Housing Market Anomalies -- Late Summer, 2010

Ancillary Fees (& Taxes) Loom Larger

If you have to ask how much something costs . . . you can't afford it.

--Author unknown

One of the anomalies of today's housing market is more properties discounted to the point where their purchase price is suddenly very attractive -- the more so with interest rates seemingly falling through the floor.

However, they come with vestigial "ancillary costs" -- a ball-and-chain, if you will -- that are still pegged to the old asking price, deterring many of those same buyers.

Out-of-Whack Property Taxes

So, in Minneapolis alone, I can think of a dozen-plus homes whose asking price has now dropped from $1 million-plus to the high six figures.

However, they still carry an annual property tax bill that in many cases still runs $15k or more.

That's a problem -- financially and psychologically -- because the move-up Buyers for these homes most likely now own homes worth $400k-$600km, and are accustomed to property tax bills that are a fraction of that.

Even though the property taxes should re-set when a deal is consummated, there are no guaranties -- and the lag can be up to 2 years.

The same phenomenon can be a hurdle for properties that carry an association fee.

When mortgages are so cheap, suddenly that $300 -- or $800 -- monthly maintenance fee looms larger.

P.S.: Hey, fellow Realtors! Here's a freebie: instead of paying for the Buyer's closing costs, maybe such Sellers should contemplate paying down the property taxes for the first two years.

You read it here first!

Estimating Home Upkeep

"Lumpy" Home Repairs

How much should you earmark for annual home upkeep?

According to one LA-based Realtor:

Homeowners should have 1% of the purchase price of their home in savings for improvements and surprise expenses. That is the absolute minimum. It's better to have 2% to 3% socked away somewhere.

--"Home Costs Keep Going Up"; The Wall Street Journal (12/28/09)

Before parsing this advice, however, first an aside: notwithstanding the article's headline, it gave no examples of how home costs are rising at the moment.

In fact, big ticket items like property taxes, as well as capital repairs like roofs and exterior painting -- not to mention major appliances -- are now getting less expensive, thanks to the recession.

Back to upkeep . . .

Yes, I agree with the 1% rule, but with a major caveat: home repairs are likely to be "lumpy." In other words, most years, homeowners will likely spend well below 1%; however, intermittently, they'll likely overshoot that quite a bit.

That's because things like roofs, exterior paint, and furnaces can last a decade or longer, but when they go . . . they go.

In the meantime, I'm a big fan of home warranty plans, which for a fairly reasonable monthly premium cover homeowners against major, unexpected outlays.

In fact, my standard advice to my Buyer clients is to get coverage for a calendar year, until they know their home, what reliably works -- and what doesn't. After that, they can re-assess as appropriate.

P.S.: Is The Wall Street Journal getting sloppy with its headlines? Consider this one, also from today's paper: 'Adjusted for Inflation, Dow's Gains Are Puny.' The article then goes on to note that the Dow, currently at 10,500 and basically unchanged from a decade ago, is only 8,140 when adjusted for inflation.

Since when does a 2,000 point drop qualify as a "puny gain"??

Great Location, Cheap -- Why?

What's the Catch? (Hint: There's 2)

Where: 31xx East Calhoun Parkway in South Minneapolis

What: 5 BR/4 BA with 4,500 FSF on .29 acre lot

How Much: originally listed for $925k on 9/21; just dropped to $825k yesterday

Who: Broker - Edina Realty; Agent - James Keane

Even in a soft market for upper bracket homes, a 4,500 square foot home, on a .29 acre lot -- overlooking Minneapolis' Lake Calhoun, no less -- stands out.

So what's the catch, besides what some might say is the plain curb appeal?

Looking for Catches

The home doesn't appear to be dated or run-down; in fact, the interior pictures are actually quite flattering.

And no, it's not a foreclosure or short sale.

So what, then?

There is a high-rise tower immediately to the north looming over the home (and no, it's not in the pictures).

Not a huge deal, perhaps, but not exactly an amenity, either,

Catch #2

The other catch -- at least until the taxes catch up to the lower valuation? (Like many expensive Twin Cities homes now, this one is listed for well below the tax assessed value.)

An almost $17,000 annual property tax bill.

In truth, property taxes are a looming issue for many, many other upper bracket homes as well, but particularly in Minneapolis (by way of comparison, you'd expect an $800k Edina home to have a $10,000 property tax bill, give or take).

$10k Property Tax Bill? "That's Nothing!"

It's All Relative

One of the things you have to remember doing open houses around the City Lakes is how much the housing costs, relatively speaking -- not to mention the property taxes that come with.

Normally, a $10,000 annual property tax bill isn't a selling point.

However, I had three parties come through my $600k Sunset Gables open house yesterday who were contemplating downsizing from significantly more expensive, nearby homes.

I literally heard variations of the following multiple times: '$10,000 a year? That's nothing. I pay double (or triple) that now!"

P.S.: I remember getting gas a few years ago, and the man one pump over couldn't seem to take his eyes off my two sleeping kids (pure angels when they're asleep!).

The look in his eyes could only be described as wistful. I gently said to him, "You must not have kids." "Oh, God, no," he answered. "I have nine."

Tax Trial Balloons

Gov't. Financial Squeeze = Homeowner Squeeze?

The mortgage-interest deduction has been a political no-go zone for decades. The same for local property-tax write-offs. But with billowing deficits and the need to raise trillions to help pay for health-care reform and the economic stimulus bills, somewhere, somehow, Congress is going to be pressed to raise revenue.

--Kenneth Harney, "Going Where Congress Hasn't Gone"; The Washington Post (8/29/09)

Kenneth Harney's column today makes the (valid) point that just because Congress is in recess, doesn't mean that policy shifts aren't afoot.

In fact, Congressional staff are right now busily proposing all sorts of revenue-raising ideas to close gaping budget deficits as far as the eye can see.

"That's Where the Money is"

At the top of the list: various proposals to limit the size of mortgages that qualify for interest deductions; eliminating the itemized deduction for state property taxes; and raising capital gains taxes.

To "lessen" the impact of the foregoing, Congress would employ incremental phase-in's (for higher taxes) and phase-out's (for deductions).

Locally, the City of Minneapolis is floating the idea of annual, 10%-15% property tax increases practically off into the sunset.

Why are homeowners such fat targets?

To paraphrase what Willie Sutton said when asked why he robbed banks: 'because that's where the deductions are.'

Property Tax Appeals

'Shrunk to Fit': Tax Values in a Declining Market

Homeowners across the country are challenging their property tax bills in droves as the value of their homes drop, threatening local governments with another big drain on their budgets

--Jack Healy, "Tax Bill Appeals Take Rising Toll on Governments"; The New York Times (7/4/09).

Which would you rather have, 85% of $100, or 100% of $85?

In fact, they're exactly the same.

Add three (or four) zeroes, and that describes today's property tax environment in much of Minnesota.

Conservative No More

Until recently, most local tax authorities seemed to observe an unspoken rule that, when it came to assessing homes, conservative was better.

So, a house with a fair market value of, say, $250k might only be assessed at $200k. (Of course, another reason for conservative valuations -- at least in a rising market -- is that they're set two years ahead of time).

Today, local governments need every penny they can get. And yet, the housing market is falling, prompting homeowners to challenge their property tax assessments.

What many homeowners are finding out is that their home has "shrunk to fit" the more conservative tax assessed value. In other words, the $250k home that was taxed as though it were $200k now really is $200k. Voila! No tax refund.

Of course, tax assessed value is just one component in determining the tax owed; the other component is the tax percentage, also called the mill rate.

If the mill rate goes up more than your tax assessed value drops -- a distinct possibility these days -- your property taxes rise, not fall.

Closing MN's Budget Deficit

State Tax Deductions for Housing: Endangered Species?

Is now a good time to make upper bracket housing in Minnesota (or anywhere else) more expensive?

The Minnesota state legislature -- or at least the House -- seems to thinks so.

On Saturday, it passed a bill that would make mortgage interest and property taxes non-deductible in calculating state income taxes (the bill would also raise taxes on those making more than $250k). The moves are the corner piece of the legislature's efforts to close an estimated $4.2 billion deficit.

Leaving aside the public policy merits of the bill, consider its effect.

If you want to make something more expensive, tax it -- or in the case of housing, remove a long-standing subsidy.

The problem with the House's bill is that upper bracket housing is already under siege, from multiple quarters.

The gap between "conforming" loans -- up to $417k-- and jumbo loans is at record levels. The former carry an interest rate around 4.75%; the latter, well over 6%. The reason is that only conforming loans can be readily packaged and sold to investors via Fannie Mae, Freddie Mac, etc.

"(Un)settled Expectations"

Of course, the recession is already pressuring prospective Buyers of upper bracket housing.

Companies trying to pare their labor costs can save a lot more axing senior executives than more modestly paid subordinates.

Meanwhile, anyone who can afford an expensive home has likely seen their investments -- and their wherewithal to come up with a healthy, six figure downpayment -- whacked by as much as 50% the last two years. That's at the same time that the middle-bracket home they currently own has dropped an average of 25%, metro-wide.

Further raising the cost of owning a more expensive home is not exactly going to stimulate demand.

Even if subsidizing expensive housing isn't something that we, as a society, want to continue to do, the fact is that thousands of area homeowners made their purchase decisions relying on the rules as they understood them to be at the time. Lawyers and policy-types refer to this phenomenon as "settled expectations."

For now, the debate is likely moot: the Minnesota Senate hasn't taken action on a companion bill, and Governor Pawlenty has signaled that he will veto anything that the entire legislature approves.

However, you could say that the issue is now on the table.

Title Insurance Traps

Title Traps Can Bite
Foreclosure Buyers

The potential traps that lurk for Buyers procuring title work, especially for foreclosures, reminds me of a favorite attorney joke (I'm allowed to tell them because I am one, albeit non-practicing).

When a neighbor charges that the attorney's dog bit him, the attorney first denies it. When he's shown photos of the bite and the emergency room bill for the neighbor's stitches, the attorney then argues that the dog attacked in self-defense. When numerous witnesses come forward to testify that the attack was unprovoked, the attorney says . . . it's not his dog.

Similarly, Buyers paying good money for title exam and insurance need to be mindful of numerous pitfalls, especially when foreclosures are involved. Herewith is a partial list:

--Who is the title company working for? If they're hired by the bank that owns and is selling the property -- as some banks require -- their motivation to uncover all potential liens and claims against the property may be compromised.

--What's in the fine print of the owner's title insurance policy? Specifically, what's included -- and more importantly, what's excluded? Many municipalities are now imposing hefty abandoned building fees (Minneapolis' is $6,000). Is the title examiner checking to see if such a fee has been imposed? How recently did they look? Ditto for property taxes, unpaid utility bills, contractor liens, etc.

--Even if the owner's title policy covers a potential claim, it may be subject to a significant deductible. Or, to collect, the owner may have to incur significant legal fees that the title policy won't reimburse.

--Is the company issuing the owner's title policy financially sound? Even an airtight claim is worthless if the company standing behind the policy is bankrupt or otherwise out of business.

When it comes to title work, inattentiveness or unwise penny-pinching can cost Buyers A LOT down the road.

What's It Worth?

2445 Portland Ave. So.

Minneapolis

Asking Price: $132,905
Assessed Tax Value: $505,500
Property Taxes (2009): $8,216
Last Sale: $480,000 (3/1/2007)

This 5,200 FSF, Brick Four-plex came (back) on the market late Friday afternoon. A quick look at its selling history indicates that it's been on and off the market, at ever lower prices, since July, 2005.

What it actually sells for is anyone's guess (I haven't been inside). But it's a safe bet that it's worth a fraction of the $505,500 the city says it is. Bet #2: it would sell faster without an $8,216 annual property tax bill attached -- more than the next owner's likely mortgage payments. (You'd further guess that those taxes haven't been paid in quite awhile, leaving a big, fat lien against the property.)

Such out-of-whack tax bills are one of the reasons many foreclosures languish on the market.

Property Tax Pitfalls

How Foreclosure Buyers Can
Reduce Their Property Taxes

Q: When is fair market value not "fair market value"?
A: When it's a foreclosure sale.

Because of the process(es) described in "Sticky" Property Taxes, foreclosure buyers should not expect dramatic property tax relief any time soon after closing their purchase. Even worse, unless they're careful to document the initial condition of their property, they may inadvertently be penalized for any home improvements that they subsequently make.

That's because many cities calculate each home's annual tax assessed value as of a fixed point in time (in Minneapolis, it's January 2).

As an example of the potential property tax pitfalls, assume that someone buys a dilapidated foreclosure January 1, 2009 (eleven days ago) for $60,000. Further assume that the foreclosed property's tax assessed value is currently $200,000. While that would make the purchase price 70% below the tax assessed value, in this market such discounts are increasingly commonplace.

So the new buyer's tax assessed value for 2009 is $60,000, right? Wrong.

Because 2009 property taxes are determined January, 2, 2008, the 2009 taxes are already set. That means 2009 taxes are pegged to the old, $200,000 assessed value.

Comparing Bruised Apples to Oranges

So at least the Buyer's 2010 property taxes will reflect the $60,000 purchase price, right? Wrong again.

As of January 2, 2009 -- the date relevant for establishing 2010 property taxes -- the foreclosure was merely a pending sale, as far as the city and county are concerned. It won't be until 6-8 weeks later, when the sale is typically recorded, that the government will know otherwise.

That means the default value for 2010 property taxes is the old, $200,000 tax assessed value.

However, thanks to an informal appeals process, taxpayers effectively have until mid-April to dispute property tax values set January 2. Here's where it gets interesting.

The foreclosure Buyer will definitely want to contact the city assessor assigned to his neighborhood -- the assessors each have geographic territories -- and challenge the $200,000 assessed value. But the $60,000 he just paid is not deemed relevant for establishing property tax values, because foreclosures are not deemed "valid sales" for comp purposes.

Instead, the city assessor can only consider recent, nearby sales of homes that were not bank-owned. In practice, that means that the home's new tax assessed value won't be $60,000, but an amount much closer to $200,000 -- most likely at least $140,000 (in practice, a 30% reduction from the previous year's tax assessed value appears to be the maximum) .

The new owner must also carefully document the condition of the home at the time of purchase.

Otherwise, any post-closing improvements done by the new owner may have been deemed to exist as of January 2, driving up the following year's property taxes!

"Sticky" Property Taxes

Q: How long does a property tax hangover last?
A: Two years-plus

One of the sticking points, literally, for would-be Buyers of foreclosed properties is an unpleasant hangover from the erstwhile housing boom: bloated property taxes.

In today's, foreclosure-tinged market, it's not unusual to see homes listed for 30% or less of their assessed tax value (no, that's not a typo). However, even if the Buyer pays the dramatically lower, current list price, they'll temporarily be stuck paying taxes pegged to the older, inflated price.

When the property taxes do adjust lower, the drop is likely to be disappointingly small, given how cities calculate "assessed value."

Some examples illustrate the point.

In Minneapolis, a home assessed at $60,000 might owe about $1,000 in annual property taxes. A home that the city values at $200,000 would owe around $2,500. So, if you buy the formerly $200,000 house in foreclosure for $60,000, your property tax bill will be $1,000, right? Wrong, at least not for a few years.

While property taxes will certainly drop once a sale at a dramatically lower price is recorded, the drop is likely to be much smaller, and take longer, than many Buyers might reasonably expect.

"Bruised Apples to Oranges"

There are two reasons for that:

One. Property taxes can lag the market by two years.

By convention, Minneapolis property taxes are set each January 2 for the following year. That means whatever the city deemed your home to have been worth last Friday, is what you'll pay 2010 property taxes on. In turn, the value last week is based on comp's ("comparable sold properties") from the tail-end of 2008.

Depending on what the housing market does from here, it's certainly possible that late 2008 prices may not be so accurate two years from now. Or put it this way: the odds are pretty good that your 2008 property taxes, pegged as they were to 2006 prices, were artificially high.

Two. Municipalities like Minneapolis do not consider what Buyers paid for foreclosed properties to be fair market value (let that sink in for a minute).

That's because bank-owned homes -- foreclosures -- aren't considered "valid sales" for comp purposes.

According to Minneapolis, a valid sale doesn't involve duress. Because foreclosures by definition involve duress . . they don't count. (Interestingly, "short sales," whereby the bank agrees to reduce the mortgage balance owed, usually do count as valid sales -- at least that's what my contact in the Minneapolis Assessor's office told me).

As a practical matter, what that means is the city assessor must establish the foreclosed home's market value by comparing it to sales of nearby, non-foreclosed homes. Common sense suggests that such "bruised apples-to-oranges" comparisons might be a stretch, and skew the price of the foreclosed home upwards.

"Who are you going to believe . . .?"

Which is exactly what seems to be happening.

So instead of the $60,000 foreclosed home being reduced from the $200,000 assessed value to the actual purchase price -- $60,000 -- in practice the new tax assessed value is likely to be much higher. Depending on what's happening with the closest non-foreclosed home sales, the new, tax assessed value could be anywhere from $100,000 to $150,000.

It reminds me of one of my favorite New Yorker cartoons.

In the original version, the non-cheating spouse catches the cheating spouse "in the act." The cheating spouse protests, "who are you going to believe, me or your own lying eyes?"

In the updated version, the cheating spouse simply says, matter-of-factly, "believe me, it's not what it is."

Part 2: Property tax tips for foreclosure Buyers.