Picking up where Part 1 left off, let’s dig deeper into the question of whether or not good schools matter. To be more precise, I should say that I’m digging myself deeper into the hole of arguing that good schools don’t matter. So I’m looking forward to some pushback in the comments!
Though theme of this post is about why LA investors don’t need to invest near good schools, in reality what we’re really going to explore is the exciting topic of: property tax reassessments. This is an important concept for Los Angeles investors and house hackers to understand, and it actually does tie back into the school question in a really fascinating way. Keep reading because I promise, the insightful juice is worth the super nerdy squeeze.
Property Tax Reassessment: A Quick Overview
Let me first explain what a property tax reassessment is.
Property tax is an annual tax levied on the owner of any real property. If you own a house, a condo, a duplex, an office building, a strip mall – any real property incurs an annual property tax. How much is property tax? Well, that depends on two things: the property tax rate where you live, and the assessed value of the property.
Next question: what is assessed value? A property’s assessed value is its value in the eyes of the county. Every county in American has a County Assessor, and the County Assessor’s job is to keep track of what every property in the county is worth.
The County Assessor plays the biggest role in determining what your tax bill will be because the tax is based on your property’s assessed value. If your local property tax rate is 2%, then your annual tax bill will be 2% of whatever the County Assessor says your property is worth.
Next question: how does the County Assessor determine what your property is worth? Well, different states have different rules for their County Assessors to follow, and these different rules create huge disparities from state to state. To demonstrate, we’re going to compare two fast-appreciating markets: Los Angeles and Austin, Texas. Let’s start with Austin.
Differing Approaches to Assessment: Austin
In Texas, homes are assessed by the county in the same way they would be appraised by an appraiser. The County Assessor or any appraiser would look at recent sales for similarly sized homes to determine the fair market value of the subject property. And in Texas, this process happens annually. There is an annual property tax reassessment in every county in Texas.
So what does this mean for a fast-appreciating market like Austin? Imagine you live in a hot Austin neighborhood with skyrocketing sales prices. Every year, your home is being reassessed with those new sales as comps. So even though you haven’t renovated your home or done anything to add value, in the County Assessor’s eyes, your home is gaining significant value every year, so you’ll be getting a significantly higher property tax bill every year.
According to Zillow, property values in Austin have gone up about 40% over the last five years. I can’t confirm that property taxes have gone up 40% across the board over the last five years, but with annual reassessments, the increase in property taxes over the last five years has been significant.
Differing Approaches to Assessment: LA
Let’s focus on Los Angeles, which had a problem with runaway property taxes in the 1970s. In 1978, California voters passed Proposition 13, which enacted two meaningful rules for how County Assessors in California can operate.
Firstly, California assessors can only reassess a property to market value when it’s purchased or inherited. And secondly, outside of those two events, reassessments are limited to a 2% increase per year.
What does that mean for homebuyers and investors in Los Angeles? First off, when you’re looking at a property to buy, the current property tax burden is irrelevant. The property will be reassessed to market value when you buy it, and your tax burden will be based on the reassessed value.
Side note: because the LA County Assessor reassesses at purchase, they use the purchase price as the new assessed value. This makes sense because the property just sold on the open market, so the price it sold for is de facto the fair market value.
To estimate your property tax burden on a new purchase, multiply your purchase price by the local property tax rate, then divide by twelve to get your monthly tax expense. In Los Angeles City, the property tax rate is 1.27%. In other parts of LA County, the property tax rate is as low at 1.2%. Your local property tax rate is determined by the state, county, and city in which the property resides.
LA homebuyers and investors should appreciate that their property tax will not increase more than 2% per year during their ownership. This is awesome, and Texans who bash California for our high income taxes seem to overlook this huge property tax advantage of living here. In Austin, your property taxes may have gone up 40% over the last five years. In Los Angeles, no matter what’s happening in your neighborhood, based on that 2% annual increase limit, the most that property taxes can go up in a five-year period – the most – is 10.4%.
To recap: in Austin, properties are reassessed to market value every year, whereas in Los Angeles, properties are reassessed to market value only upon sale or inheritance.
Property Taxes and Good Schools
What does this have to do with good schools? Well, about half of school funding comes from local property taxes.
I can’t argue that there’s a direct correlation between school funding and school performance, but we all know they’re connected. Adequate funding helps a school shine, and inadequate funding hampers any school’s performance. So better schools tend to be a product of greater property-tax revenue.
Most counties in America do periodic reassessments. In Texas, it’s every year. In Colorado, it’s every other year. In Ohio, it’s every six years and called the Sexennial Reappraisal, but there’s also an adjustment on the third year between reassessments called the Triennial Update. The point is, in most markets, all properties are reassessed to market value on a periodic basis.
This means that as a neighborhood gentrifies and for-sale properties start to sell at higher prices, all of the properties in the neighborhood get periodically reassessed to higher values. It might only take 10% of a neighborhood’s homes to sell at record new prices for 100% of the neighborhood’s homes to see a hefty property tax increase at the next reassessment. After a cycle or two, you’ll have significantly more property tax revenue, meaning significantly more school funding, meaning generally better school performance. In this context, finding a school on the rise is indicative of a neighborhood that’s in the middle of the gentrification process.
But not so in Los Angeles. Here, only properties that are bought or inherited get reassessed to market value. So if 10% of a neighborhood’s homes sell at record new prices, only 10% of the neighborhood’s homes are getting significantly higher tax.
I’ll give you an example. I bought my duplex in 2019, and my annual tax bill is $22,543. The duplex next mine is identical in almost every way except that it’s been in the same family for decades, since long before Prop 13 was passed in 1978. Their annual tax bill: $1,725.
In Los Angeles, a neighborhood’s total property tax revenue grows much more slowly, meaning school funding grows more slowly, meaning schools improve more slowing. A school on the rise is not a sign of a neighbor in transition. It’s a sign of a neighborhood that has already transitioned.
Try this instead. A good neighborhood for investment in Los Angeles probably doesn’t have a great public school, but it probably has one or two good charter schools, one or two good coffee shops, one or two trendy restaurants, and proximity to a more affluent area. These are the neighborhoods ripe for gentrification, and gentrification is what speeds natural appreciation in a market like Los Angeles.