$471 million lost taxes

Estimated annual statewide property tax revenue loss from no rent escrow law

Impact on lower-income neighborhoods

January 2007

Who loses when tenants play the “free rent trick” unchecked by a rent escrow law? The knee-jerk answer: landlords. And who cares about landlords?

True, landlords are the direct losers, but the landlords’ losses soon translate into neighborhood and statewide impacts – notably in property values and property tax revenues. As explained later, the estimated property tax loss is $471 million annually – almost half a billion dollars – for the entire state.

Spreading impact

Each landlord’s loss from one tenant playing the free rent trick is substantial: unpaid rent for many months plus higher-than-normal repair and eviction costs, all hitting at once. This substantial income loss forces the landlord to shift strategy and cut other expenditures he or she would otherwise make: repairs for other tenants and capital improvements to the property. The property starts to deteriorate.

If the property is located in a lower-income neighborhood where tenants live on tight budgets, any upset in their finances can precipitate non-payment of rent and the “free rent trick.” If a “free rent trick” tenant happens as often as once every few years for one landlord, that landlord may be chronically starved for enough income to cover repairs and improvements – and his or her property will steadily continue to deteriorate. If the “free rent trick” happens too often in one property, the owner is often forced to abandon it, letting banks foreclose or the city take it over for delinquent taxes.

The contagion factor

All the ethnic faces in Boston Housing Court on eviction day (Thursday) indicate that non-payment of rent and the “free rent trick” occur primarily in lower-income neighborhoods. When landlord cost-shifting from the “free rent trick” occurs systematically across a lower-income neighborhood, hitting some proportion of properties all the time, the whole neighborhood suffers accordingly. It’s the contagion factor. Realtors and ordinary people know intuitively that one blighted house on a block hurts the value of the other houses on the block.

For a more precise estimate, a recent study^[1] of Philadelphia’s blighted neighborhoods shows the impact of the most extreme form of deterioration: abandoned housing. Analyzing the sales of 14,526 houses across Philadelphia in 2000, the study found that, all other things being equal, the sales prices of houses dropped an average of 12.4% if they were within 150 feet of an abandoned house, dropped 11% if they were 150 to 300 feet away from an abandoned house, and dropped 5.8% if they were 300 to 450 feet away.
 

As the authors of the study explain:

One of the reasons why abandonment appears to be contagious is that the presence of an abandoned house on a block [will] reduce the value of the remaining houses. In this case, even one or two abandoned houses may begin to deteriorate the housing market in a neighborhood. We know that abandonment can have many consequences for a neighborhood ranging from decreased safety to increased risk of fire to higher heating costs for adjacent properties.^[2]  Changes in property values, however, offer a concrete way to measure the consequences of abandonment at a neighborhood level. Estimates of the fiscal impact of abandonment also provide a basis to project the potential benefits that might come from renovating abandoned housing.

Estimating cost of ‘free rent trick’

While abandoned housing is an extreme form of deterioration, one can extrapolate that milder forms of deterioration – occupied but shabby houses – will have a similar but lesser impact, namely, depressed property values resulting in reduced property tax revenues. We can extrapolate that deterioration caused by the “free rent trick” will hit numerous properties in any given lower-income neighborhood and will spread its effect by lowering the property values of other properties on the same block and in the same neighborhood.

We did a simple estimate based on known statistics and straightforward assumptions. From state statistics^[3]  we know that the total assessed valuation of all multi-family properties in Massachusetts is $213.4 billion, a hefty 35% of all residential valuation. Let’s assume conservatively that only 20% of this residential valuation relates to lower-income multi-family neighborhoods, and that the spreading impact of the “free rent trick” would cause only a 10% reduction in property values throughout these lower-income neighborhoods. For example, a house in good condition worth $400,000 in a good, moderate-income neighborhood would sell for $360,000 if located in a deteriorating neighborhood. We used $11 per thousand as the property tax rate, which is approximately the middle value for municipal property tax rates statewide.

The result is a loss of $4.3 billion in property values statewide, leading to $471 million annually in property taxes not collected because of the “free rent trick,” enough money to run Vatican City for a year.

Investment from escrowing

One can quibble with our estimates, but even half these amounts – $2.2 billion in lowered property values and $235.5 million in lost taxes – are nothing to sneeze at. Governor Deval Patrick would like to infuse more money and more value into local municipalities. Here it is, at zero cost to taxpayers, automatically focused on neighborhoods most in need.

With a rent escrow law, landlords would still lose about three months of rent, the time it typically takes to go through the court procedures to evict a non-paying tenant. But the extra months of no rent would end. The extra-high repair costs, many of which are for unneeded cosmetic details, would end. And eviction costs would drop significantly.

Instead of focusing all financial resources on evictions, landlords in lower-income neighborhoods could spend their resources maintaining and improving their properties. There is every reason to believe that landlords will do that if they have the available resources. That’s what landlords in higher-income neighborhoods do all the time. This new investment would then slowly reverse the trend toward depressed property values. As suggested in the Philadelphia study, higher property values in lower-income neighborhoods would also bring the benefits of less crime and better quality of life.

¹ Eastern Pennsylvania Organizing Project and Temple University Center for Public Policy, “Blight Free Philadelphia: A Public-Private Strategy to Create and Enhance Neighborhood Value,” 2001.

² William Spelman, “Abandoned Houses: Magnets for Crime?” Journal of Criminal Justice, 21:481, 1993.

³ Based on 2004 statistics at: www.dls.state.ma.us/mdmstuf/PropertyTax/lvclstatetotals8604.xls