February 16, 2011

Property Market Bugbears

It might be high time to reconsider the taxation of property, at least of primary residences.

Not long ago, there was a self evident truth on property: “its value always goes up!” This ‘axiom’ resulted in people buying property without a second thought. All the considerations that would make a person stop and think were irrelevant because:

“If I lose my job, or have to trade down in compensation for any reason, and cannot make the mortgage payment, I’ll sell the house for a profit. In fact, this profit itself will keep me going for a while!”

“The property tax and insurance that I pay for the house together is 2% of the price, while the price goes up every year at 4%, so I stay net positive on the property tax that I pay!”

“No price is too high as long as I can make the mortgage payment that I will start at (it might reset later) as the price will still go higher. If the later, reset payment is too high then I can sell and cash out positive.”

But the ‘axiom’ has now crumbled, and it’s better to see the house more like a car, something that you consume but pay for over time. Even if one continues to see an investment angle to it, it has to be seen as buying a share or mutual fund. It can gain or lose value - nothing can be predicted around that with any certainty.

It has now become imperative to assess if the price and payment makes sense. It is even more important to assess whether one will keep a job with which one will be able to make the payments for a continuous 15, 20, 30 years (as the term of the mortgage may be). Nobody wants to dutifully make payments for say, 10 years, and then lose the house with one’s job - because of lack of cash flow to continue payments and a momentary housing market where you happen to be underwater. Towards this, I had blogged about a deferred ownership plan structured like an insurance policy with surrender value. Here, I want to discuss the other bottleneck today in making a home purchase decision. The reluctance of buyers, even when the price is right, leads to avoidable ghost neighborhoods and lost business transactions around home repairs, remodeling, broker commissions, et al.

This other bottleneck is the Property Tax.

Consider that one buys a home for $500,000. The property tax and insurance payment for this comes to about $ 600/month (after factoring in its tax deductibility – ASSUMING you were already itemizing before you bought the house, i.e. were already not taking the standard deduction).

So, even after paying this house off over 30 years, one will still be paying 'rent' of $600/month for the rest of one’s ‘ownership’ (assuming at that point too itemizing is better than taking the Standard Deduction – otherwise the figure goes over $800). This is clearly too high, and takes away half the feeling of really being an “owner”. What was driving people into buying homes before the crisis was the investment angle they saw in them (especially an annual rate of appreciation greater than property tax + insurance payment), which now stands diluted without much chance of resurrection through policy. In order for the new driver – real desire of ownership - to take hold, the property tax side of things will need some work.

Instead of a property tax on everyone in possession of a mortgaged or paid off home, a general Net Worth (Net Wealth) Tax needs to be considered, with a strong dose of partial exemption for one’s primary residence . Individual Home value, per se, as the focus/unit of taxation ought to be shrugged off.

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