a program of code enforcement and widespread utilization of federally subsidized home improvement loans and grants was timely. It did not reverse the course of racial transition the neighborhood is now 70% black. It did stimulate rehabilitation activity. In doing this, the program helped ensure that during the difficult period of racial succession, neighborhood deterioration did not accelerate.

By now the new nature of the neighborhood is becoming clear to residents and investors alike. With a mixture of middle income whites and blacks committed to the idea of preserving the West End as a healthy, integrated neighborhood, there is reason to believe that the decline has been reversed. This reversal of expectation is best demonstrated by the privately financed construction and rehabilitation of apartment units to serve the expanding middle income black population.

The West End of Atlanta gives a clear example of how the worst expectations of large and small investors about the future of a neighborhood can be reversed. While the key in Atlanta was the timely utilization of a program of loans and grants, the important role that tax policy has to play in such a neighborhood should not be overlooked. As the next section will illustrate, the success of various Federal Housing programs is intricately related to local assessment practices.

CHAPTER VI

THE PROPERTY TAX AND

FEDERALLY SUBSIDIZED HOUSING

IN BLIGHTED AND DOWNWARD TRANSITIONAL NEIGHBORHOODS

The discussion of the private market in the last two chapters may have obscured the fact that most current investment in the housing stock of blighted and downward transitional neighborhoods is federally subsidized. Rehabilitation under Section 236 of the 1968 Housing Act by itself accounts for a substantial proportion of all investment in these neighborhoods. No less than 88% of the total dollar value of rehabilitation in the blighted and downward transitional neighborhoods of our sample came from 236 rehab projects. These projects now dominate investment in multi-unit stock in blighted areas; no federal policy exists as to how these projects should be taxed. Assessors in two cities identified the lack of federal guidelines on how to assess 236 projects as among the most urgent policy problems they confront. Without exception, investors in these projects reported that the uncertainty surrounding property tax liability was a principal obstacle to their planning and operation. The matter at stake is important, for how the property tax is administered affects the volume of federally assisted projects undertaken in a city, and helps to determine how successful a program is in reducing rents for low-income families.

Assessment of Subsidized Projects

The great dilemma in assessing federally assisted housing projects is that the "value" of these projects is inherently ambiguous. Construction costs are known; but these overstate the market value of a project, since in the absence of subsidy the rental stream produced by the property would not justify the actual expenditure on construction.

The cost of rehabilitation under a Section 236 program may exceed $2 million, yet the re-sale value of this same project, if sold on the free market without its federal subsidy, may be zero, or even negative in the event that annual unsubsidized costs exceed market rent. Should the local taxing authority then enter the project on its tax rolls at the cost of $2 million? At the assumed free market value of zero? Or should it apply some other criterion, such as a percentage tax on gross rents? In the absence of plain reasons for preferring one assessment basis to another, cities have vacillated among various formulas for taxing 236 and 221(d)3 projects. The result is that it has become extremely difficult for operators of projects to predict their tax liability into the future. The chance that the assessor will change the standard of assessment, thereby substantially augmenting a property's tax liability, adds significantly to the risk of operating 236 and 221(d)3 projects. These projects are so highly leveraged that a change in property taxes can easily convert

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a project with a significant positive rate-of-return into one with a negative cash flow.

Non-profit organization A in Atlanta operates a 280 unit 221(d)3
project for low-income families. A two-bedroom apartment rents for
$72.50 per month. The respondent reported that in his judgment "The
City is eating up the federal housing program through property
taxation." The building sponsored by A was assessed at $568,000 in
1965, its first full year of operation. In 1966 the assessment was
jumped to $790,000. After appeal, it was lowered in 1967 to $501,000.
These erratic movements in assessed valuation imply differences of
more than $14,000 in annual tax liability. For a non-profit organization
operating at the very edge of its cash flow, an additional $14,000
in tax liability translates into a $5 a month rent increase (with HUD
approval) or a serious cash deficit. The organization felt that with it
now paying 18% of gross for property taxes, it had become nearly
impossible to operate low-income housing.

Investor B in Portland was forced to place in escrow $28,000 to cover
his annual property tax liability on a 236 project, since Portland
maintains that it taxes these projects on "market value." As a
precautionary measure, this investor estimated that he might be
reassessed for 70-80% of FHA productions costs. To date, B has not
been reassessed for any part of the $600,000 rehabilitation he carried
out. Though thankful, B reports that if Portland does not intend to
assess at close to construction costs, there are a series of 236 projects
he would like to undertake. All that he requires is a clear understanding
of his tax obligation.

The vulnerability of federally assisted projects to local tax policy can be seen from Table VI.1. Upward reassessment was much more likely to occur in federally subsidized rehabilitation or rehabilitation carried out by non-profit sponsors than it was in private-market housing. Most municipalities seem to feel that tax increases in the former case are passed on to the federal government or the non-profit sponsor, and so represent a free good to the municipality.

Investors' Perspective

From the point of view of investors, the present system for determining tax obligation on 236 projects has three defects.

(1) Obtaining a property tax commitment from the assessor often is the most time consuming step in the application for a letter of feasibility. The operator of a 236 project in Chicago reported that, "If a uniform rule existed for taxing 236 projects, we could speed up the application process by 45 days."

(2) The level of property taxation and the risk that assessment will be increased makes many 236 projects infeasible. So many risks exist in these programs that the additional

Notes:

Residential structures built prior to 1961.

Federal government aided rehabilitation projects include 236, 221d3, and 312 loans
and grants as part of a FACE program. Other projects included in these categories are
owned by non profit corporations set up to provide low or moderate income housing
under various state regulations.

The tables summarize information obtained from 228 owners regarding 420 individual properties in ten cities.

risk of miscalculating a major cost such as property taxes can discourage investment altogether. The State of Michigan now has legislation stipulating that non-profit operators of 236 projects pay 10% of net shelter rent in lieu of property taxes. One non-profit organization in Detroit reported that, before passage of this legislation, it submitted to HUD a proposal for a 430 unit 236 project, which was rejected as infeasible. After passage of the legislation, the organization resubmitted its proposal. Its tax liability was now 33% less than the assessor's previous estimate; and the organization was guaranteed that this liability would not increase unless rental rates increased. The project was approved by HUD, and now operates at 100% occupancy.

All operators of 236 projects agreed that a long queue of presently infeasible 236 projects would become feasible if taxes were fixed at a known low level of gross income. How greatly such a change in tax policy would affect overall investment depends, of course, on whether the present 236 program is constrained by a lack of feasible projects or a lack of budgetary funds. If the constraint is budgetary, the mere fact that more projects become feasible need not imply that more projects will be constructed.

(3) Once constructed, 236 and 221(d)3 projects run the risk of having to absorb substantial tax increases due to changes in the basis for assessing properties. These must either be passed on to the tenant, raising the cost of housing to low-income families, or absorbed in the form of a reduced cash flow, increasing the probability that the operator will not be able to maintain mortgage payments after the exhaustion of depreciation benefits. Smaller owners who had taken advantage of 3% rehabilitation loans under the 312 program reported that local tax policy consumed much of the subsidy of these programs. The owners believed, and Table VI.1 tends to confirm, that the Assessor's office was much more active in reassessing 312 rehabilitation then it was in reassessing the same work, where carried out privately. An effective 3% property tax levied on the cost of rehabilitation raises the interest and tax payment to 6%, comparable to what it would be on the private market, without reassessment.

The Municipality's Perspective

From the point of view of the municipality, the objective in taxing 236 projects is to collect the maximum possible revenue without driving away the federally subsidized programs or making rent levels impossibly high for low-income families.

Table VI.2 summarizes the tax formula presently used by each of the sample cities.

Those cities which tax 236 projects at a very low rate reported that they feel they are doing so at the expense of their tax base. According to Baltimore's Assessor, the agreement to tax 236 projects at 6% of gross rent was worked out by the City solicitor, against the judgement of the Assessor's Office. The Assessor felt that the accumulation of tax-exempt low-income and elderly housing eventually would increase the tax burden on private sector housing. He reported that already several private investors who had lost tenants to the subsidized projects had demanded that their assessment be reduced, as well. Several other Assessors reported that federally subsidized programs in their cities substituted for private investment. One effect of the program was to replace fully taxable properties with partially taxable property, reducing the city's tax base.

Those cities that tax 236 properties at a very high rate tend to see their actions as inducing a pure transfer of federal funds into municipal coffers. In Atlanta, the assessors reported that HUD automatically permitted rent increases when a 236 project's tax liability increased, and that a substantial part of this rent increase was absorbed out of rent supplement monies. Consequently, a significant proportion of local property taxes were absorbed directly by federal rent supplement funds. The City seemed to follow a policy of taxing 236 programs at the maximum rate possible without discouraging their further construction. For low-income families now on rent supplements, the direct consequence was higher rents.

Conclusion

As Table VI.2 makes clear, no agreement exists as to how 236 rehab projects should be taxed. This confusion extends to other federally subsidized projects like 221(d)3 projects