What the Housing Market Slowdown Will Mean for Property Taxes

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Public Finance Update - Oct. 18, 2022

Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week, I’m writing about property taxes.

As quickly as the housing market heated up during the pandemic, it’s cooling down. At the beginning of this summer, home prices were nearly 16% higher than the previous year and up nearly 9% from the beginning of this year, according to the CoreLogic Case-Shiller Home Price Index. But in July prices dropped 0.2%—marking the first national decline since 2012. Most experts and local government officials expect the market to slow considerably over the next year. In fact, Fitch Ratings estimates that national home prices during the first half of this year were overvalued by a whopping 12.2%.

But whether or not the home price decline actually shows up in local tax revenue will depend on a number of factors that affect assessed property value. Things like the timing of property assessments, homestead credits and the balance of commercial and residential tax reliance all create separation between market movements and taxable values. In most places, property tax revenue tends to smooth out and mute whatever’s happening in the real estate economy. While this can be really annoying for some governments when the market is booming, the revenue stream’s unruffled nature usually offers stability for localities during a downturn.

Because of the lag between what happens in the housing market and when assessments are done, most local governments will have a year or two before the current movements may (or may not) affect property values. But that doesn’t mean local officials should sit back and wait. For one, says Olu Sonola, head of U.S. regional economics at Fitch, the mortgage market is only just beginning to see the impact of the Federal Reserve’s rate-raising.

“From a local government standpoint, you should be paying attention now,” he said. “You have to start taking defensive actions and anticipate the severity of the decline.”

And many already are, thanks to the more immediate impact that inflation is having on all revenue streams. The National League of Cities’ City Fiscal Conditions report released last week noted that even though last year’s property tax values rose nearly 6% on paper, inflation essentially negated those gains. And looking ahead, “unprecedented inflation rates over the past several months” have local officials budgeting conservatively and expecting a loss in property tax receipts, according to the report.

Which Places Could Feel the Housing Downturn More?

Local property tax revenues’ responsiveness to the housing market varies widely by state. Fitch has looked at that correlation and found that property tax receipts for municipalities in Florida are the most sensitive to home price changes in the nation, largely mirroring price movements (after accounting for the two-year lag). A recent analysis by researchers at Florida Atlantic University and Florida International University found that southwest Florida is the nation’s most overvalued housing market. As of the end of August, Cape Coral-Fort Myers buyers were paying an average of 70% above the area’s long-term pricing trend. Even though the city has lowered its tax rate for several years in a row, total property tax revenues are climbing thanks to the boom.

The main driver of elevated prices has been strong demand mixed with a shortage of homes for sale, Ken H. Johnson, an economist in FAU’s College of Business said in a statement. The destruction by Hurricane Ian has made the situation worse by exacerbating the housing shortage at a time when the state’s home insurance market is getting even more expensive. But Johnson does expect demand to continue.

“Several storms hit the state in 2004 and 2005 and more since then, and there was concern existing residents and transplants may choose to go elsewhere, but the state is as popular a destination as ever,” he said. “People have short memories when it comes to storms.” 

Hawaii and Virginia also have a high correlation between property tax revenue and home prices, according to Fitch. 

On the other end, home prices in South Dakota, Nebraska, Minnesota and Maryland have the weakest relationship with local property tax revenues.

But aside from the direct relationship, the housing market can have an indirect link to property taxes in how it might influence policymakers’ decisions, noted Chris Berry, director of the Center for Municipal Finance at the University of Chicago. With inflation putting strain on constituents, many elected officials may not want to be seen as “raising” property taxes when residents receive their bills reflecting the higher assessment values.

In Chicago, for example, the city several years ago passed a measure that allowed for the total property tax revenue growth rate to be tied to inflation—up to a maximum annual levy increase of 5%. In the previous low interest rate environment, the move was rather benign. But not anymore. Mayor Lori Lightfoot ultimately scrapped any levy increase in next year’s budget proposal even though she could have upped total property tax revenue by about $42.7 million.

The Downturn Could Worsen Affordability

Longer term, Berry is concerned about how the housing market movements could potentially create an even bigger housing cost burden for those who can least afford it. That’s because during the last market downturn over a decade ago, lower-value properties saw larger relative declines than more expensive ones.

“You have low-value properties going down faster than high value ones, and assessors are slow to catch up,” he said. That means that even though the value of those lower priced homes may be falling sharply, the property taxes owners are paying on them lags behind and stays elevated. 

“That’s my first concern: if we are entering a phase of declining housing market values, are we going to see that same phenomenon?” Berry added, referring to the last time the market fell.

In addition, he pointed out that the rising mortgage rates are likely to discourage current homeowners from selling (and thus taking out a new mortgage). “That worsens this issue of generational equity,” he said. “For people who bought a few or ten years ago, if you took out a 30-year mortgage at 3% or less, you’re going to sit on that for 30 years.”