Research Note: Increased Housing Density can Increase Local Property Tax Revenue
This is the third in a series of Research Notes written by our summer intern, Ethan Roth. This summer, his work focused on housing issues. This post is a review of a study done by the American Enterprise Institute.
Local governments face tradeoffs. Increased housing density (and the associated benefits of lower housing costs and higher margins for builders) comes at the cost of expanding infrastructure and responding to higher demand for public services like schools and emergency services.
The American Enterprise Institute’s recent study, “Local Property Tax Rates and the Revenue Case for Density: National Estimates by Jurisdiction,” provides compelling insights into the tax incentives for local governments to create broader allowance for denser housing. They note that the United States “faces a housing supply shortage of roughly six million homes as of 2025,” and claim that the lagging supply response in the highest demand cities is a major cause of the problem.[1]
Light-touch increases to single-family density, AEI proposes, is a way to combat the lagging supply response and free up housing markets so builders can capitalize on higher margins from high-density projects while providing low- and middle-income earners a more affordable source of housing. However, the benefits aren’t just for the private sector. Local governments stand to gain from light-touch density increases too: “Allowing light-touch increases to single-family density is itself a revenue generator, even absent its effects on the supply for new housing.”[2]
AEI defines these light-touch density (LTD) conversions as “the opportunity to increase housing supply and affordability by replacing or converting single-family homes and vacant lots into up to eight new homes, such as duplexes, triplexes, fourplexes, or townhomes, with or without splitting the original lot.”[3] In addition, they examine LTD in new residential subdivisions (NRS), when “multiple single-family lots are created from larger parcels of land…allowing more homes to be built on smaller lots.”[4]
For light-touch density in both NRS and conversions, the price of each unit is lowered in part because each unit consists of less land area. When LTD conversions happen, an average of 4.4 net new units are created and the increase in new homes outweighs the decrease in per-home value and tax revenue. AEI demonstrates that LTD conversions generate 2-5x more property tax revenue than building a McMansion (single-family tear-down rebuild), commonly the choice to redevelop large lots in areas that don’t permit lot splitting. In new subdivisions, LTD policy allows for 108% more homes per acre.
AEI states that light-touch density generates a mean of $1.1 million in additional annual tax revenue per jurisdiction while lowering per-home costs, a 6% increase after the first year. After a decade of LTD policy, AEI claims jurisdictions see a mean of $52.6 million with cumulative new construction, a 58% increase compared to a decade without LTD policy. Nationally, the mean annual property tax revenue per home is $3,900, calculated for a mean property value of $434,000 and mean effective tax rate of 0.97%.
With LTD policy, the total housing stock is increased, more affordable homes are created, and tax revenue increases. It’s a win-win scenario when cities unearth the value that is trapped in large minimum lot sizes and restrictive land use ordinances.
AEI analyzed the property tax implications of the light-touch density policy adopted by Seattle in 1994. They found that the median value of eight-home LTD conversions is $7.1 million, four-home conversions is $3.6 million, and McMansion rebuilds is $1.5 million. LTD conversions generated substantially more total property value per lot, and consequently more property tax revenue per lot. In districts not allowing LTD conversions, homeowners seeking to maximize the value of their lot are forced to build large, expensive McMansions that “generate less tax revenue for the very government setting those limits.”[5] Through LTD the community gains a larger affordable housing stock and greater value per lot of land.
In Seattle, townhome conversions resulted in a total annual tax revenue of $115 million, compared to an estimated $46.9 million if these lots had instead been converted into McMansions. These LTD conversions occurred due to market forces and did not require public subsidy: “developers voluntarily chose townhome construction because it is more profitable than McMansions.”[6]
Nebraska municipalities ought to carefully consider how tax revenue increases from light-touch density policy offset the cost of increased density. Read the full AEI paper here for a deeper look into how LTD policy frees owners to maximize the value of their land, bolsters affordable housing supply, and increases tax revenues for local governments.