The only difference is the roll-over. With equities I pay the tax on the gain and roll over the difference. With a home I can defer the tax on the “gain” because I don’t really have it yet, unless I downsize, in which case I pay tax on the differential gain.

    So, I think I’m with you, it is wrong at the federal level but OK at the state level, and that is obviously screwed up.

    If the federal and state deductions went away, we would all be renters for most of our lives, and the speculators would really win big.

    The obvious answer is to put the minimum amount down and pay as little as possible on the longest loan. Pretty scary.

    But the result is that your “real” investment gets the maximum leverage for the longest time. If you have any capital gain, cash it out through equity loans or refinancing. Invest the gain in equities where it won’t get taxed, and/or else in other properties in other locations to spread your risk. Become a speculator.

    There will always be some businesses, because people have to buy things unless they are very unusual. If you invest in enough businesses, you can’t lose unless we all lose everything. You may gain at a much slower rate, but you will still be better off than those that did nothing.

    Likewise with homes. Barring a major die-off people have to live somewhere. If you own enough places, you will have some winners, and historically, conception is working in your favor.

    So, now you are a massive success and you own a bunch of homes and other equity speculations.

    Then you die.

    Your equities pass to your heirs and they pay estate tax. Essentially they are paying a tax on income a(what you gave them). If they have to sell some of the equities to pay the tax, they still have a money producing, tax free remainder, and a new basis.

    If your home or business passes to your heirs they may have to sell ALL of it to pay the taxes. They can, of course invest the remainder in a smaller (or larger) home, and start the cycle over again. The difference is that they have lost their family heritage which cannot be replaced, and the community has lost the continuity that comes from stability.

    The new buyer starts his portion of the cycle all over again, but with a new basis.

    If you take the long view, it makes no difference whatsoever to the government. Eventually the property will get sold and the income (capital gain) will be taxed.

    Since the government is omnipresent and eternal, it can easily afford to, and should, take the long view. The government’s interests in cash are minor compared to what should be it’s real goal: the protection of the interests of family and community.

    Over all, the same amount of cash is going to go around and around, unless fear takes over and we invest everything in gold. With a good, equitable, and fair government, we should have nothing to fear other than natural calamities beyond the government’s control.

  10. Toomanytaxes Avatar
    Toomanytaxes

    Ray – I understand your argument against proffers but with delays on higher assessments, but I think that you are ignoring the need for capital investments in public facilities because of the added people. Let’s go to good old Cooper Middle School in McLean. Before the many new homes in McLean and Great Falls were built (Cooper serves all of Great Falls and part of McLean), Cooper’s lunch room facilities were adequate to serve lunch to the students at reasonable hours (say 11 to 1). Now because of the new houses and Fairfax County’s failure to collect adequate proffers, half of Cooper’s 7th graders eat lunch starting at 9:45 or 9:50 am. At the same time, real estate taxes are up 85% plus over the last six years or so, but we still we see lunch before ten o’clock in the morning.

    Further, I submit that had taxes gone up twice that amount over the same period of time, we’d still see Cooper without adequate facilities and 7th graders eating lunch well before a reasonable time.

    I’d be a lot more sympathetic to the concerns of builders if they were not regularly in van before the General Assembly demanding that taxes be increased to fund infrastructure. There’s a time to fight fire with fire. Those who request higher taxes ought to be first in line with their checkbooks. Therefore, let’em pay big time!

  11. Ray Hyde Avatar
    Ray Hyde

    TMT: I agree. I own property in Fairfax, too. I feel your pain, exactly. I’m fortunate only because I phisically got out, but the reason I ept my place in Fairfax is that I know my luck may be only temporary.

    What I am suggesting is that eventually we both benefit from increases in Fairfax activities (even if we don’t like it, we still eventually benefit). It is the eventually part that hurts in the meantime.

    I don’t know your situation, but say it is similar to mine. My initial home payment was $600 a monthand taxes were $1500/year. I figured after thirty years it would be paid off and even if the property doubled my taxes would be $3000 and by then I would have put aside enough to cover that.

    Now it looks like when thirty years are up my taxes will be $7000/year, or about what my original payment was. YIKES.

    That wasn’t in the plan. Then I added on to the house, and had storm damage the insurance would not cover, etc. etc. so I have not put back what i planned and my loan is longer. YIKES.

    I’m still better off than I ever imagined, but the tax increase is killing me.

    I agree with you, but what if you are my son,and you are where I was thirty years ago? With proffers, YIKEs, you are screwed.

    Hey, Dad, I could use a little help………..

    We are all screwed. and the reason is the government, which is omnipresent and eternal, did not look down the road far enough.

    By proposing some kind of sliding scale on assessments, here is what I really think will happen. Old homes are under assessed, but slowly catching up via the sliding scale. New homes are fully asseessed but proffers are not added on top, or elsr the proffers are modest.

    The county expenses are estimated and a tax rate is set that meets those needs. The tax rate for everybody is higher than it would be without proffers, but the assessments are skewed. Newcomers get hammered for a while, and oldtimers get a break for a while.

    The transients come and go, and some take their profit with them. I don’t begrudge temprorary owners like military types, just because they are “speculators”.

    For the rest of us, in the end it levels out. We are paying taxes on the value we owe, and that value is partly due to newcomers. They have been paying higher taxes to help protect us, but if they are stable, eventually they will share our condition.

    Sounds like a win win.

    I agree with your argument about the lunch room, but I have a problem with claiming it is the (sole) result of failing to collect adequate proffers.
    The reason is that the argument is so often made that none of us pull pourt own weight: residences ar a net tax loss.

    So here is the deal: I believe my argument protects old homeowneers like you and I more, because the slope on the line is temporarily higher.(Temporary ought to be close to or longer than a lifetime, depending on the rate of assessment increases). At the same time it gives more hope to new homeowners.

    But, if the height of the line is way off (residential does not pay enough to cover its costs), then the argument about slope is meaningless.

    I’m no more in favor of higher taxes than anyone else: Im with JAB on this. But that only applies if we are talking about higher taxes as an iedeology (Like the D__n Dems). If we truly are not paying enough as a class to meet our desires, the we have a problem.

    The problem is, how do we prioritizze our desires? How do we prioritize them without screwing our children?

  12. Jeremy Hinton Avatar
    Jeremy Hinton

    From an earlier comment by Ray Hyde:

    I don’t think that the property tax is going away, but I do think there ought to be some way to tie it to ability to pay, such as that the tax may not increase above 15% of household net income, or some such figure.

    Not exactly the same, but i believe many localities have programs to assist those on lower fixed incomes, like the one in hampton:

    http://www.dailypress.com/news/local/dp-43178sy0jun08,0,2230335.story

    Does it help everyone? no. But it should help many of those with the biggest problem, the eldery and disabled.

  13. Larry Gross Avatar
    Larry Gross

    I see two distinct issues:

    1. – The first is how money is raised to pay for services.
    2. – The second is how that money is spent for services.

    Localities in Va raise money from the property tax. My previous comments pointed this out – that the State and the Feds do not raise money on this basis but rather on how much income you have.

    I pointed out the irony of the Fed tax structure essentially subsidizing home ownership vice other kinds of ownership and how, at the same time, localities and citizens of localities are forced to provide services to the homes that the Feds subsidize.

    Localities in Va have pointed this out and have asked for a local income tax to replace the property tax because it does have inequities.

    The second point – providing services. There is no way to get around this. New homes require new infrastructure and new services.

    Localities have existing levels of service that are, in fact, degraded, if more homes are built without paying for the required infrastructure to maintain those levels of service.

    As I see it – the issue is not about the need to provide infrastructure and services, it’s about who should pay.

    Should all taxpayers in a locality pay ALL the costs associated with new homes or should those that buy new homes pay ALL the infrastructure costs associated with that new home?

    I think “affordable” is a red herring because it’s like saying that manufacturers should not charge what they charge for cars because they’ll become too expensive to be “affordable” by some people.

    There IS affordable housing in every locality. A person may not want to live in a one bedroom apartment with kids but if that is what they can afford – then they have made a choice already and as far as I am concerned, I have absolutely no responsibility to assure that every new person that moves to my county is able to afford a 3 bedroom home on a 1/4 acre.

    This is the argument with proffers I believe. Either folks who want a house pay for ALL the costs necessary to service that home.. OR we turn around and tax others to provide that infrastructure.

    When a locality has a LOW growth rate – the infrastructure costs can be absorbed with modest allocations of existing residents tax dollars. There are many localities throughout Va and the nation that function quite acceptably in this regard.

    But when a growth rate is high – requirng the provisioning of infrastructure on an accelerated basis – the the cost of doing so is much higher requiring substantial increases in the tax rate. So, in my mind, the question is – when there is a high demand for housing in a locality – what is a fair and equitable distribution of the associated costs between new home buyers and existing homeowners?

  14. Ray Hyde Avatar
    Ray Hyde

    Yup. I agree with all of the above.
    and Larry is right, high growth rates are particularly painful because we have to do so much so fast and the capital costs are high, let alone the operating costs.

    But I have a hard time saying that newcomers have to pay all of their costs when none of the rest of us are. If we were and had been, then the new costs which need to be absorbed might not have been quite so high.

    Some kind of deferred assessment scheme combined with a means test raises the bar for all, a little bit, but it still puts the major burden on newcomers, at least until they become oldcomers.

    The way it is now, last one in the door gets hammered and the pain immediately passes to his neighbors.

  15. Toomanytaxes Avatar
    Toomanytaxes

    Ray – Even assuming for the moment that builders can always pass through the full costs for proffers to new home buyers, the process doesn’t dump all costs on new development. For example, Prince William County provides reductions in the requested proffer for schools to reflect that portion of the costs for constructing new space at old or new schools that are recovered from state or federal sources. It also provides a reduction to reflect the amortization of projected Capital Improvement Plan debt through ordinary real estate tax payments. A quick and dirty calculation indicates that these credits are worth about 19% for an new single family home.

    I’m not here to argue that Prince William County’s approach is absolutely correct, but it seems reasonable.

    If we accept a principle that cost-causers should pay something towards the recovery of government costs (the gas tax, tolls on roads, mass transit fares, etc.), why aren’t proffers/impact fees on new development not also fair? Who causes the consumption of the additional infrastructure, the residents of the new development or the person who has lived in the same home for 20 years?

    I won’t argue that proffers/impact fees are perfect pricing solutions, but they seem reasonable, especially given the current state of affairs (high construction costs, sky-rocketing taxes and general citizen angst over growth).

    Moreover, by imposing a cost on construction/development, these fees also send a price signal that developers and builders should care about how efficiently government operates. For example, most baconsrebellion readers/posters would quickly agree that VDOT is a mess. It has no cost controls. Moreover, roads are built without regard to their impact on improving transportation results or economic efficiency. These problems cry for reform. Yet, the home builders lobby in Richmondm for example, is no where to be seen in the VDOT reform movement. Indeed, this lobby group is leading the van for higher taxes to fund the same broken processes. By requiring this group to pay cost-based proffers/impact fees for transportation, builders are more likely to push for VDOT reforms so that their cash payments are not wasted.

    Ditto for schools. By imposing a price for school capital costs on the real estate industry, we are more likely to see that industry use its considerable knowledge to offer ways of improving the effectiveness and efficiencies of school construction and remodeling projects.

  16. Ray Hyde Avatar
    Ray Hyde

    Yup, agreed. Proffers is what we got.

    But they don’t preclude either an income means testing arrangement or one which limits the annual increase and thereby delays the pain for existing owners. Whether all of the proffer is passed on to the owner or not, whether they cover all the costs or not, those higher values are reflected in other home assessments immediately.

    I guess you could say that watching what happened to my friend on the Vineyard had a profound effect on my thinking. I remember sitting in the coffee shop on Circuit Avenue, cranberry bread and kale soup, and him telling the story with tears running down his face.

    Yeah, he walked away with a few million, but he lost his home and three hundred years of family heritage. Just because somebody else paid a high price for property near by.

    I see proffers as causing the same effect, but on a wider and smaller scale.

    We think a lot about preserving the land, maybe we are saving the wrong things.

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