The Real Estate Rub

A downturn in the housing market is beginning to spell a slowdown in local revenue.
by | April 2007

Now that the real estate market is cooling, state and local governments are concerned about a cooldown of a related kind: in the amount of money coming in from property, real estate transfer and mortgage-recording taxes, as well as from construction-permit fees and even from sales taxes.

Clearly, the fiscal environment at the municipal level is changing. No one is in panic mode, but the boom times--an era in which home sales and soaring property values sent local government revenue up, up and up--are ending and with them some of the related revenue.

With fewer homes being built or sold, taxes and fees from real estate transfers or construction have begun losing their revenue-generating power. Those, however, make up a relatively small chunk of state and local government income. A larger blow will come from a downturn in sales-tax revenue.

Part of the reason for the sales-tax decline is that construction companies and their workers spend heavily in boom times. "When we see a downturn in the housing market," says Michael Coleman, a fiscal policy adviser for the California League of Cities, "that's also accompanied by fewer construction jobs. The whole economy feels it."

But the effect on sales tax is bigger than just that. New homebuyers tend to spend heavily to furnish their dwellings. A favorable housing market also leads homeowners to take out second mortgages, providing them with more money to spend. "With the market slow and interest rates going up, you don't have as much purchasing or refinancing," says Scott Pattison, executive director of the National Association of State Budget Officers. Sluggish sales-tax growth was one reason Florida recently reduced revenue projections by $1 billion.

Another impact on local income is likely to come from a reduction or stabilization in property-tax revenue--but that effect may not be here yet. Assessed property values tend to lag behind home prices.

Not every government used higher home values to reap revenue rewards. "Over the past few years, many localities that had large run-ups in housing prices, rolled back their tax rates," says Megan Neuburger, a director in Fitch Ratings' U.S. Public Finance group. "So they have some cushion there." What remains an open question, however, is whether local officials will have the political will to raise rates should budget shortfalls develop.

State laws that disconnect property taxes from market values further complicate matters. In Florida and California, for instance, assessments aren't allowed to increase rapidly except when a home is sold. That means governments haven't gotten the full benefit of higher property values yet, although assessments on long-time homeowners will likely continue their slow rise. But, with less home-buying going on, the big jumps in assessments--from, say, $250,000 to $500,000--are going to be a lot less common.

Josh Goodman
Josh Goodman | Former Staff Writer |