The Housing Market Cooldown Has Implications for Property Taxes

During the pandemic, the housing market heated up rapidly, but in recent months we’re starting to see a cooldown. According to the CoreLogic Case-Shiller Home Price Index, at the start of summer, home prices were 16% higher than the previous year and had risen 9% since the beginning of the year. However, in July, prices declined by 0.2%, marking the first national decline since 2012. Most experts and local government officials anticipate that the market will slow significantly in the next year. In fact, Fitch Ratings estimates that national home prices were overvalued by 12.2% in the first half of the year.

The impact of the home price decline on local tax revenue remains uncertain, as it depends on several factors that influence assessed property value, such as the timing of property assessments, homestead credits, and the proportion of commercial and residential taxes. Typically, property tax revenue tends to smooth out and dampen fluctuations in the real estate market, which can be frustrating for governments during a market boom but provides stability for localities during a downturn.

Although assessments will lag by one or two years following housing market changes, local officials should not wait for the impact of current housing market movements on property values. The mortgage market is just starting to feel the impact of the Federal Reserve’s rate increase, says Olu Sonola, head of U.S. regional economics at Fitch.

“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.”

The National League of Cities’ City Fiscal Conditions report released last week indicated that local officials are already taking action due to the impact of inflation on all revenue streams. Although property tax values rose 6% last year, inflation negated those gains. With “unprecedented inflation rates” in recent months, local officials are budgeting conservatively and expecting a decline in property tax receipts, the report noted.

Where could the cooldown hit the strongest?

The responsiveness of local property tax revenues to the housing market varies greatly across states, according to Fitch’s analysis. Florida municipalities have the highest sensitivity to home price changes in the nation, following the price movements with a two-year lag. Researchers at Florida Atlantic University and Florida International University recently found that the southwest Florida housing market is the most overpriced in the country. As of August end, buyers in Cape Coral-Fort Myers were paying an average of 70% above the area’s long-term pricing trend. Despite lowering its tax rate, the city is seeing a rise in total property tax revenues due to the boom.

The driving force behind high prices is a combination of strong demand and a shortage of homes for sale, according to a statement by Ken H. Johnson, an economist at FAU’s College of Business. The destruction caused by Hurricane Ian has worsened the situation by exacerbating the housing shortage while the state’s home insurance market becomes more costly. However, Johnson anticipates that demand will persist.

“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,” said Johnson. “People have short memories when it comes to storms.” 

Fitch reports that Hawaii and Virginia also have a strong correlation between property tax revenue and home prices. Meanwhile, South Dakota, Nebraska, Minnesota, and Maryland have the weakest relationship between home prices and local property tax revenues.

Aside from the direct relationship, the housing market can also indirectly impact property taxes through its influence on policymakers’ decisions, as noted by Chris Berry, director of the Center for Municipal Finance at the University of Chicago. With inflation affecting constituents, many elected officials may avoid the perception of “increasing” property taxes when residents receive bills reflecting higher assessment values.

As an example, several years ago, Chicago passed a measure linking the total property tax revenue growth rate to inflation, with a maximum annual increase of 5%. In the previous low-interest rate environment, this was a minor change. However, this is no longer the case. Mayor Lori Lightfoot ultimately chose not to increase the levy in next year’s budget proposal, even though she could have boosted total property tax revenue by approximately $42.7 million.

Long-term effects

In the long-term, Berry is worried about the housing market movements potentially causing a larger housing cost burden for those who can least afford it. This is because during the last market downturn more than a decade ago, lower-value properties experienced larger relative decreases compared to more expensive ones. “You have low-value properties going down faster than high value ones, and assessors are slow to catch up.”

Another concern is that rising mortgage rates will discourage homeowners from selling their properties and taking out a new mortgage. “That worsens this issue of generational equity. 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.”