Landmark Links May 13th – No Free Lunch

pigs-at-the-trough

Lead Story… Earlier this week I wrote about the FHA portion of a video that Ivy Zelman posted last week regarding how high impact fees, when combined with low FHA loan limits are stifling the home building recovery in the inland growth markets of California where most new home production typically takes place.  Today I want to focus on a different angle that was not discussed by Zelman or by Nick Timiraos who wrote a follow up article in the Wall Street Journal:  Why are California impact fees so damn high to begin with?  As you can see below, California’s fees are at nose-bleed levels compared to the rest of the country and there is indeed a very high correlation between the cost of impact fees and the level of housing growth.  The six highest fee markets are all in the Golden State when measured as a percentage of the FHA maximum loan in each area:

The knee jerk response here would be to blame California’s high tax/regulation environment for runaway fees.  While there is some truth to that, I don’t believe that is the main culprit here since California’s property taxes are actually very low and therein lies the root cause: Proposition 13.  First, a disclaimer: I am not against Prop 13, per se as I own property in California and, am therefore a beneficiary.  I generally tend to favor lower taxes.  However, I am also of the belief that it’s important to understand the unintended consequences that large, sweeping statutes like Prop 13 can have on other parts of the economy years after they were passed.

I have somewhat of a unique prospective on property taxes because of where I’ve lived the over the past 37 years.  While I have been a California resident for the last 15 years, I lived in New Jersey before that and New Jersey couldn’t be more different from California when it comes to property taxes.  NJ is the most overtaxed state in the US with an effective rate of approximately 2.3%.  To make matters worse, New Jersey residents have virtually no protection against re-assessments which happen on a regular basis (beyond indexing for inflation) and can and do jump 10% at times.  A house that my parents own was once reassessed a whopping 25% higher in one year along with hundreds of other similar properties on a lake.  There were no renovations done to the home, the local municipality just felt that values had increased and acted accordingly.  In a supreme bit of irony, the tax increase substantially reduced the value of the re-assessed homes and made them very difficult to sell.  (Just an aside, my parents still own that home and spend the summer there but sold their other house and moved to Florida to escape the insanity of the NJ tax man.  They now spend their days in a St. Petersburg, Florida Walmart on the lookout for funny crime stories to send to me for this blog.)  As you can probably imagine, getting “taxed out of your home” is a very real issue for New Jersey residents.

California has no such problem.  In 1978, nearly 2/3 of the state voted to reduce the property tax to 1% of the purchase price of real estate (that rate doesn’t include local assessments that typically must be approved a 2/3 majority and any Mello Roos fees associated with an underlying CFD) and capped future increases to no more than 2% per annum.  It also took the responsibility for allocating property taxes from local municipalities and transferred it to the state.  Prop 13 was intended to avoid the New Jersey scenario mentioned above of people getting taxed out of their homes.  In that regard, it has been a success.  However, it created a major market distortion and provided fuel that helped property values soar.  It also led to a decrease in local revenues and forced local governments to rely increasingly on impact fees to mitigate the impacts created by new development.  In other words, local governments could no longer rely on spreading the cost of new infrastructure across an entire tax base, they now had to focus the cost solely on new development which constitutes a much smaller number of units.  It also means that a local government only gets one bite at the proverbial apple via impact fees rather than a recurring income stream that can be assessed upwards as need dictates.

This “one bite” mentality provides a large incentive for local governments to hike non-recurring fees in order to pad a highly irregular income stream, shifting the full infrastructure burden to new units to the benefit of existing ones.  Under Prop 13, new developments bear the brunt of all new infrastructure by default, primarily because there is literally nowhere else left for the income to come from.  As the old saying goes, there ain’t no free lunch.  Prop 13 didn’t actually force a reduction of government as many claimed it would, instead it merely shifted the burden of funding the local government from many to few and home builders and land developers are paying the price for that today. That works fine when prices are increasing enough to offset rising impact fees.   However, prices in secondary markets like the Inland Empire haven’t recovered anywhere close to their prior peak while fees have continued to rise which is a big reason that the market is so stagnant today.

The counter example  the Inland Empire in the Zelman video is Houston, Texas, which has been the leader in housing expansion during this cycle and has nominal impact fees of about $1,000 per home.  Texas is commonly considered to be a low tax state (at least when compared to California) but it actually isn’t when it comes to property taxes.  Believe it or not, the Lone Star State has the fifth highest property taxes in the US which is a large part of the reason why they are able to keep impact fees so low when compared with California.

Property owners and investors benefit greatly from Prop 13 since it keeps their taxes low and allows them to lock in a basis that only increases moderately over time.  I would argue though that it has largely hurt developers (and buyers of new homes) who are the only ones left to plug the gap of the revenue shortfalls that hit local governments when Prop 13 was passed.   Again, there ain’t no free lunch.  Someone ALWAYS pays.

Economy

That Didn’t Take Long: Remember that speculative boom in the Chinese commodities futures markets we mentioned a couple of weeks ago?  It’s already unraveling and getting uglier by the hour.

Just the Beginning: Goldman thinks that the search for yield is only going to get worse as investors come to grips with a low return world and bond managers scramble to get back in the high yield bond market which has rallied hard after a slow start to 2016. 

Lasting Impact: The scars from the great recession are deep and they aren’t going away any time soon.   But See: Wage bargaining strength is finally increasing.

Commercial

Gone to Pot: Dusty Coachella Valley outpost Desert Hot Springs is finally having it’s moment as big money rolls in to develop marijuana growing facilities leading to a feature article in the LA Times yesterday morning.

De-Clutter: Self storage is booming in New York where residential units are tiny and space is at a premium.

Residential

Elusive: Consider this the latest reminder that it’s really, really difficult to build new homes at an entry level price when land is expensive and fees are high.

Lenders of Last Resort: Mortgage availability is still low by historical standards leaving the door open for private investors to gain market share by lending to those that don’t qualify but it’s not cheap.

Boom Town: Rents in Seattle rose 11% YOY in May, the highest in the US.  See Also: How a house went $335k over asking price in the white-hot Seattle market.

Profiles

Supreme Irony: Zenefits seemed to be the perfect startup until it imploded.  This is what happens when an HR firm runs into epic HR issues.

Chart of the Day

No comment necessary.

MCAI 3

WTF

Rats: A grandfather in Texas found a dead rat floating in a half-empty 20-oz bottle of Dr Pepper that his 3-year old grandson had been drinking.  Health officials ran a few tests and determined that the deceased rodent was actually the most healthy thing in the bottle.

Video of the Day: Check out a pod of False Killer Whales (a type of very large dolphin) hunt and kill a shark off the coast of Sydney, Australia while being filmed by a drone.

Trouser Snake: A Florida man (of course) tried to steal a snake from a pet shot by shoving it in his pants.  He was arrested after he was caught on surveillance video.  If I didn’t know any of this and saw a picture of the guy on the video, I would describe him as looking like the type of guy that would steal a snake by putting it in his pants.

Can’t Keep a Good Man Down: Former NY Jets cornerback Antonio Cromartie’s wife just gave birth to twins, the former NFL star’s 11th and 12th kids (from 8 different women).  He underwent a vasectomy months before the children were conceived.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links May 13th – No Free Lunch

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