- – - UPDATE – - -
Do to the many, many comments I’ve recieved from people who seem to think I’m somehow bashing Houston here, I thought I’d repeat here what I posted in one of the comments:
I’m not arguing that Houston collects disproportionately more taxes than other cities do, because I don’t know whether or not they do. I’m not trying to say that Houston is ruthlessly pummeling its citizens with taxes. My point in this post is not that Houstonians are over-taxed in total, merely to examine the significant impact that our property taxes have on the market value of our homes.
This is clearly a major contributor to the list-prices for homes in Texas being lower than in many other states. The ways in which we choose to collect taxes distorts the market, and I find this particular impact to be interesting because I think people are overlooking it when they talk about the “low price” of housing. There are a lot of factors that contribute to the low market price of housing in Houston, and this is a big one.
That’s my one and only point in this article.
I’d strongly encourage everyone to scroll through the whole post and read all the comments, there’s some interesting stuff! Thanks for reading!
- – - – -
At one point in my recent trip through the northwest I was talking with my brother-in-law, Drew. Both of us have been thinking about buying homes recently, and we were comparing some of the differences between the Seattle area housing market and the Houston area housing market.
Since I’ve only recently begun to consider buying a home, I have only recently begun to pay close attention to the real world impact of property taxes. I have to say I was a little surprised when I realized what a significant chunk of any monthly payment I might make would go to taxes, and I was a little disappointed when I realized how much less home I could afford after taxes.
Now, when I first started talking with Drew, I was trying to be considerate of how much tougher it must be for him to afford a home in the Seattle area, where median prices are notably higher than they are here. He was talking about how he couldn’t find much under $200k, and I was saying that’s too bad, he should move to Houston. Then we started talking about property taxes, both of us agreeing that they were way too high, and that it was really frustrating when you realized how much less home you could afford after tax.
Then I gave him the example of what the taxes would be on the price of home I’m looking to buy, and his jaw dropped.
“Woah. Our taxes aren’t THAT high,” said Drew.
It turns out he’s right. By state law, property taxes are capped at 1% in Washington, whereas in Houston taxes are about 2.5%. What difference does that make?
Well, let’s consider the possibility that we’re hypothetically both in the market for $250,000 homes. At today’s interest rate (about 5.5%) and 5% downpayment that would require a principal + interest payment of about $1290.
In Houston, your taxes would be $6250 per year ($521/mo). In Seattle, they would be $2500 ($208/mo). Therefore, the base payment (principal, interest, and taxes) in Houston is $1811, and in Seattle is $1498.
The Houstonian pays $313 per month more for the exact same mortgage.
Now, I know what you’re about to say: “But Texas doesn’t have income tax!” Guess what? Neither does Washington.
Now, this got me thinking. The monthly cash flow I lose to taxes would equate to a significant increase in the amount of mortgate I could afford. That means, logically, that in a place with higher taxes, the VALUE of a home must be lower in order for it’s COST to be the same to the purchaser.
At this point it dawned on me: monthly payments nationwide are probably a lot closer together than people think – but the home value will be much higher where taxes are low. Therefore many of the places that we lambast for their high prices may not actually cost as much more as we think. To figure out whether or not this was actually true, I decided to compare property taxes in the 4 largest cities in the US: New York, Los Angeles, Chicago, and Houston.
First and foremost, let me say this: finding out good information about property taxes is surprisingly difficult. I spent quite a while digging around to get the information I could, and it’s not perfect. For instance, I could not find any reliable information about average property taxes in a metro area, and good data about median prices across entire regions is hard to come by as well. Additionally, every place collects taxes using different (and sometimes asinine) methods, so it’s hard to be sure whether you’ve accounted for all the taxes in an area.
For what it’s worth, I found that Los Angeles was the easiest place to get good information, followed by Houston (but only because I know how to use HCAD), and then New York and Chicago. Chicago is impossible, I don’t think that the government there even knows where they get their taxes from. However, after a lot of effort, I was able to get defensible averages to compare residential properties to each other in all four cities.
To make a comparison I calculated the tax bill on a $100,000 property, which makes it very easy to see the effective tax rate (annual tax/property value). Here’s what I found:
New York City:
The tax rates in New York City are very unusual. They have divided the city into four classifications of property, each of which is taxed at a different rate. From what I can tell, this rate contains all the various taxes (city, county, schools etc). This is somewhat different from the rest of New York, which has a tax system more like what we have in Texas (layers of taxes seperately assessed by various entities).
Residential property is considered Class 1 property, and it is taxed like this:
Market Value * 8% = Taxable Value
Taxable Value * Tax Rate = Tax Bill
In New York, a $100k home would pay $1,295.68 in property taxes annually. This gives us an effective tax rate of 1.3%.
Property taxes in Los Angeles were actually very easy to determine, you simply had to determine what your Tax Rate Area is. The state has a 1% property tax, and special local bonds are added as a surcharge to this.
For a property in central LA, a $100k home would pay $1200 in taxes, with an effective tax rate of 1.2%.
Ok, Chicago’s tax system is ridiculous. Here’s how it works…
Estimated Market Value * Assessment Level (10%) * State Equalization Factor (2.8) – Standard Exemption ($5000) * Tax Rate = Tax Bill
Now, I couldn’t get any good information about the exact tax rate in Chicago, but I found a list of tax rates for the region here. Based on an average of about 8% tax assessment on adjusted assessed level after exemption (???!!!) it looks like this:
A $100k home would pay $1840 in property taxes annually, with an effective tax rate of 1.8%.
As locals, we should probably be familiar with the Houston tax system. We get charged layer upon layer of little taxes from the various entities that provide services to our property, and these add up to an average of about $2.50 per $100 valution in the city.
A $100k home would pay $2500 in property taxes annually, with an effective tax rate of 2.5%.
So in other words, Houston’s taxes are more than double those of Los Angeles and New York, and quite a bit higher than Chicago’s.
How does this impact property values?
To compare the effect this has on property values I ran some simple math. For each city I compared the Principal and Interest payments for a mortgage at today’s rate of 5.5% for homes at five different price levels ($100k – $500k). Next I computed the property tax for each of those homes and determined the combined base payment (Principal, Interest, and Tax) for each. Then I calculated how much “additional mortgage” the taxes were worth – in other words, how much more loan could a person get for the exact same monthly payment if there was no property tax.
Here are the results (all numbers are rounded):
For a $100,000 home:
For a $200,000 home:
For a $300,000 home:
For a $400,000 home:
For a $500,000 home:
So, as you can see the price impact of the Houston’s taxes becomes increasingly apparent as you move up the price ladder. When a person buys a $200,000 home in Houston they’re actually making payments worth $273,000 including taxes. When a person in Los Angeles buys a house for $200,000 they’re making payments worth $235,000. It costs the person in LA the equivalent of $37,000 less to obtain the same loan.
Now, back to our original point: the median home price in these other cities is higher, but how much higher is their monthly payment?
So, while homes remain clearly more expensive in these other major cities, it’s also clear that the actual cost of ownership isn’t as dramatically different as one would think based on the sales price alone. Most shocking of all is to compare the tax bill in Chicago and Los Angeles. People in Chicago and LA actually pay LESS property tax than people in Houston, even though their homes are worth significantly more.
To look at the cost and value of housing a different way, I compared the median prices to the median payments in percentages using Houston as a baseline.
Cost Versus Value
(Using Houston as a baseline)
What this shows us is how much more a home is worth in one of the other cities, versus how much more it costs. The biggest surprise is Los Angeles, where an average home is worth double the average in Houston, but costs only 175% as much.
The most important number here is the tax impact. Basically what this means is that in Los Angeles about 31% of the difference in price as compared to Houston is solely because of tax differences. Basically, because the taxes are lower people can afford to borrow more for the same monthly payment.
The greatest irony here is how this plays out at the high end of the market. Because our taxes are so high, the cost to own valuable property becomes significantly higher here. I’ve illustrated how this progresses with a simple chart.
What you can see in the chart is how the actual cost to own a property is much higher than the real value of the property, and how this gap becomes larger as a property increases in value. For instance, if you have enough cash flow to make payments worth $200,000, you can only actually afford about a $150,000 home in Houston. As you look up the scale the difference becomes more ridiculous. $750,000 worth of cash flow actually gets you $550,000 worth of property in Houston – that’s $200,000 in value lost to property taxes.
Therefore, if you’re rich, and you’re planning on buying a mansion, you’re better off living in Los Angeles or New York.
The tax punishment is even worse when you consider the impact of appreciation. Even at 5% average appreciation (A little more than inflation, realistic for Houston) a house at the median price today ($189k) would see its taxes rise from $4750 per year today to $19,500 per year at the end of a 30 year loan!
When you consider the scale of differences that large corporations face, owning factories and big office buildings, suddenly these costs are big enough to cause someone to think twice about moving to Houston. Why would a corporation relocate here from elsewhere if they need a large, expensive facility to do business in? Yes, Texas has other tax advantages, but do they completely offset our property taxes? I don’t think we have as big of an advantage as we like to think we do.
My purpose in writing this today is just to put the thought out there and let people mull it over. When we in Texas compare ourselves to other states (especially California), we take a lot of pride in declaring how much more affordable we are. We often credit our state governments with being much more efficient, and declare that our tax burden is much lower than theirs. “We don’t have those wasteful government programs that they do,” we like to say.
Is that really true? For all the city services and big bureacracy that exists in Los Angeles, they are collecting less tax on the average property than Houston is. When you consider California’s tax value protections (your taxes are fixed at the price you bought the home for – no appreciation impact), it’s clear that Los Angeles is collecting a LOT LESS in taxes than Houston is. So how are they paying for all that stuff that they do?
I don’t know the answer to that question. Clearly the state must make up some of the difference through distributing income tax revenues. And clearly, California has major problems and I don’t think we want to imitate them. But is our government really efficient?
I think the answer is no. It isn’t. In fact, I have this bad feeling that we’re actually even more wasteful than the people on the left coast. Texas collects extraordinary amounts of tax income from its citizens, and the electorate here votes strongly against most government spending programs. But we’re still in budget trouble. How is this possible?
The most obvious explanation I can think of is that our government is wasting more money than theirs is.
If anyone wants to help me out with this one, I’d be glad to hear what the difference in Houston’s budget and Los Angeles’ is. But if I’m right, and we really are just wasting a lot more money than the left-coasters, then the question I have to ask is can we afford to keep doing that?
So, that’s all the food for thought I can offer for one day. I’m really interested to hear what everyone else out there has to say about this, so start things off by leaving your comments!