Thursday, October 21, 2010

problems with the proposed Indiana property tax caps

An edited/shortened version of this essay from Jim Baker appeared recently in the Jeff/NA News-Tribune...

The referendum that will be before Indiana voters this fall has been a source of much discussion and disagreement since it has been proposed. Those in favor generally represent the majority of property owners who are homeowners and who will benefit the most from this possible change in the state's constitution; however, most of these owners are unaware that they are still going to be subject to property tax increases every year. Those who own farms or investment properties in the 2% category and especially those who are in the commercial 3% category are negatively impacted by this potential change because of the additional annual expense this places on their properties.

As with many things that are political in nature, this appears to be another form of redistribution of wealth from one group of taxpayers: commercial real estate owners, landlords, tenants and farmers, to another group: homeowners. Also, it appears that the motivation of those who have proposed and favor this change is due to the fact that there are many more voters in the latter category than in the first one, thus making this easier to be passed in to law. However as with many things that look good politically, what seems to be best for the most can actually be harmful to everyone when examined in a larger context.

Therefore, I will attempt with the following examples, to show the reasons why I believe the proposed property tax caps are bad for Indiana businesses and property owners:

1. The 1% cap for homeowners does not keep property taxes from increasing due to future increases in the home's assessed value. For example a home that is now assessed at $100,000 is limited to $1000 per year in taxes under the 1% cap, but in a few years that could easily double if for example the property 's value increases to $200,000. Also, as long as property taxes exist , a homeowner never really owns their home and will forever be renting their home from the state.

2. The 2% cap on rental homes/apartments and farms is also flawed due to future increases in the property's value and thus increased assessment. Also, it difficult for the landlords/owners of rental homes and apartments to pass property tax increases to their tenants in the form of increased rent for fear of losing the tenant. However, if a landlord/owner is able to pass the increased property taxes to their tenants, then the tenant (who generally represent those from families in our state that are the least able to pay more) are penalized twice as much as a homeowner who only pays 1% of the assessed value. Many landlords have indicated to me that the 2% cap amounts to as much as 3 months or more of the annual rent that they collect and thus makes the property very difficult to cash flow, maintain and own. As a result of this, most landlords feel as if the government has a greater interest in the property and benefits more from it than the landlord/owner.

3. The 3% cap can represent as much as 30% to 50% of the property's gross income and therefore decreases the total value of the property by 20% to 30%. This can easily be proven by the following formula: the additional 2% (as compared with properties in neighboring states such as Kentucky that pay about 1%) when divided by a capitalization rate of 10% = 20% of the property's value. When a lesser capitalization rate is used, say 9%, the loss in value jumps to 22.22. At a capitalization rate of 8% the loss in value is 25%. This literally represents hundreds of millions of dollars in lost property values when applied across the entire State of Indiana.

4. The 3% cap for most income properties usually represents 30% or more of the property's annual income and therefore makes these properties difficult to cash flow and maintain (not to mention difficult to pay the existing mortgage payments and debt service). For example, a $1,000,000 property that has a 10% annual net lease rate based on its market value would produce $100,000 in annual income. If the property taxes are 3% of the property's value/assessment, the property taxes would be $30,000 per year and therefore 30% of the gross income. There are no examples that I am aware of where a business in any industry is able to pay 30% or more of GROSS REVENUES (not net revenues) in taxes and thrive, or even survive, in today's economy.

5. The 3% cap on property taxes creates losses of jobs. Those who pay these additional property taxes are not just the commercial property owners, but are also many times the tenants who have NNN (net, net, net) leases. Most small business tenants are finding it difficult to stay in business and some have gone out of business due to the added pressure that the additional property taxes have created for them. A tenant or owner who is paying $30,000 per year in taxes on a $1,000,000 commercial property (as in the above example), is paying an additional $20,000 per year in taxes versus a business in a state that is only paying 1%. This additional amount per year could easily represent another job that now can't be added or that needs to be eliminated from the business due to the higher property taxes.

6. Two other major issues which I feel need to addressed concerning property taxes and property tax caps are:

A) Property tax assessments will always have inaccuracies due to a subjective system that determines the amount of the assessed values. There is no method or system to accurately assess every property for the correct current market value. Appraisals/assessments always: 1) vary from one appraiser/assessor to another, 2) are the result of a non-scientific process and 3) are the opinion of the appraiser/assessor (even when the very best sale/lease comparables and methods of valuation are employed).

B) Until our political leaders are willing to create spending caps there will never be a limit on the amount taxpayers will be taxed to fund government. Since many property tax rates are currently below the 1%, 2% or 3% cap, the taxes needed to fund increased government spending will be met by increasing property tax rates to the maximum caps allowable.

In summary, the proposed property tax caps are not the answer to limiting property taxes for Indiana property owners and will only create more inequities, loss of values, loss of jobs and greater tax burdens for property owners if permanently enacted.


At October 25, 2010 at 11:47 AM , Blogger Steve said...

Thanks Eric for this insightful article. #6-B is the bottom line for me. That is what I was thinking from the start when I heard about tax caps. If we vote for tax caps, they will most likely be implemented immediately to the max allowed. Consider the economic crisis our State is in. What we really need is some reasonable form of spending caps.

At October 31, 2010 at 7:27 PM , Blogger robert said...

thanks eric for alot of b.s. what are the chances in a homes value increasing from 100k to 200k? Are you serious? They are passing this legislation, because of the blind abuse of the system, if government needs a litle more money just raise taxes. p.s. I own 750k worth of commercial property and I am for the caps.

At November 2, 2010 at 12:06 PM , Blogger Tammy Jennings said...

Thank you, Eric. Owning a lake rental and knowing the reality of a home's value increasing significantly as in your example, I can see where the tax caps is not what we need. I really appreciate you taking the time to post your thoughts on the matter so we can be better informed.


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