September 27, 2023
Real estate investment isn't just about choosing the right property; it's about understanding the myriad of factors that influence its value and potential returns. One such often-overlooked factor is the millage rate. Let's delve deeper into this concept by answering the following questions:
What is a Millage Rate?
A millage rate, often simply called "mill rate," is a tax rate used to calculate property taxes in the United States. The term "millage" is derived from the Latin word "millesimum," meaning "thousandth." Here's how it works:
How to Calculate Millage Rate:
The millage rate is expressed in mills. One mill represents $1 in tax for every $1,000 of assessed property value. So, if the millage rate is 10 mills and your assessed property value is $100,000, your property tax would be $1,000 (or 10 multiplied by $100).
How is a Millage Rate Determined:
The rate is usually set by local government agencies, such as city councils, county commissions, or school boards. They determine the total amount of revenue needed from property taxes to fund their budgets, and then they set the millage rate accordingly based on the total assessed value of all taxable property in their jurisdiction.
How is a Millage Rate Used:
Different jurisdictions and entities (e.g., municipalities, school districts, fire departments, water districts) might have their own millage rates. When a property is located in multiple jurisdictions, multiple millage rates might apply. In such cases, you would add together all the applicable millage rates to determine your total property tax rate.
Assessed Value vs. Market Value:
It's important to note that the assessed value of a property, which the millage rate is applied to, might not be the same as its market value. The assessed value is determined by the local tax assessor's office and might be a percentage of the market value or based on other local regulations. Some jurisdictions might offer exemptions or reductions in assessed value for certain types of property owners (e.g., veterans, seniors, or agricultural land), which can affect the final tax amount.
In summary, the millage rate is a way to express property tax rates. It determines how much property owners owe in taxes based on the assessed value of their property. If you know your property's assessed value and your local millage rate(s), you can calculate your annual property tax bill.
Mill Rate vs. Millage Rate
"Mill Rate" and "Millage Rate" are terms that are often used interchangeably to refer to the same concept, especially in the context of property taxation in the United States. Both terms denote the amount of tax payable per $1,000 of assessed property value. However, let's break down any potential nuances:
Refers to the tax rate expressed in mills.
A mill is 1/1,000 of a dollar, or $0.001.
If a property's assessed value is $100,000 and the mill rate is 10, the tax due would be $1,000 (because 10 mills is 10 x $0.001 = $0.01, and $0.01 x $100,000 = $1,000).
Also refers to the tax rate expressed in mills.
The term "millage" is derived from the Latin "millesimum", meaning thousandth, reinforcing the concept of a tax per thousand dollars of value.
The calculation is the same as the mill rate: using the above example, a millage rate of 10 would also result in a tax amount of $1,000 for a property assessed at $100,000.
In practice, you might hear one term used more commonly in one region and the other term in a different region. Both terms, however, essentially refer to the same concept: a way to express property tax rates based on the assessed value of the property.
How much is the average millage rate?
The average millage (or mill) rate varies significantly by state, county, city, and even specific districts within cities, largely because property taxes in the U.S. are typically determined at the local level. The rate is influenced by local budget needs, voter-approved measures, and other local factors. For example, areas with higher spending on public schools, emergency services, infrastructure, and other public services might have higher millage rates than areas with lower spending.
Several components often factor into a total millage rate:
City or Municipal Taxes: These are taxes levied by the local city or town.
County Taxes: The county might have its own tax rate.
School District Taxes: These might be the most significant component of property taxes in many areas.
Special Districts: Some areas have special taxing districts for services like fire protection, libraries, or flood control.
In many areas, the total combined millage rate (including all local jurisdictions) might range between 10 to 50 mills, meaning $10 to $50 in tax for every $1,000 of assessed property value. However, some areas could be lower, and others might be significantly higher.
If you're interested in the average millage rate for a specific area or state, you'd likely need to consult the local tax assessor's office or a relevant government website. They often provide up-to-date information on local millage rates. Additionally, various real estate and tax-related organizations might compile and publish average millage rates or effective property tax rates by state or locality, which can give you a comparative perspective.
How a high millage rate can impact real estate investors returns
A high millage rate (or high property tax rate) can have several implications for real estate investors, impacting both the returns and overall attractiveness of an investment. Here are some ways in which a high millage rate can affect real estate investors:
Reduced Net Operating Income (NOI): High property taxes will increase the annual operating expenses of a property. This will reduce the net operating income, which is a key metric used by investors to evaluate the profitability of an investment property.
Decreased Cash Flow: After paying off any debt service (like a mortgage), the remaining cash flow might be considerably less with high property taxes. For investors who rely on rental properties for steady income, this can be a significant deterrent.
Impact on Property Value: High property taxes can potentially suppress property values. This is because the carrying costs of owning a property (which include property taxes) factor into a potential buyer's willingness to pay. If the taxes are high, the property's attractiveness might diminish, leading to lower appreciation rates.
Tenant Turnover: For rental properties, high property taxes might lead to higher rent levels as landlords attempt to pass on some of the costs to tenants. This can result in increased tenant turnover or longer vacancy periods, which can further reduce an investor's returns.
Resale Challenges: High property taxes can be a point of negotiation or contention when trying to sell a property. Prospective buyers might ask for concessions or price reductions to compensate for the high ongoing tax obligation.
Difficulty in Refinancing: Lenders consider a property's expense when underwriting loans. High property taxes can affect the loan-to-value ratios and the debt service coverage ratio, potentially making refinancing more challenging or less favorable.
Budgeting and Forecasting Uncertainty: In areas with high millage rates, there may also be volatility in property tax assessments or frequent reassessments. This can make it challenging for investors to forecast future expenses accurately.
Risk of Tax Liens: Failing to pay property taxes can result in tax liens, which can lead to foreclosure in some jurisdictions. While this might seem like an extreme scenario, it's a potential risk that increases with higher tax obligations.
Consideration of Other Incentives: Sometimes, areas with high millage rates might offer other incentives for investors, such as tax abatements or redevelopment grants. Investors need to weigh these potential benefits against the costs of high property taxes.
Potential for Appeals: Investors might find themselves more inclined to challenge or appeal their property tax assessments in areas with high millage rates. While successful appeals can result in savings, they also require time, effort, and potentially money.
In conclusion, while high millage rates or property tax rates can pose challenges for real estate investors, it's essential to consider the complete financial picture, including purchase price, rental income potential, growth prospects, and other local tax or financial incentives.
How to use millage rate in your real estate financial mode
Incorporating the millage rate into your real estate financial model is essential for accurately predicting expenses, cash flows, and returns on a property investment. Here's how you can use the millage rate in your financial model:
Determine Assessed Value:
- Research the current assessed value of the property.
- Note how the local jurisdiction calculates assessed value (e.g., a percentage of market value, recent sales comparables, or another method).
- If you're projecting into the future, consider potential appreciation or depreciation in the property value and how that might impact the assessed value.
Calculate Annual Property Tax:
- Multiply the assessed value by the millage rate. If the millage rate is given in mills (e.g., 20 mills), then for every $1,000 of assessed value, the tax would be the mill rate divided by 1,000.
- For instance, for a property with an assessed value of $200,000 at 20 mills: Tax = $200,000 x (20/1,000) = $4,000.
- Incorporate into Cash Flow Model:
- Deduct the annual property tax from your gross rental income (along with other expenses) to get your net operating income (NOI).
- If you're financing the property, then further deducting your debt service from the NOI will give you the cash flow.
Project Future Property Taxes:
- While the millage rate might remain stable, the assessed value can change over time. In some areas, properties are re-assessed regularly.
- Also, millage rates can increase or decrease based on local government decisions or referendums.
- Factor in potential changes in both assessed value and millage rates for future projections.
Consider Impact on Sale:
- High property taxes might impact the property's resale value, as potential buyers might factor in these costs when deciding on a purchase price.
- In your exit strategy or sale projections, consider how property taxes might play a role in negotiations or marketability.
- Conduct a sensitivity analysis around various millage rates or property tax scenarios. This is especially useful in areas where property tax hikes are being discussed or where frequent re-assessments occur.
Factor in Potential Tax Deductions:
- For many real estate investors, property taxes are deductible expenses. This can offset some of the costs when considering overall profitability, especially if the property is held in a taxable entity.
- Consult with a tax professional to understand how property taxes might affect your taxable income.
Incorporate Tax Appeals or Abatements:
- If you believe the property is over-assessed or if there are tax incentives or abatements available, factor these potential savings into your model.
By incorporating the millage rate and the resulting property tax calculations into your real estate financial model, you'll be better equipped to understand the true costs, potential returns, and overall attractiveness of an investment property. Always keep in mind that while taxes are a significant expense, they are just one of many factors to consider when evaluating a real estate investment.