The sudden collapse of the national housing market initially attributed to mortgage financing problems but later stemming from economic recession and rising unemployment has resulted in lower investment expectations, slower turnover of homes, rising defaults and foreclosures and expanded inventories that are difficult to liquidate.

Austin Jaffe, Ph.D.

But there are a few surprising secondary effects:

Growing Property Tax Burdens — Property tax assessments are based upon the value of the property (land and buildings).  With declining house prices, the property tax burden rises for the homeowner.  It does not matter if the assessed value is established as equal to market value or some fraction thereof; property tax levies are likely to be set based upon some assessed value.  These values are used only for property taxation but are determined by local tax authorities (sometimes using only the historic price paid at the time of sale and not adjusted over time but more often, increased via an index by the authorities). With recent declines, the effective property tax burden becomes significantly higher as a percent of the true (market) value. (Of course, overall assessed values could be lowered, too. But this is not likely these days.)

Most local tax systems enable homeowners to appeal their tax bills to win lower assessments,  however, this is often a costly and bureaucratic process. At the same time, communities with local income taxes have seen this source of revenue stagnate or decline and now look toward property taxes for an even higher percentage of funding local services. State and local government budgets are feeling the pinch from the economic slowdown so pressure is on to look for revenue. It is quite unpopular to consider higher property tax rates at any time  – but especially these days. Yet, unlike the federal government, most state and local authorities are required by law to run balanced budgets.

The Failure of Home Improvement as an Investment Strategy — One plan in the old real estate market was to buy, fix up, sell and move up. The idea was not just home ownership as a route to wealth creation; it also included remodeling and/or expansion to increase the modernity, quality and size of the asset.  CNNMoney.com <http://money.cnn.com/2010/11/16/real_estate/home_remodeling_costs/index.htm> has just concluded that remodeling for profit-making purposes does not pay off.  The article notes that the concept of remodeling for profit has been becoming less attractive for years and observes that 2010 has seen a “particular decline” in the percentage of home improvement costs recouped. They report that only about 60 percent of remodeling costs are typically recovered at sale, about 16 percent less than the average a year ago.  They conclude that the more spent for a job, “the lower the percentage of return.”                                                               

No Wealth Accumulation Through Home Ownership.  Many of the Baby Boomers’ plans have gone astray since homeowners can no longer rely on rising house prices to provide a source of funding for home improvements, college tuition, vacation or other needs and desires. Equity build-up remains available for fixed-rate mortgage borrowers (the savings portion of the borrower’s monthly mortgage payment kept by the lender until sale) but it is quite slow to accumulate. When house prices decline significantly, the reduction in equity easily exceeds the accumulation of equity through the sinking fund provision built into the fixed-rate mortgage commonly known as equity build-up.

Estimates are that the equity reductions since the peak of the housing boom now exceed 50 percent for the typical household.  This is greater than the decline in house prices because of the leverage effect. In other words, when house prices fall, the existing debt remains the same so dollar-for-dollar, the reduction comes out of equity. (Remember: when prices were rising and debt was fixed, it was common to cheer the gains from leverage!)

Most economists rely upon the theoretical notion of market equilibrium, a cornerstone in neo-classical economics.  There is an overall belief that the current housing market is slowly making its way to stabilized conditions and a new equilibrium.  Along the way, there are substantive difficulties and often unintended consequences.