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The Abatement Stakes

In the second of a deep-dive series, a well-respected economist notes that houses with a tax abatement hold their value, even when the tax break expires

In the second of a deep-dive series, a well-respected economist notes that houses with a tax abatement hold their value, even when the tax break expires

Since the current abatement program’s inception in 2000, 10,404 residential properties have seen their abatements expire. All of these were abated and purchased in the 2000 to 2009 period. Because the key rationale for the program is that it is an incentive to improve and expand Philadelphia’s stock of real estate—and thus grow its tax base—it is reasonable to examine what has happened to the values of these properties once their favorable tax treatment has expired.

If their values have dropped significantly, then this provides support to those critics of the abatement who have asserted that the program’s long-term benefits are low relative to its high short-term costs. Alternatively, if abated properties have held their value or even grown in value, then this provides support to the program’s supporters, who have contended that the program’s short-term costs are more than offset by the long-term benefits of a permanently expanded tax base that would not have occurred but for the abatement. This article will endeavor to provide some empirical analysis to inform this debate.

It is first necessary to identify those post-abated units that sold under reasonable market conditions, and hence whose sales prices reflect reasonable market values. Of the original 10,404 dwellings that have since seen their abatements expire, only 3,530 have since subsequently sold. However, in order for this data to be useful in effecting an accurate analysis of how the abatement may affect the value that buyers may place on it, the transactions of these abated dwellings had to meet all of the following conditions:

  1. The initial purchase price of the abated unit had to occur within one year of it being granted an abatement, when the abatement’s benefits were still large;
  2. The subsequent sales price of the abated unit had to occur either in the year its abatement expired or after that;
  3. Both the original purchase price and subsequent sales price had to occur under arms-length conditions;
  4. No unit could transact in between its initial purchase and its subsequent post-abatement sale.

Of the original 3,530 units that transacted more than once, only 1,175 met all of the above conditions for further analysis. This constitutes only 11 percent of all previously abated units, which may seem like an unexpectedly small sample to both critics and proponents of the abatement program. The following map shows the location of these 1,175 previously abated dwellings:

The greatest concentration of post-abated properties is in and around the downtown area of greater Center City. However (perhaps surprisingly to skeptics of the abatement), there are also significant concentrations of formerly abated residences in University City, Northwest Philadelphia and Northeast Philadelphia.

We begin our analysis by providing some general summary statistics on the transaction prices of previously abated properties both before and after their abatements expired. The following table gives some summary statistics on both the initial purchase prices and subsequent (post-abatement) sales prices of these 1,175 dwellings:

In general, it can be observed that the prices of formerly abated units generally increased between their initial purchase and their subsequent post-abatement sale:  

  • The median purchase price of an abated property between 2000 and 2009 was $347,000. But after their abatements expired, and they sold in the post-2009 period, their median sale price was $360,000.  
  • The average purchase price of an abated property was $400,000. But the average sales price of these same properties in their post-abatement period was $425,000.  
  • Across all previously abated properties, the median price change was $8,800 and the mean price change was $25,600.
  • Lastly, the higher a property’s initial purchase price, the greater the typical price appreciation it experienced, in both dollar and percent terms.

Although, the data indicate that the price of most abated properties increased between the period of their original sale and in their subsequent sale after their abatement expired, there are some caveats: First, it should be noted that there was enormous volatility in house prices during the 2000 to 2017 period since both the largest housing bubble and then the deepest postwar recession occurred during this period. Simply computing the number of increases v. decreases without adjusting for this volatility risks oversimplification of the issue.

Second, if the general level of house and/or condo prices in Philadelphia increased by a larger margin than the value of abated properties during a given period, then this could reasonably be considered a relative loss, despite being an absolute gain. Conversely, if the value of abated properties fell by less than overall house prices during a given period, then that could be considered a relative gain for abated properties, despite being an absolute loss. Just as equity fund managers evaluate the performance of their particular portfolio by comparing it to the overall performance of the stock market, so too is it fair to compare the performance of abated properties to the overall performance of the housing market.

The following chart compares the median prices of all previously abated properties to the median prices of non-abated dwellings (houses and condos) in Philadelphia in two different periods: 2000 to 2008 (when the abatements were in effect), and 2009 to 2017 (after the abatements had expired). To ensure a clean apples-to-apples comparison, only houses and condos that met the same general criteria as post-abated properties were included this analysis.

In general, the price of abated properties increased by less than housing prices citywide during this period:  

  • Abated properties were purchased for a median price of $347,000. After their abatements expired, they sold for a median price of $360,000; a 3.7 percent increase.
  • During 2000 to 2008, the median purchase price of all non-abated dwellings in Philadelphia was $76,000. After 2008, the median sales price of these same properties was $156,000; a 105 percent increase.  
  • Although previously abated properties are generally much higher-priced than non-abated properties, the value of abated properties appreciated by much less than the value of non-abated properties following their original purchase in both dollar terms ($13,000 v. $80,000) and in percent terms (3.7 percent v. 105 percent).

While these numbers may indicate an aggregate relative loss in value, they do not provide any insight into the number of individual gainers and losers. To do this, it is necessary to “mark to market” each previously abated property by comparing the percent change in its original purchase price and subsequent post-abatement sale price to the overall percent change in house prices during the same period.

The following chart plots the house price indices for both previously abated properties and all non-abated properties from 2000 through 2017:

The blue line in the index for previously abated dwellings, while the orange line represents the index for non-abated dwellings. The percent change in either index between any two years reflect the general price appreciation (or depreciation) rate of properties in each index. The vertical dashed line in the middle of the chart represents when abatements that were previously granted began to expire after 2008. Hence, the movements in the blue line prior to 2008 represent how abated properties changed in value when their abatement was in effect, while movements in the same line after 2008 represent how these same abated properties changed in value after their abatements expired.  

Using these results, a counterfactual sales price was computed for each property by applying the citywide house price index to the dwelling’s original purchase price. Essentially, the original purchase price was “grown” by the percent change in the index to the dwelling’s actual time of sale. This price represents what each post-abated dwelling would have sold for if it had appreciated at the same rate as non-abated properties. The following table compares summary statistics on actual v. counterfactual sales prices:

The results indicate that abated properties generally appreciated at a slower overall rate than that of the general housing market:  

Using these results, all formerly abated properties were then re-classified as “Relative Gainers” or “Relative Losers” based upon whether or not their percentage change in price pre- and post-abatement either exceeded or lagged the overall percentage change in the housing market’s price index during that same period. The following chart compares the number of relative gainers and losers in each year as abatements expired:

These results indicate that the number of relative losers exceeded the number of relative gainers in each year following the expiration of these dwelling’s abatement.

In summary: Most abated properties generally sold for prices that were higher than their original purchase price once their abatements expired. However, their general appreciation rate has lagged that of non-abated properties.

The results would seem to suggest a number of broader implications about Philadelphia’s abatement program:  

  • First, any assertions or concerns that the expiration of the abatement would lead to a massive liquidation of previously abated properties at steep discounts is strongly refuted and rejected by the data.  
  • Second, the data indicate that the value that buyers/investors place on the abatement is both very large and very real: adding approximately 15-20 percent to a property’s purchase price. After adjusting for general price fluctuations in the market, most previously abated properties sold for a relative discount of 15-20 percent compared to non-abated properties. Since abated properties are either new construction or had recently undergone significant improvements, it is unlikely that this decline can be explained by deterioration in their physical quality. It is also unlikely that this could be explained by declines in the location value of these dwellings (e.g. deteriorating neighborhood quality-of-life) since the majority of them are either in the prime neighborhood of Center City or in the revitalizing neighborhoods surrounding Center City. That only leaves the only other thing that can affect the property’s value: its tax treatment; i.e. the expiring abatement.  
  • Third, interpreting the financial benefit that the abatement’s tax treatment confers to a dwelling is likely to depend upon one’s personal opinion about the abatement. To critics and skeptics of the program, the 15 to 20 percent premium that the abatement adds to a property’s initial value but then dissipates afterwards will likely be viewed as an unnecessary and wasteful tax giveaway that simply pads the bottom line of developers who build these properties. To proponents of the program, the 15 to 20 percent premium is proof that the program is giving a needed boost to house prices in order to help cover Philadelphia’s very high cost of construction, thus making new development happen that wouldn’t otherwise.  
  • Finally, preserving and increasing the location value of abated dwellings is the best way to mitigate against any future (post-abatement) losses in value, whether absolute or relative. The more that city officials and community groups can do to increase the desirability of these neighborhoods, the greater the increase in the land value of abated properties will be, which will ultimately soften and potentially counteract declines in the structure value of these properties once their abatement expires.

Kevin Gillen, PhD, is the senior economic advisor at Houwzer, a Philly-based real estate agency. He is also a senior research fellow at the Lindy Institute for Urban Innovation at Drexel University.

 

Photo: Melody Joy Kramer via Flickr (CC BY-NC-ND 2.0)

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