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What Happens When Homes Cost More to Demolish than They Are Worth?

by Editor | ezLandlordForms

By Brian Davis

The average cost to demolish a home in Detroit is $10,000, according to Detroit 2020, largely due to the thick red tape involved in the 36-step process mandated by Detroit's regulations.

The average listing price for a home in Detroit is, unbelievably, also $10,000, according to Zillow's December 2012 data (the most recent month available).

So what happens to the 50% of homes on the under-side of average, that cost more to take down than they are worth?

Homeowners and landlords are, of course, likely to abandon them, as they fall on the "Liability" side of the ledger books.  As more homeowners and landlords abandon homes around Detroit, real estate values near abandoned homes drop.  As home values drop, more people abandon them, thus creating a downward cycle.

And what happens to demolished properties afterward?  Do they sit as vacant lots?  In the best case scenario, the City may be able to convert them to park space (although this will create ongoing maintenance costs), or hold it for a year (or ten) to resell to a developer for a profit.  In the worst case scenario, the cityscape becomes pocked with empty pieces of land sitting in limbo, forgotten by the bureaucracy and scarring neighborhoods.

There is another possibility: homes can be recycled.  This solution is laudably green, cutting down on landfill usage and lumber/treecutting demand, and preventing the manufacture of unnecessary new products.  But if bulldozing a house costs $10,000, how much does it cost to carefully dismantle a home piece by piece and recycle each component?

And who is going to pay these costs, regardless of whether the home is demolished or recycled, converted to a park or added to a land bank?  The short answer is "the City of Detroit," but this cycle is not sustainable economically.  As more properties are abandoned and demolished, and property values are driven down, causing more homes to be abandoned and demolished, what happens to Detroit's tax revenue?  The majority of city-level revenue comes from real estate taxes, after all.  Detroit could cut spending, but Detroit has overspent for so long (Detroit has a $200 million budget deficit and $13.2 billion in long-term structural debt) that now that they actually need to spend, they are already in a hole too deep to dig themselves out.  They will need to raise revenues, which means charging their citizens more in taxes, fines and fees, which will push more residents to move away (and abandon their homes for possible demolition).

Population & Real Estate Investing

So what should the City of Detroit do?  The population drops, so tax revenues drop and home values drop.  Homeowners and landlords abandon their homes because they are worth less than their mortgage, or the cost to demolish.  The City of Detroit spends more, on demolition programs and social welfare, because there are fewer jobs and opportunities, which means more poverty.

One possibility is allowing the State of Michigan to assume control of the city government, as the State has threatened to do, which would set a new precedent for handling cities that have proven not responsible enough to govern themselves.  Another possibility is attacking the root of the problem: economic decline.  Population follows job availability, so if the mayor could magically snap his fingers and create 200,000 new private-sector jobs in Detroit, suddenly there would be a population spike and subsequent real estate value spike.  It would suddenly make sense financially for real estate investors to buy up empty homes and renovate or replace them.  Values and occupancy would rise, and city tax revenues would rise.

Alas, creating 200,000 private sector jobs would be a Herculean challenge, even if the City of Detroit utterly devoted its efforts to boosting entrepreneurship and attracting companies to relocate there (which it has not).  So Detroit will increase its deficit by demolishing homes – their goal is 10,000 total demolitions by the end of 2013 – and the downward spiral continues.

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