Is Texas as cheap as it seems?

[Vikram C.]

While doing the due diligence for an apartment building in Texas I noticed that the property tax rate was quite high compared to many other states. I understand the state has no income tax, but that's not relevant to out-of-state investors.

I think when we look at Texas properties, we should consider the real price to be about 25% higher than what we pay to account for this tax differential. Here's how the numbers look to me based on a simplified example:

Gross Scheduled Rent: $200
NOI: $100
CAP: 10
Purchase Price: $1,000

Comparing Texas's approximately 3% property tax with a state that has 1% property tax, we get a 2% hit each year based on the property value, which means the real comparable NOI is lower by $20.

Thus, comparable NOI = $80
This means we should have paid $800 for the property and not $1000.

If we do not account for this while comparing investment opportunities in different states, we could end up paying a whopping 25% more for a texas property than a comparable property in a state with lower taxes.

I understand there are ways around this, such as setting up a C corp, taking salaries out, etc. but none of them are costless.

Anyone having a contrary viewpoint? Or a solution to this problem? If it were a small difference, I would not think much about it but paying 25% extra seems like a lot to me.

[R Sean]

Originally posted by Vikram C.:

Rich, I was not trying to compare TX to CA. That one's a no-brainer. I was trying to compare TX to other cheap states such as AZ. More precisely, I was trying to figure out a proper way to account for the tax differential. TX might still be the best game in town. But I think we need to come to that conclusion after accounting for the huge tax effect.

Roman, it is not captured in the NOI figures. The NOI assumption of 50% is a general assumption. But if one state is going to have 10% of GSI as an extra tax, then that state's NOI will be correspondingly lower.

Your approach works if you assume rents are equal, which comparing class A California MF vs. TX class A MF, there is up to a 50% difference.

Looked at another way Vikram: if NOI is correspondingly lower, so will the value of the asset, keeping the yield unchanged. 10% on a $1000 NOI is the same yield as 10% on a $800 NOI, but each yields very different asset values.

Values are driven by a multitude of factors: supply constraints, land values, SF home affordability, interest rates, capital markets, blah, blah....which impact the going in yield (cap rate) of a propsective investment.