Monday, April 30, 2012

Property Taxes and Wealth versus Income

You can own a home outright and still not be able to afford it.  Huh?

In the last 20 years something weird has happened in America, and most folks are not talking about it.  I am not talking about the housing bubble, the tech bubble (and it soon-to-recur reprise) or the coming retirement debacle.   What I am talking about is the staggering increases in property taxes and homeowner's insurance that has made the cost of owning a home, well, staggering.

Oddly enough, one cause of this problem was an attempt to fix it.   For example, in the 1980's in Florida, they passed a law, called the "Save Our Homes!" act, which capped property taxes for "homesteaded" owners at 2% increase per annum.  While this may have saved the homes of people living there, it meant that in order to raise revenues, the local governments had to raise other folk's taxes substantially.

So, if you lived in Florida since 1985, the property taxes on a $750,000 home might be $3500.   But if you bought that home today, your taxes would skyrocket to $12,000 to $15,000, depending on jurisdiction, and that is even if you are "homesteaded".   In fact, until recently, this law was so perverse that when people sold their "homesteaded" home and moved to a smaller home or condo, their taxes would go up as a result.   Today, they allow you to "transfer" your homestead exemption, which at least helps the homesteaded.

Of course, this means that out-of-State owners (who can't vote in Florida) pay a lot more in taxes, as do commercial owners.  But it also means that you can own a home outright and not be able to afford it.

Insurance is the other shoe to drop.  Granted, in coastal Florida, insurance is high - particularly when you have to have three policies - wind, flood, and fire - which can top $3000 to $5000 a year.   But even in other States, the cost of insurance has escalated as claims for things like toxic mold have crept up.  Suddenly, what was a trivial, almost incidental part of home ownership is a major headache.

Property taxes are an interesting beast, as they are not tied to income, but rather to something you already bought and paid for.  So it is possible, over time, to pay more for a home in taxes than you did for the home.   For the $750,000 home example illustrated above, at $15,000 a year, in 50 years you've paid more in taxes than the purchase price of the house.   And given that taxes go up every year, chances are, you are talking closer to 30 years.  Throw in the insurance, and maybe 20.

Buying a house, as I have noted before, is only buying the rights to rent it from the government.  The local taxing authority is the ultimate landlord, and recently has been raising the rents, significantly.

We recently returned from Florida, where Mark has a remainderman interest in his Parent's house.   His step-Mother has a Life Estate, and when she passes (or surrenders the property) the house will pass to the three children.   The problem is, the house, even in this recession, is worth a lot of money, even if it is still an original 1950's Florida house.   It is on the beach - and the land is worth more than the house.

As former Florida residents, we realize that the staggering taxes and insurance - which could be close to $20,000 a year - are out of our league.   Even if the house is given to us for free, we could not afford to retire there.   Well we could, but we'd rather spend the money on something other than property taxes.  Unfortunately, Mark's siblings haven't done the math on this and think they could keep the home as a "Vacation home" or "investment" and then rent it out to pay the taxes.

The problem with this approach is that it will be rented out almost all the time to pay the taxes (and the overhead of the rental agency) and as a result not be available for use by the three siblings.  Moreover, it won't be much of an investment, at least for another 5-10 years as housing prices remain flat in Florida.

The house is free.   But owning it isn't.  And we ran into this with our vacation home in New York, even though the taxes and insurance there were an "affordable" $8000 or so.   We realized, after five years, that the carrying cost of the home - paid for in cash - was more than we could afford.  We could afford to own it, just not to keep it.

All across America, we are seeing this same calculation playing out, on everything from a trailer home to an opulent mansion.  People may have money, but they don't have the income to pay property taxes, which recur regardless of your income and regardless of whether your income decreases - which it will, when you retire.

And as property taxes and homeowner's insurance go up, housing prices go down.   Housing prices are dictated by how much people can afford to pay.   Yes, buying something on monthly payment is dumb - but even if the overall transaction costs of owning a home are zero, you still have to make those monthly payments in the interim.   And if all you can afford is, say, $2000 a month, a $500 a month property tax and insurance bill pretty much dictates how much is left over for the mortgage.   Reverse Amortize this with the current interest rates and bingo - you've arrived at the price.

It is a teeter-totter.  As interest rates go up, housing prices go down.  As insurance costs and property taxes go up, housing prices go down.   And even in this era of low interest rates, what is strangling property price growth is higher taxes, insurance, and other fees (fire fees, trash fees, and other fees, once part of property taxes, are now being priced a la carte in many jurisdictions).

So it is ironic - I can afford to buy a million-dollar home, but I cannot afford to live in it.   And this is true for a lot of people - who are finding out now that the mini-mansion which looked so cool is also so utterly unaffordable, particularly on a retirement income.

Why have property taxes skyrocketed?  Why have insurance rates jumped?  In part because of a lot of weak thinking on the part of government.

In New York State, we were priced out by Albany - and the Federal Government.  The Feds dictate to the States that they have to provide a welfare "safety net" - but doesn't provide enough funding to pay for this "mandate".   The States then foist this off on the Counties, who in turn sock it to the taxpayers.   In many counties in Central New York, things like fire protection, police protection, and road maintenance are being slashed, so that the welfare "mandates" - which cannot be cut - can be funded.

It is an odd scenario - the very things that were once considered necessities, such as roads and Police and Fire protection, are now deemed luxuries.   And putting people on the dole is deemed a necessity.

The other half of that coin is the luxurious pay scales the teacher's unions have put through - as well as their very fat retirement plans.   No school teacher is worth $100,000 a year - sorry.  That is twice the median income in the USA.  And yet many make that much.

Many of the folks here on "retirement island" are retired New York State school teachers, and yes, they all drive brand-new cars.   While other folks suffer in a recession, State workers do pretty well, particularly when they are retired and cannot be laid-off.

The net result is a $7,000 tax bill on a $400,000 house - an amount I could not afford.  So we sold.

Insurance is another area where weak thinking by the government has interfered with the market.  I am not a big fan of State Farm, as I have expressed here before.  But after Hurricane Katrina, a well-meaning kindly Judge in Alabama decided that since so many people lost their homes, that State Farm should buy them a new one, even though they wrote policies which explicitly excluded flood and wind protection.

As a result, State Farm - and a lot of companies - stopped writing policies in coastal areas.   And the few remaining people writing policies had less competition, and rates escalated.   The thought of writing a fire policy and then having it bootstrapped into a hurricane policy no doubt scared them - and they had to factor-in that risk.   When a Judge can re-write an insurance policy to suit his whims - because he "feels sorry" for people who lost vacation homes on the beach - you cannot underwrite the risk.

So today, homeowner's insurance is no small thing - it can dominate your monthly mortgage payment nearly as much as property taxes.  And combined, these can mean that even though you own a home free-and-clear, you still have to pay hundreds of dollars a month - perhaps thousands - just for the privilege of living there.

In the example of the Florida house, with the property taxes, hurricane insurance, utilities and maintenance (pool service, lawn care, cleaning), we are talking about $2000 to $2500 a month.  In order to pay this, the house would have to be rented from December to May.  So much for a vacation home - well not for our vacation, but maybe someone else's.

So how do you get out from under this conundrum?   By not owning an expensive home or a big home, or more home than you need.   While it may be swell to have a mini-mansion and granite counter-tops, you do pay for this, every month, every year, in the form of taxes and insurance, not to mention utilities and maintenance.

And because of this, we see today, so many people being "house poor" even as they drag in $100,000 a year or more.   They spend every penny on living expenses, particularly mortgage payments, and under-fund their retirement.  They have income - but no wealth.   I have wealth, but no income - which is an interesting conundrum.   The income person can "afford" the fancy house, but cannot afford to accumulate wealth.   I have the wealth, but don't have the income to afford the fancy house.

Frankly, I am happier with the latter.   Why?  Because the less I have, the smaller a footprint I am for the tax man.    Working more and owning more, to me, means only paying more taxes.   So I work less, own less, and do more.

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