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The Perfect Storm

Property reappraisals for 2009 could bring choppy financial weather for homeowners and local government.

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Using a computer program similar to Google Earth, Shelby County assessor Cheyenne Johnson and three staff members look like hard-core gamers as they pore over aerial photographs of a subdivision in Cordova.

Zooming in, they can see a house from every angle, measure its square footage, and spot backyard additions and swimming pools that can't be seen from the street.

Johnson is making a valiant effort to perform a Herculean task: place a fair-market value as of January 1, 2009, on 331,881 properties in Shelby County at a time when the bottom has fallen out of the real estate market. What will fair-market value be at the end of a year when gas went from $3 to $4 to $2, stocks often lost 10 percent or more of their value in a single day, banks such as First Horizon shed their mortgage business and eliminated their cash dividend, there are as many foreclosures as home sales, and the federal government bails out banks?

The stage is set for a tax crisis the likes of which Memphis has never seen. Or, as Johnson says: "We have a situation."

Every four years, Tennessee's 95 counties are required to reassess property. Nowhere are the stakes higher than in Memphis and Shelby County, which have, by far, the highest property tax rates in the state. Along with the sales tax, property taxes are the main source of government revenue in Tennessee, one of the few states without a broad-based income tax.

Property owners will get their new appraisals in early 2009. Appraisals determine how much taxes homeowners and businesses pay. The difference between a house in Memphis appraised at $100,000 and one appraised at $200,000 is $1,822 a year in taxes.

The total value of assessed property in Shelby County, currently $16 billion, is called the tax base. If it shrinks, governments have two choices: cut spending or raise taxes.

Johnson, who took office in August, isn't saying whether the tax base will grow or shrink.

"I'm not ready to call it," Johnson said last week, after saying in an earlier interview that the tax base would probably be stable. The first people to get the news in January, she says, will be mayors Willie Herenton and A C Wharton.

Rising foreclosures and a scarcity of standard home sales have made the 2009 reappraisal unusually difficult and certain to generate a wave of appeals when notices start going out in February. The value of a home is mainly determined by the sales price of similar homes or "comparables" in similar neighborhoods.

"Sales tell us more than anything," says Johnson, but there are projected to be only about 6,000 bona fide sales in 2008 compared to an average of 15,000 sales in each of the five previous years. At the rate things are going — 4,000 foreclosures in the first nine months of 2008 — there may be more foreclosures than sales this year.

Fewer sales mean fewer comparables and more guesswork.

Here's the ticking time bomb: Even though banks like First Horizon and Regions Financial have written off billions of dollars worth of bad mortgages and are participating in the taxpayer bailout, many Memphis and Shelby County homeowners may actually find their 2009 appraisals have gone up, not down.

There are three main reasons. To keep this simple, let's go back to high school for a minute.

First, the state of Tennessee does not allow county assessors to use foreclosure sales as comparables in determining value. Such sales are not considered to be "arms-length" transactions between a willing seller and a willing buyer. Imagine calculating your high school grade-point average by excluding the tests you flunked.

Second, the houses sold in 2008 are more likely to be the cream of the crop, purchased by buyers who could get financing under stricter terms than the "zero-down" loans offered in the years of easy credit. Your comparable, in other words, is that immaculately kept house down the street that fetched the asking price. Forget the $50,000 foreclosure sale a block away and all the houses owned by people too discouraged to even try to sell them. As your parents said when you were in high school: "You should be like that nice boy (or girl) who makes good grades, never gets in trouble, and is going to college."

Third, the last reappraisal was in 2005, and 2004 was a great year for home sales, thanks to all that optimism and easy money. There were 17,854 bona fide sales in 2004, and prices surged. To apply the high school analogy one more time, grade inflation was rampant, because there were lots of easy teachers and anybody could get a B. Now the easy teachers have been run off, and you have to earn the grade.

To summarize, by looking at the good houses that sold in 2008, ignoring the bad houses that didn't sell or were foreclosed, and using the boom year of 2004 as a benchmark, the Shelby County tax base stays at around $16 billion, the Memphis tax base stays at $9.5 billion, and government does business as usual.

Unless, that is, property owners revolt and imitate the bankers and mortgage companies that made their loans in the first place and either walk away from them or demand an appraisal that more accurately reflects the day's news headlines. There will be legions of tax consultants and former bankers and real estate agents to help them with their appeals.

The "situation" is not limited to poor neighborhoods. Rich or poor, every house is a potential mystery that can take hours to unravel. I asked Johnson's staff to randomly examine a house on Tournament Drive in the exclusive Southwind gated community. They found one with 5,500 square feet built in 1988 and purchased that year for $460,000. It sold for $468,000 in 2000, again in 2006 for $850,000, and again in April 2008 for $425,000. Its current appraisal is $681,400. Next year, who knows?

"Everybody is getting ready for a rude awakening," says Jackie Welch, a suburban developer who prospered in the boom days. "The lots I've been selling for $65,000 will be $45,000 next year. The municipalities that collect the taxes are going to have to realize that the $300,000 house is now $200,000, and the strip shopping center that rented for $18 a foot is now getting $12 to $14 a foot."

Johnson says reappraisals will start going out in February, and all notices should be distributed by April 20th. Appeals can be made until July 31st. The first step is the assessor's office, the next step is the Shelby County Board of Equalization. Appellants should be prepared to explain why they think their appraisal is too high and offer some evidence.

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