We’re constantly told ours is an ownership society in which owning a home is the foundation of household wealth. The concept of ownership may appear straightforward, but consider these questions:
1. If the house is mortgaged, what does the homeowner “own” when the bank has the senior claim to the property?
2. If the homeowner owes local government $13,000 a year in property taxes, what does the homeowner “own” once they pay $260,000 in property taxes over 20 years?
The answer to the first question: the homeowner only “owns” the homeowners’ equity, the market value of the home minus the the mortgage and closing costs.
In a housing bubble, homeowners’ equity can soar as the skyrocketing value accrues to the homeowner, as the mortgage is fixed (in conventional mortgages).
But when bubbles pop and housing prices return to reality-based valuations, the declines also accrue to the homeowner’s equity.
If the price declines below the mortgage due the lender, the homeowners’ equity vanishes and the property is underwater. The property may still be worth (say) $400,000, but if the mortgage(s) total $400,000, the owner owns nothing but the promise to pay the mortgage and property taxes and the right to claim a tax deduction for the mortgage interest paid.
To answer the second question, let’s consider an example. In areas with high property taxes (California, New Jersey, New York, Illinois, etc.), annual bills in excess of $10,000 annually are not uncommon. If we take $13,000 annually as a typical total property tax in these areas (property taxes can include school taxes, library taxes, and a host of special assessments on top of the “official” base rate), the homeowner “owns” the obligation to pay local tax authorities $130,000 per decade for the right to “own” the house.
In states without Prop 13-type limits on how much property taxes can be raised, there is no guarantee that property taxes won’t jump higher in a decade, but for the sake of simplicity, let’s assume the rate is unchanged.
In 20 years of ownership, the homeowner will pay $260,000 in property taxes. Let’s compare that with the rise in their homeowners’ equity.
Since home values are high in high-tax regions, let’s assume a $400,000 purchase price with an $80,000 down payment and a conventional 4% 30 year mortgage of $320,000.
In 20 years of mortgage and tax payments, the homeowners paid about $197,500 in interest to the bank (deductible from their income taxes), and about $170,000 in mortgage principle, leaving them total homeowner’s equity of the $80,000 down payment and the $170,000 in principle, or a total of $250,000.
Since they paid $260,000 in property taxes in the period, have they gained anything? If we look at the property as merely leased from the local government for the annual fee of $13,000, then was “ownership” a good deal for the local government or for the homeowner? If the homeowner subtracts the lease fee (i.e. property taxes) from their equity, they are underwater by $10,000.
The real estate industry answer is that “ownership” is great because the skyrocketing appreciation accrues to the homeowner. If the house doubles in value from $400,000 to $800,000 in a decade, who cares about the $130,000 in property taxes paid? If we subtract this $130,000 lease fee, the homeowner would still pocket a hefty profit: $800,000 sales price minus the $400,000 purchase price, the $130,000 in property taxes, the costs of 10 years of maintaining the home and the selling commission and closing fees.
So in effect, anyone “owning” a home with high property taxes is leasing the property from the local government for the “right” to gamble that a new housing bubble is underway.
But of course real estate doesn’t always go up. Overseas buyers can vanish (or be arrested by angry mobs at home before they abscond to North America with their dirty money), mortgages rates can click higher despite central bank manipulation, and the economy can tank, causing household income to crater and home buyers to dry up.
The “ownership” gamble is a big loser if real estate declines over the 20 years.If our example property declines in value from $400,000 to $300,000 in 20 years instead of doubling (or property taxes rise another $4,000 a year as local governments demand their pound of flesh to cover rising pension costs), the net equity of the “owner” declines to a $110,000 loss after 20 years.
The conventional response to this “ownership” gamble is that renters have no upside. But this is not true. Renters can leave for cheaper regions without losing equity or having to wait for their house to sell. Renters can negotiate lower rent somewhere else.
If we understand property taxes as a lease from the local government for the right to gamble on another housing bubble arising, we see “ownership” in a different light. As the saying goes, buyer beware, especially if there’s no limit on how high desperate local governments can jack up their lease fees, i.e. property taxes.
My new book is #3 on Kindle short reads -> politics and social science: Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle ebook, $8.95 print edition)For more, please visit the book’s website.