common for properties purchased 10-15 years ago to produce a negative cash flow. This is true largely because the investor is saddled with debt payments based on a purchase price which far exceeds the current value of the structure. If the property were to change hands today, debt payments on the new purchase price would be so much lower that a positive cash flow might well result. For all structures, except those which should be abandoned, there is some price at which a property will produce a positive cash flow. If the real estate market is functioning well, the market price of the property will adjust until debt payments on that price do leave a positive cash flow.

Since Table III.1 showed that owners who suffer a negative cash flow are reluctant to upgrade their properties, one function of the market should be to transfer these properties at lower prices to new owners who will be more likely to undertake investment. Actually, a structure's operating income provides a better indication of its current profitability than its cash flow. Operating income is the total that remains from Gross Rents after subtraction of expenditures on Maintenance and Operations. It is the amount which is capitalized into the asset value of a property. However, even the operating income of a building may turn out to be highly variable. Our interviews indentified a large number of investors who purchased properties, and immediately appealed the assessment, using the lower purchase price as evidence that the building was overassessed. If the appeal was successful, one important component of operating costs, property tax liability, was reduced. Other new purchasers found that replacement of the heating plant could significantly slash operating expenses, or that cosmetic rehabilitation of a structure's interior could greatly augment rents. Often, upon transfer of ownership a property's operating income changed drastically. Table III.9 illustrates the case of a skilled investor who in late 1966 purchased a property in a quasi-blighted neighborhood. The investor at once appealed the assessment, changed insurance coverage, repainted the interior of the building and filled vacancies. By 1968 the operating statement bore little resemblance to that of 1966.

PROPERTY TAX AND THE SUPPLY OF HOUSING

In terms of the traditional demand-supply diagram, imposition of a uniform property tax can be represented as a shift upwards in the supply curve of rental housing, since at every level of housing supply the owner must cover all his previous costs plus the additional tax payments. With typically shaped curves, this shift upwards in the cost of supplying rental units will both raise the price of housing and lower the quantity of housing provided. Increases in the price of housing are easily observed as rent increases. Decreases in the quantity of housing may be harder to observe. The "quantity" of housing stock is a composite measure of the number of dwelling units and their quality. A diminution of the housing stock can take the form of a reduction in the number of dwelling units or a reduction in the "quality," or standard of maintenance and building services, provided by each unit. Imposition of a residential property tax usually is thought to have both effects. It discourages some investment in rehabilition and maintenance of the existing stock and eliminates some new investment. Reducing the property tax would have a reverse effect: it would lower prices and stimulate investment.

Diagram I illustrates the shift to a new equilibrium caused by imposing a property tax.

Note: This cash flow statement of a particular investor was selected as representative of the point discussed in the text.

After imposition of the tax (t) the price of housing (P2) is higher and the quantity of housing (Q2) is lower than before the tax.

Whether property taxes have their principal effect on the quality of housing or rent levels depends on the elasticity of the supply and demand curves that is, the responsiveness of housing supply and demand to price changes.

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Housing market experts sometimes seem to argue that reducing the property tax burden will benefit tenants only if substantial improvement of the housing stock results. This view disregards consumer preferences. For poor families, there are many necessities to be purchased. Better housing, desirable as it is, may seem less urgent to a family than other needs. These savings from a property tax reduction may be passed on to the tenant in the form of improved housing better maintenance and repairs, for the same rent - or in the form of rent reductions. Without a detailed study of each housing sub-market, it is impossible to determine whether a reduction in the cost of supplying housing will benefit tenants principally by improving housing quality or by reducing rents. However, if the objective of governmental policy is to improve the welfare of tenants, it does not matter which effect predominates. Given that the benefit must be passed on to the tenants, tenants' preferences will determine whether benefits occur in the form of rent cuts or quality increases.

The crucial question is whether reduction in the property tax rate would be passed on to the tenant at all. If landlords can maintain the same rents, in the face of reduced property taxes, the entire effect of a tax reduction would be to make landlords richer.

Who ultimately benefits from a tax reduction, or any other reduction in the cost of supplying housing, depends on the competitiveness of the housing market. If owners of housing must compete with one another to attract tenants, either by price cutting or undertaking minor repairs, then eventually the cost reductions achieved by a tax cut will be passed on to the tenant. If the housing market is more oligopolistically organized, so that owners can fix prices, free from competition, the principal beneficiaries of tax reduction will be landlords. The degree of competition among suppliers of housing is crucial in determining the welfare implications of property tax policy. The neighborhood chapters of this study indicate that housing investors behave more competitively than generally is conceded. If this is so, a substantial part of any property tax reduction would be passed on to tenants, even without compulsory legislation. The discussion now turns to an analysis of these neighborhood sub-markets.

CHAPTER IV

BLIGHTED NEIGHBORHOODS

The underlying reason for low-quality housing is the disparity between the rents low-income households can afford to pay and the rents required by landlords to supply standard housing. Most low-income households, even spending 30 or 35 percent of their income for rent, cannot pay enough to cover the costs of good quality housing. If property owners were compelled to supply only standard housing, their rates-of-return in what are now blighted areas, could not compete with alternative investment opportunities, and eventually properties would be abandoned. In several cities, the active enforcement of housing codes already has had this effect of accelerating abandonment. Of the 11 examples in our sample of properties about to be abandoned, all of the owners, without exception, cited as a contributory cause to abandonment the need to meet housing code standards, the cost of which they were unable to pass on to tenants because of the lack of demand for the features which housing codes emphasize.* Since the primary cause of urban blight is the insufficiency of residents' income, changes in the property tax alone will not eliminate blight. Modification of the property tax, however, can improve the welfare of low-income tenants and stimulate some improvement in housing conditions.

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

**A similar conclusion was also reached by Linton, Mields and Coston, Inc., "A Study of the Problems of Abandoned Housing and Recommendations for Action by the Federal Government and Localities", A Research Report prepared Under Contract to the U.S. Department of Housing and Urban Development, Office of Research and Technology, (1971), p. 237.

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