Not Fair Market Value


The City of Alexandria, VA insists that it assesses real estate at "fair market value":

Each year, the Department of Real Estate Assessments appraises each parcel of real estate in the City to assess its estimated fair market value. These values are used by the Department of Finance to bill for and collect the real estate tax, which accounts for approximately half of the City's annual revenue.
Actually, the City uses a software package to automate the assessment process based on historical data. In a fast-paced sellers market, in which average price increases have been reported at 25% annually, this type of assessment can dramatically undervalue properties. In this post, I will demonstrate this with actual data.

Now, my tax bill has gone up considerably since we bought in October 2001, all due to increases in "fair market value". And as David Bernstein noted (he lives in adjacent Arlington County, most likely in a reasonably small house I probably cannot afford), you can hear the "great sucking sound" for miles around. Personally, I would love to see an historical study of the productivity of city employees over the past 10 years, as tax revenue has soared... In any case the City has been underassessing it's resident-owners for years now, and I'm thankful for it.

Despite my glee over paying less that I could, reading public economics texts has taught me that tax rates and tax assessments are just implicit prices for a tremendous assortment of government services. Prices should broadly reflect market values of those services.

Personally, I don't think any such thing as an "efficient tax rate" exists when the funds that flow from thousands of diverse people are used to produce hundreds if not thousands of goods and services.

In this massive exchange context, "efficient" means "low" but "enough". But for some reason I've come to believe that "efficient" should also mean honest and transparent. If not useful to aid in the market efficiency local government financing of goods and services, at least it can give homeowners an honest assessment of current market values. (This easy-to-read paper (PDF) gives several points of view on property tax efficiency).

The most recent assessment for the City of Alexandria was completed in January. And its clear to me that assessments for condominium apartments in my building are way below actual market prices -- even though data is readily available to the assessors' office: three dozen apartments were sold here last year and thirteen have already been sold this year.

Given so much data about sales, just how close is "fair market value" to actual market prices in my condo-apartment building?

Fortunately, the city puts online all sales of all real estate in the City. The data used for the 2005 assessment are also online for all to see.

What's great about the former data is that it shows that already in 2005, the average apartment is selling for $30K (19%) above assessment.

What's great about the latter data is that it shows sales in 2004 and assessments for those same properties in 2005. Upon examination, it becomes immediately clear that the "fair market value" used is actually the historical average sales prices for the entire previous year -- the sales prices of last June. This is how the city gets "fair market value", which might be OK for a stagnant market like Buffalo, but is not OK for DC.

There are 5 types of properties in my building: 0, 1, 2, and 3 bedroom apartments, and commercial space. So here's a time-series chart that normalizes the different styles and sizes into one figure: 2005 assessments divided by actual sales prices:


What the regression figures tell you is that, on average from 1/1/04 to 3/15/05, the 2005 real estate assessment became lower than the spot price by about 0.07% every single day . Over a month that means the assessment loses 0.07*30=2% compared to the spot price. Over the year, the assessment loses 0.07*365=25% compared to the spot price.

Since we know with great liklihood that this will happen, what I'm suggesting to our benevolent despots in Alexandria City Government is that a more accurate "fair market value" be implemented.

For taxation purposes, you should utilize all sales information for the previous several years -- not just the last year. Use all that information to forecast the average prices to the middle of the current tax year, not the middle of the previous tax year. By adjusting your method, you could get the increase in next year's assessments today. In a fast moving sellers' market, your historical average only guarantees that the city will underassess nearly all properties.

For the sin of advocating abolition, economics became the dismal science. For advocating honest assessments, economics could become marginally more dismal.

Questions: 1) If governments want to maximize tax revenue, why haven't local governments gobbling up the windfall from sellers markets already switched over to forecasting next year's prices? Are they waiting until times get lean again?

If I were a budget maximizer, I would play a coy game. Right now I would simultaneously increase the assessment amount and decrease the tax rate. Then later on, I would raise rates to "historical norms" to justify myself.


Let's say real estate increased 25% last year. Did the city's cost of doing business - paying workers, paying for schools/roads/police etc. - also increase 25% last year? Hell, no. So what is the basis for the increase? Are we going to get "25% more" out of the government next year? Somehow I doubt it.

A lot of people argue that real estate is a "bubble" that will pop soon. If they are correct, and housing prices plummet, it will be interesting to see if tax assessments drop correspondingly. My guess is they will not.

In a larger sense, it seems to me that no wealth is actually created due to any increase in home prices. Wealth is simply transferred from one owner to the next, and to the banks and the government. This is not good.

The Buffalo example is a great one for illustrating what would happen if the real estate bubble burst.

When I bought my first home in '97, I paid $110k, but it was assessed for $140k. The assesment was not updated because of the sale, and I appealed my assesment, going from $5k per year to less than $4k.

This was a popular thing to do at the time, as many homes were selling for less than the assessed value.

This is why so many assessments are NOT based on market value, but some convoluted procedure that is (supposedly) only a portion of market value. My assessment in Chicago was $22,000, for example. It was like 30% of market value or something. All I did to verify its accuracy was compare it to home sales in my neighborhood.

In answer to your question;

1 - Depression. I live in the city of alexandria and am tired of forking over more and more $ to the city government. Finding out my assessment is too low is not what I want to hear.

2 - I would think that from the politicians POV, the mechanism used has to be a balance of revenue generating and defensible/explainable to the thousands of nuts (like me) that call in every year to find out why their assesment went up 25%. They may feel the current system is easier in that regard.

3 - Perhaps city officials have a longer term view and the quarter or so lag in prices is not of great value to them as they know they'll make it up the following year?


In discussing such things that will help us better understand such things would really mean that we have to study a lot. - Lindsay Rosenwald


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This page contains a single entry by Kevin published on April 3, 2005 12:27 PM.

Information Asymmetries and Dating was the previous entry in this blog.

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