Just how far off are property tax guides? Try about $2,086 per year on a $200,000 home in Houston, for example. For an investor, that represents a 15 percent decrease in cash flow, assuming a 7 percent cap rate.
According to a recent study by the National Association of Home Builders, the reported property tax rate for the state of Texas is $18.17 per $1,000 of value; in Harris County, where most of Houston is located, however, the property tax rate comes out to around 2.86 percent, or $28.60 per $1,000 of assessed value based on 2006 tax rates. Unfortunately, the study by the NAHB is not the only one off the mark as far as investors are concerned.
Recently, the U.S. Census Bureau has begun to track property tax information for each state and made its findings available to the masses. While this information can be helpful, it could lead investors to use it as a basis for calculating potential cash flow, which could be a dire mistake.
The NAHB study, based on data from the 2005 census, ranks states by median property tax rates for residential properties. Texas, Wisconsin, Nebraska, New Jersey and New Hampshire were the states with the highest rates. Some of the lowest were Louisiana, Mississippi, Arkansas and Alabama. At one end of the spectrum, Texas’ median tax rate is 18.17 per $1,000 of value, while Louisiana’s is just $1.72 per $1,000.
While investors may be able to get a picture of what they can expect in the pricier Northeast or the comparatively inexpensive South, it is important to take note of four major factors that can skew the percentages.
1. In the state of New York, Niagara County has a median property tax rate of as much as $28 per $1,000 of value, while Kings County has a rate of just $4.72 per $1,000. This showcases the potential for vast difference in property tax rates between counties in a single state.
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Since investment properties tend to be located in cities within counties within states, it is vital that investors are aware that taxes will be different in each county and even each city. Typically counties will designate a county tax and then cities will tack on a city tax, as well as the school tax and other local taxes. Not all states assess a state-wide tax; however, states such as New Hampshire, which requires an education tax of more than $3.00 per $1,000 of value, do.
2. Homestead exemptions, which are only available to owner occupants, can significantly decrease property taxes. This is a benefit investors will never see. By applying for the exemption, typical single family homeowners can take tens of thousands of dollars off the taxable value of a property, ultimately saving hundreds and even thousands of dollars per year.
The U.S. Census Bureau bases its numbers on taxes actually paid by homeowners, not the taxes homeowners were supposed to pay before any exemptions. Since many homeowners utilize the homestead exemption in those states that offer it, the true tax amount an investor can expect to pay will be that much higher. The census numbers do not specify the states that have the exemption.
3. A few states have property tax assessment increase caps. Florida, for example, has the Save Our Homes program. In this program, homeowners who have occupied their residence for a specified amount of time can cap the amount of growth on their property at 3 percent per year to keep assessment levels low for property tax purposes.
While this benefits homeowners, investors do not get to participate in these tax savings. In the case of Florida real estate, where property has appreciated at 10 to 20 percent a year for 10 years, a 3 percent yearly cap means homeowners are saving a considerable amount. As with the homestead exemption, the census includes this discount in their numbers.
4. Some states tax owner-occupied properties at lower rates than investment or rental properties in order to protect homeowners. Alabama taxes just 10 percent of fair market value on owner-occupied homes while investment or rental properties are taxed at 20 percent. Similarly, Mississippi charges just 10 percent for single family owner-occupied homes and 15 percent for all other personal and real property.
Investors could be looking at property taxes double what the average homeowner pays in certain areas, and the census may not accurately reflect those numbers.
The census and the study by the NAHB each present a fair assessment of some states, essentially those without exemptions. Unfortunately, most states have exemptions of some kind, and many others are moving to that model. Since most property owners are not investors, and only own their personal residence, politicians typically can raise property taxes by showing voters that it won’t really affect them.
Investors should use published reports as a starting point while further researching what kind of property taxes they can actually expect. These reports will understate taxes, but they won’t overstate them. So if a state has high tax rates, investors can rule that state out if they choose. However, just because a state appears to have low property tax rates, that does not mean those rates will accurately reflect what an investor can expect to pay.