It Costs Extra to Hear Your Neighbors Sneeze

When two biotech professionals moved to Princeton from Switzerland via San Francisco, they had a hard time explaining to their real estate agent what type of house they wanted to buy. When the agent showed them multiple large homes on 2-acre lots, assuming that was what a family with three kids wanted, they were not interested. Eventually, they settled in a comfortable but not large home on one of the densest and most beloved streets in Princeton. They found a way to brilliantly describe their living arrangement: "we can hear our neighbors sneeze." They probably realized that the small plot of land they bought, so close to downtown, is much more valuable than those large lots farther away. However, what they probably did not realize are the tax implications. In some areas in Princeton, small condo owners pay 18 times more in property taxes per acre of land than people who live on a large lot in the same block. This is not about larger homes having a larger tax ("improvements"); this is about the land itself, our most valuable resource, and the tax implications of our current system.

Most of us now agree that walking or biking to work, shopping, and restaurants for adults, as well as school, friends, and activities for kids, is something desirable, sustainable, and healthy. As a professional working on creating opportunities for more families to purchase homes in walkable neighborhoods with good schools and jobs, I find that it is increasingly difficult and worsening every day. We hear many reasons preventing the construction of gentle density housing: claims that we are already built out, the need to protect historic neighborhoods, and, of course, the fear of increased traffic. While these points have some validity, what about taxes? What if our tax system disincentivizes the creation of the walkable, healthy, and sustainable housing options we desire?

Recently, there has been a surge of discussions about the Land Value Tax. Great articles are circulating, and proposed changes in laws are being discussed. The idea is simple, and StrongTowns described it best: "you get what you tax for." Our current system discourages improvements to existing buildings and incentivizes inaction—leaving land abandoned, holding empty lots in high-value neighborhoods to appreciate. Once we become aware of this, how difficult would it be to change the entire tax assessment model? Not very. (Read on.)

Princeton, NJ, serves as a good case study. It is a wonderful place to live, with its abundance of jobs, a prestigious university, a historic downtown, great schools, parks, and more. However, like many similar areas, the real estate prices are astronomical, and there is a lack of housing options for entry-level buyers. Numerous surveys have indicated that residents prefer small-scale, in-fill development rather than overwhelming Manhattan-style density. This concept is often referred to as "Livable Lovable Density." But what does the tax system incentivize? Does it promote this lovable density or encourage inaction?

In New Jersey, property value is determined by two components: land and improvements (what is built on the land). The value of the land is influenced by factors such as its location, development potential, and the amount of land owned. Similarly, the value of improvements is influenced by the size and condition of the structures. For the purpose of this analysis, let's set aside the value of improvements and assume they are consistently valued. Instead, let's focus on the value of the land itself. After all, land is our most valuable resource, and its supply is fixed—we cannot create more of it.

For adjacent properties with the same lot size, one would expect that they would pay the same land tax. However, Figure 1 clearly demonstrates that the land value is not constant in the Wiggins block:

• Lot 32 contains a single-family home, while Lot 34 has a former single-family home that has been converted into three small condos. Despite having the same area, the land value of the condo lot is assessed at 222% of the value of the land under the single-family home.
• Lot 35, similar to Lot 34, was once a large home that has been converted into apartments, but it is owned by a single landlord and rented out. Although the condo lot (Lot 34) is roughly half the size, its land is assessed at 225% of Lot 35's value. When adjusted for area, this difference amounts to 376%.

How is this possible? According to the tax assessor's office, the calculation of land value consists of two components: the site value and a coefficient for the size of the lot. However, the site value is so large that it dominates the calculation. As a result, each of the three condo owners on Lot 34 are required to pay the site value/land tax, leading to a triple evaluation of the overall land value. Essentially, parcel 34 is being taxed three times, while the neighboring lot is proportionally under-taxed.

Moving on to Figure 2 (below), we see another sample block situated slightly further away. This area features a grocery store, a bank, small businesses, and easy access to transit. Moreover, it is only a few minutes' bike ride away from the town center and schools. Like the previous neighborhood, this area offers a diverse range of housing types that people appreciate. For instance, there is a 17-unit condo building situated on a .43-acre lot, providing a rare opportunity for individuals to own a more reasonably priced, entry-level home in Princeton.

A few comparisons:

• Let's compare Lots 11 and 7. Lot 11 is collectively owned by 17 condo owners, resulting in the "site value" being charged 17 times and leading to a land value of nearly $13 million per acre. On the other hand, Lot 7, located across the street, is owned by a single individual and has a land value of $700,000 per acre. Interestingly, the condo owners collectively pay $139,000 in land taxes each year. Considering that Lot 7 is 190% larger than Lot 11, one might expect it to pay around $265,000 in land taxes. However, in reality, they only pay $15,000. This tax is intended to cover services such as street cleaning and road maintenance, among other things. Hard to believe that such a significant difference in taxes is justified, especially when considering that services related to the number of residents would typically be better estimated with taxes on improvements.
• Comparing Lot 11 and Lots 171-172 is equally concerning. The Bank of America's small building and empty parking lot located on lots 171-172, is valued at only 1/12th of the value of Lot 11 (the condo land). Despite being larger in size and zoned for even denser housing than the condo lot, the bank lot faces no real incentive for development or improvement. Their annual taxes amount to only $39,000, in stark contrast to the $139,000 paid by the condo owners.
• Lots 195 and 196, owned by Bank of America, are also intriguing. These lots are the same size as the adjacent Lot 197, which has a single-family home. It is remarkable that the land value of these empty lots is only half of the land value of the occupied lot next to them, excluding any improvements.

NJ law requires that property taxes be calculated "ad valorem," which means they are based on the value of the property. The significant disparity in assessed and values raises concerns about the current valuation methodology and its impact on encouraging land under-utilization. While transitioning to a Land Value Tax system, as allowed in Pennsylvania and proposed in Detroit, would be ideal, it is naive to expect a major change in state tax law. A more realistic approach would involve conducting a re-evaluation and fine-tuning the valuation methodology to accurately assess the true value of the land within the framework of the existing law.?

We get what we tax for. So how about really taxing owners of empty parking lots, big mansions in walkable areas, and similar underutilized land in a way that actually causes some financial pain? They can still choose to do nothing, however, their higher land taxes will help offset the burden on entry-level homeowners and others who can hear their neighbors sneeze.