by Bradley Tennant, Esq. , MSRE, CRE
Housing Wire has recently published an nteresting article regarding the proportional cost of property taxes and insurance for homeowners. Because mortgage value can serve as a proxy for home value in this scenario, it shows that local government exactions and property insurance are increasing relative to homeowners’ investment, thereby decreasing equity. I wondered how this tracks commercial real estate.
Unlike residential mortgages, where taxes and insurance are generally paid by the mortgage holder, commercial property treats them as an operating expense. As with other costs, it is ultimately passed along to the tenants. This is supported by statistics showing that the ratio of these expenses to gross income has remained fairly consistent, averaging anywhere from 9% to 18% over the last four decades. This is not unexpected, as it is controlled by CRE owners. Rent tracking that rises in proportion to these increases operates in a bit of a feedback loop with rising market values.
“So what,” you might say, “this is how the market works, right?” Perhaps, but does it have to be? While oft-debated, several studies have shown that lower property taxes can actually result in more income for local governments – at least to a point. Paradoxical? Not when you think about it proportional to transaction volume. Put simply, lower taxes can equal more transactions.
- Costs are inherently a barrier to entry. Lower prices and expenses nearly always result in more transactions.
- More transactions = more jobs. The average CRE transaction can take up to 60 different people to effectuate. More jobs = more residents = more taxes.
- Many governments have assessment or property tax caps. When a property is sold, that cap is lifted (well, outside of Arizona at least). This means a $500k property that may have only been assessed at $200k thanks to caps, now gets reassessed $300k higher, bringing in more money to the government.
- Transfer tax collection (doc stamps in Florida), of course, increases when transaction volume increases. While it is less of an issue with owner/occupied homes, it is most definitely a line item in CRE pro formas (just ask Los Angeles).
This isn’t meant to advocate for dramatically slashing or increasing taxes, merely wondering if there is potentially a sweet spot for property taxes that are as low as possible while still bringing in the most revenue as possible. Governments nearly always rely on some form of need-based budgeting, but what would it look like for a government to take a purely market-based approach to property tax revenue? Could they actually increase revenue and services? Could intrastate cities compete for residents and investment much like retail stores compete for customers? Would it be revolutionary or apocalyptic? Just curious.