This story originally appeared on PlanPhilly.
As City Hall debates how best to find more money for Philadelphia’s schools, a new report from the real estate firm Houwzer aims to dissuade politicians from cutting the 10-year property-tax abatement on new construction.
The report, the third in a series by Kevin Gillen, Houwzer’s senior economic adviser and a researcher at Drexel University, examined the abatement’s effect on buildings that have subsequently aged out of the tax break, finding that it has boosted prices of new and renovated homes enough to make up for the city’s relatively high construction costs.
Supporters and opponents of the property-tax abatement on new construction agree: The problem is that Philadelphia is the poorest big city in the nation.
That’s why the abatement has to stay: Because the city is poor, property values are low, and the abatement boosts those values enough to make up for how expensive it is to build here — at $128 per square foot, Philly is the fourth most expensive building market in the U.S. — and entice developers to invest in growing the city. “Ultimately, any discussion about modifying the abatement is treating the symptom rather than the disease,” said Gillen. “The disease is that we have very high poverty and very high construction costs. The abatement is something that helps bridge the gaps between these two things and what you can sell real estate [for] in this city.”
That’s why the abatement has to go: It robs the treasurer of tax revenues desperately needed to fix underfunded schools, which would offer the city’s children, at least, a way out of endemic poverty. “While we have this fabulous development downtown and in certain neighborhoods, we are still the poorest large city in the country,” said Andrea Moselle, education co-chair at POWER, a progressive interfaith coalition that has called for ending the tax abatement to help pay for city schools. [Disclosure: Moselle is the mother of WHYY reporter Aaron Moselle]. “That translates to a lot of black and brown kids being hit pretty hard, and the disparities with the suburban districts are quite astounding.”
Since the tax break began in 2000, 10,404 residential properties have seen their abatements expire. Of those, 3,530 were subsequently sold — a 34 percent turnover rate that’s only slightly higher than the 30 percent rate of non-abated properties over the same 2009-2018 period. Focusing on 1,175 of those properties that met certain statistical conditions, Gillen compared how much buyers paid for their tax-abated properties against how much they saved in tax breaks, finding that most purchasers overestimated the tax break’s value.
Seventy percent of buyers paid more for their abated homes than what they saved in taxes. The median buyer paid a 20.5 percent premium for the tax abatement, but got back only an 11 percent value in tax savings. (The mean values were similar: 21.5 percent price premium and 10.6 percent in actual value of the abatement.)
So, what’s the takeaway? For Gillen, it’s more proof of a need for the abatement. “The average return on investment in real estate in Philadelphia for new construction is somewhere between 9 and 11 percent,” he said, suggesting that residential development would not be profitable without the abatement.
Though Gillen’s reports add more data to the debate over Philadelphia’s 10-year tax abatement on new construction, the new economic figures won’t reconfigure the moral calculus used by opponents.
“We come at this from a moral point of view: that all kids — regardless of race, ethnicity, income level, neighborhood — should have the opportunity to go to a good school,” said Moselle. “We can’t just be a city that pays attention to a small group of people [getting the abatement] because at the end we’re going to have this tale-of-two-cities thing that gets more and more disparate.”
In Gillen’s view, the abatement entices wealthier people to move to Philly, which the city needs if it’s ever going to fix the schools. “If you want to provide public services to the have-nots, you need some haves — you can’t tax just the have-nots,” he said.
Moselle almost seemed to echo that point, but for opposite ends. “We think the city’s wealthiest must contribute their fair share to Philly schools. It can’t just be on the back of individual residents, many of whom are only just about making it, if they are making it [at all].”
Gillen also noted that these figures largely cover homes built during the housing bubble that burst in 2008, which skews some of the numbers. Buyers likely overestimated the value of the abatement because they expected the price on their newly built homes to rise dramatically. Instead, housing values dropped in the wake of the bubble, and only started recovering steadily in 2012.
The period analyzed by Gillen included a large chunk of the housing boom, which may explain some of the findings. Home buyers might have overestimated the abatement’s value because they assumed — along with nearly everyone else at the time — that housing values would continue to skyrocket. When the bubble burst, home values dropped, meaning lower property-tax bills.
This was the third report in a series by Houwzer on the abatement. The first report found that previously abated properties sold at similar rates as unabated properties — that is, most owners kept their homes even after the tax break ended. From 2009 to 2018, post-abated properties had a turnover rate of 34 percent, about the same as unabated properties (30 percent).
The second report compared the sales prices of homes when they were first built under the abatement policy and the prices when they sold after the abatement ended. Those units saw modest increases in value — $13,000, or 4 percent, in median sales price — with 46 percent selling for lower than the original purchase price. The largest gains in sales price accrued to the units that cost more to start — homes that sold originally for $471,000 or more saw an average gain of 7.2 percent, while homes priced under $252,000 only increased 1.2 percent on average. Meanwhile, unabated properties sold during the same period saw much larger increases — a median gain of $80,000, or 105 percent.
Gillen is frank about some of the abatement’s shortcomings. “There’s no denying that the abatement is disproportionately skewed to relatively higher-end development,” he said. But he argued that the answer is to increase the abatement — doubling its length or extending it to include land values. Currently, the abatement covers only improvement value — the part of a property’s value attributable to what has been built on it, rather than the intrinsic value of the land itself.
Opponents have floated proposals for ending the abatement completely, cutting it in half, capping the amount that can be abated, or limiting the abatement’s availability to certain lower-income neighborhoods.
Despite the new data, the fundamental question about the 10-year abatement remains: How much of Philadelphia’s growth is attributable to this tax break? And if it were ended, would development come to a halt?
Gillen thinks it would. “Like most economists, I’m not in favor of, generally, any specific or targeted tax breaks to particular industry groups or companies,” he said. “But we are in an unique situation where we have the cost of development of very wealthy cities but the poverty rate of a very poor city. Until we can resolve that, the abatement is a necessary evil — a Band-Aid, if you will — to help grow our tax base, to make the improvements happen and improve the quality of our housing stock that wouldn’t otherwise happen.”
Moselle disagrees. “We understand that the abatements played a role … 20 years ago, when we were losing population and nothing was getting built,” she said. “But the market has really changed, and it seems to me that the tools we’re using to spur development have to change — it’s time to take another look. It’s been 20 years, it’s a very different real estate market, it’s red hot.“
Subsidizing new development through tax breaks
Gillen argues that the abatement is needed to counteract the high costs of construction in Philadelphia, which he blames on the building trades unions, a needlessly onerous building code, and the need to get community groups’ approval for a wide range of proposals.
Economically, tax cuts, like the abatement, operate analogously to subsidies for construction. In forgoing tax revenues for 10 years, the city is effectively subsidizing new construction — the economic equivalent of handing developers, construction workers, or home buyers checks.
While there are some small differences — tax cuts are cheaper to administer bureaucratically than subsidies, but also tend to be broader in their application — the bottom-line effects to both builder and the city remain the same: The value of the new construction increases, and the amount of revenue decreases.
But the impact on the price of the newly built or renovated building would change radically between subsidization and tax cuts. The abatement adds value to the home — it makes it so developers can sell it for more money, namely, how much a buyer estimates the value of the abatement over 10 years will be. It makes new homes more expensive.
A subsidy, however, would do the opposite. In theory, it would incentivize construction of more-affordable homes that would have been otherwise too expensive to build because the prices they could fetch on the open market would be less than the cost of construction.
But the politics of subsidizing development — money that could have gone to schools lining the pockets of wealthy builders — would be even less appealing than the tax abatement.