Lease Terms Can Impact Property Valuation' "But Tax Assessors May Not Realize It

"The loss of tenant reimbursements ... can have a significant impact on the property's net operating income."

By Douglas S. John, Esq., as published by Commercial Property Executive, April 2012

In the past 24 months, published lease rates have continued to decline or remained flat in most markets and for almost all property types.

But published lease rates tell only part of the story. In an effort to keep and attract tenants, landlords have been forced to offer lease terms that can erode a property's value.

In states where tax assessors rely on leased fee valuations (valuing property based on its actual performance), the rates listed in rent rolls may omit these changes to leases. Similarly, where state law requires tax assessors to use fee-simple assumptions of market rent, published lease data typically reflects either asking rates or reported rates that also ignore the effect of these changing terms. Unfortunately for taxpayers, assessors rely on these sources, which are often unreliable indicators of true market lease rates and can result in inflated tax bills.

Taxpayers and their attorneys must dig deep into the terms of lease transactions and explain to assessors how changing terms impact their property's valuation. Following are some key changes in the leasing market and how they are affecting property values.

Transition from Triple Net to Modified Gross Leases: Tenants with sufficient leverage are no longer inclined to fully reimburse landlords for real estate taxes, insurance or common-area maintenance charges. As a result, when leases are renegotiated, the structure may transition from a triple-net lease to some form of a modified gross or even a full-service lease. A cursory review of the rent roll by the tax assessor may suggest that the rate is unchanged upon renewal. But the loss of tenant reimbursements for expenses can have a significant impact on the property's net operating income, resulting in a significant loss of value.

Free Rent: Free rent is a common inducement landlords use to keep or attract tenants. This can take many forms, with landlords offering from a few months to a year or more. In some distressed retail centers, landlords have been known to give anchor tenants free rent for extended periods as a means of retaining other tenants.

To obtain longer lease terms' "and in some instances in lieu of providing tenant improvement allowances they cannot afford' "landlords are also offering free rent on the back end of a lease rather than the front end, with tenants taking it at month 24, 36 or 48. A rent roll reflecting a 72-month lease may only provide 60 months of rent payments, with the final year rent free. In addition, landlords are offering furniture, equipment, free parking and moving allowances.

These rent concessions typically are omitted from rent rolls or published lease data, masking the extent of a property's economic vacancy, reducing its net operating income and contributing to a loss of value.

Tenant Improvements: Some space users want allowances for tenant improvements. But how a landlord accounts for their cost can significantly affect a property's value. For instance, say a tenant renews its lease at the same base rate as before but the landlord also provides $20 per square foot to rehab the property. If the landlord amortizes the improvements into the renewal lease rate, the rate reflected in the rent roll will overstate the effective lease rate. It is critical to explain to assessing authorities that using lease rates that amortize tenant improvements will result in overvaluation of the property.

Co-Tenancy Clauses: Tenants are also using their leverage to include co-tenancy clauses in leases or renewals that allow them to either reduce their lease rate or terminate the lease if the property's occupancy rate falls below a specific level or if a key anchor tenant moves out of the property. When an anchor tenant goes dark, the impact on the property's value is compounded by the potential loss in rent and expense reimbursements from smaller tenants that may decide to exercise their rights under the co-tenancy clause. The existence of a cotenancy clause may have a ruinous impact on the value of a property and should always be brought to the assessor's attention.

These and many other changes to leases that may be seen in the coming years—such as marginal or nonexistent escalator clauses and FASB rule changes—will continue to weigh down property values. It is critical that taxpayers and their attorneys develop presentations that clearly demonstrate to tax assessors, administrative tribunals and courts how a wide variety of lease changes can affect a property's valuation.

Douglas S. John is an attorney in the Tucson, Arizona, law firm of Bancroft & John P.C., the Arizona and Nevada member of American Property Tax Counsel (APTC), the national affi liation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

"While Texas remains one of the best places in the nation to do business, the property tax burden here is substantial. Careful planning of new investment in the state can considerably mitigate property taxes for a significant period of time..."

By Sebastian Rodrigano, as published by Texas Real Estate Business, April 2012

The idea that Texas offers a favorable business climate is deeply rooted in the business community, but a business must monitor its property tax burden or risk paying unnecessarily high tax bills.

It's understandable that many Texas businesses downplay the impact of property taxes on their bottom line. Late last summer, a survey by Development Counselors International rated Texas as having the best business climate in the nation for the 12th consecutive year. Survey respondents cited the tax climate, pro-business environment and economic development incentives as the top reasons for favoring the state.

As a 20-year Texas resident, I considered Texas' business climate supremacy to be indisputable. When a client requested a quick check of property tax projections to evaluate locations for a new facility, however, I had trouble reconciling the data with my beliefs about the competitiveness of Texas in attracting new business.

BIG TAXES IN TEXAS: Across a 20-year period, property taxes on four hypothetical commercial buildings, all valued at $200,000 in the first year, would be nearly four times higher in Texas than in many other states.

The client was trying to decide where to build a $200 million facility, assuming that every available property tax exemption would be granted in each of the states considered. Over a 20-year period, the estimated property taxes in Texas were close to four times those of the nearest competitor.

This result seemed incongruous, to say the least, with Texas' top national ranking in the "tax climate" category. A number of business representatives have assured me that in spite of a disproportionate property tax load carried by businesses, the overall tax picture is more beneficial in Texas than in most other states. Yet the magnitude of a business' property tax burden in this state demands significant attention and prudent management.

For existing infrastructure, much can be done to minimize taxes by ensuring that properties are properly and equitably valued. When dealing with new construction, a number of incentives and exemptions are available to help alleviate the property tax burden. Here are a few options for properties old and new.

Tax Abatement Agreements. Chapter 312 of the Texas Property Tax Code allows taxing entities to enter into agreements with taxpayers to exempt all or some of the value of real and/or tangible personal property from taxation for a period not to exceed 10 years. School districts may not enter into tax abatements. Generally, the agreement must be approved before construction begins.

Value Limitation and Tax Credit Agreements. A school district may agree to limit the taxable value of new property for up to 8 years under Chapter 313 of the Texas Property Tax Code. The limitation applies only to school district maintenance and operations taxes applicable to the property. These exemptions are commonly referred to as House Bill 1200 limitations and can be used in conjunction with a tax abatement agreement.

Economic Development Refund. Chapter 111 of the Property Tax Code provides for state tax refunds to qualified property owners that entered into chapter 312 tax abatement agreements after Jan. 1, 1996, without the benefit of a Chapter 313 value limitation.

Freeport Exemption. The Freeport exemption includes a total tax exemption for personal property (excluding petroleum products) that is detained in the state for less than 175 days for assembling, storing, manufacturing, processing or fabrication purposes. Each taxing jurisdiction must elect to participate. In some instances taxing jurisdictions that previously had not granted an exemption for a Freeport zone have opted into the exemption to incentivize business development. This exemption is described in Section 11.251 of the Property Tax Code.

While Texas remains one of the best places in the nation to do business, the property tax burden here is substantial. Careful planning of new investment in the state can considerably mitigate property taxes for a significant period of time, and a watchful eye over assessments will allow for a less costly experience while doing business in Texas.

Sebastian Rodrigano is a principal at the Texas law firm of Popp, Gray and Hutcheson, PLLC. The firm devotes its practice to the representation of taxpayers in property tax disputes and is the Texas member of the American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. Rodrigano can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

"The New York City Charter grants property owners the right to protest their tentative assessments from Jan. 15 (or the first day following weekends and/or holidays) until March 1..."

By Joel R. Marcus, Esq., as published by National Real Estate Investor - Online, March 2012

In its 2012-2013 tax roll assessment, New York City has once again reported major increases in property values. Bucking the national trend toward flat or downward value changes, the city in January found that overall market value had grown to more than $876 billion, up by more than $31 billion from last year's record $845.4 billion.

Remarkably, the taxable assessment (approximately 45 percent of market value) is only the latest step in a relentless series of increases in the taxpayers' burden, dished out each and every year since 1995. Bar graphs of total assessed values for each year by property class reveal the linear, uninterrupted nature of the changes, with nary a hint of the variations that would be expected during the two most recent economic recessions. (See chart.)

Last year's assessment increase provoked an angry backlash from both residential and commercial property owners. As a result of these widespread protests, the New York City Department of Finance agreed to voluntarily roll back assessments of cooperatives and condominiums (owned by voting taxpayers) that experienced assessment increases of 50 percent or more, choosing to instead limit increases on those properties to no more than 10 percent over the prior year. Properties that had received an assessment increase of 49 percent or less, however, went unchanged onto the 2011-2012 roll.

The Department of Finance had to correct 30,457 property assessments, and the Tax Commission handled 50,022 appeals covering 183,811 separately assessed tax lots. The Tax Commission's remedial actions yielded $560 million in tax relief to aggrieved taxpayers.

Repeat performance?

With the tentative assessment for the tax period running from July 1, 2012, through June 30, 2013, and showing dramatic value increases yet again for certain residential properties, there is a flurry of legislative activity promoting a new class of property for cooperatives and condominiums. As proposed, this class would have its tax increases capped at no more than 6 percent each year, the same treatment now accorded to one-, two- and three-family homes.

This legislation, if passed, still won't eliminate the precipitous disparity in taxes between apartments and homes. The cap on homes has been in effect since 1982, and now most homes are assessed at a very small fraction of their current market value.

Citywide, the taxable assessed values of one-, two- and three-family homes (Class 1) increased 3.11percent from last year's assessment. Rental apartments, co-ops and condos (Class 2) are up 5.15 percent, and office, hotel, retail and other commercial properties (Class 4) are experiencing an increase of 7.26 percent.

A red flag

A red flag

Before publication, the Department of Finance detected massive errors in the assessment roll and delayed its release. Officially, the Department of Finance cited the need "to correct an error in one of the computer systems it uses to calculate values." But insiders report that quality control issues were also a factor in the delay. On Jan. 19, 2012—two days late—the Department of Finance published the city's tentative assessment roll, covering more than 1 million separately assessed parcels of real estate.

The New York City Charter grants property owners the right to protest their tentative assessments from Jan. 15 (or the first day following weekends and/or holidays) until March 1. The law authorizes owners of one- to three-family houses the right to contest their tentative assessments until March 15. The protests must be filed during these time periods with the New York City Tax Commission, an independent city agency authorized to review and correct the Department of Finance's property tax assessments.

In announcing the delayed assessment release, Finance Commissioner David M. Frankel stated that "we will keep the roll open for an additional two days this year." The Tax Commission's legal authority to review protests filed after March 1 and March 15 is questionable, however. In the absence of remedial legislation expressly authorizing the Tax Commission to review protest applications filed after March 1 and March 15, applicants are better off assuming that the current statutory filing dates will continue to govern.

Commercial consternation

During the period after the publication of the tentative assessment and prior to the publication of the final assessment roll on May 25, the Department of Finance is permitted to increase assessed values of nonresidential properties. This authority may only be exercised until May 10, however, and only where the department has mailed written notice to the owner at least 10 days prior to May 10. The mailing of such notices after Feb. 1 extends the protest period for affected owners, who have 20 days after the notice was mailed to apply for a correction of their assessment.

In Frankel's announcement, he also mentioned that the Department of Finance is reviewing whether thousands of properties which have historically enjoyed not-for-profit exemptions remain eligible for such benefits. Previous exemptions for many properties which did not file timely renewal applications prior to Nov. 1, 2011, were removed on the tentative assessment roll, but Frankel advised that these properties can still regain their exemptions for the 2012-2013 tax year if they provide the required documentation by Feb. 13.

This email address is being protected from spambots. You need JavaScript enabled to view it. is a partner in the law firm of Marcus & Pollack LLP, the New York City member of American Property Tax Counsel.

Rather than simply redevelop existing buildings to suit their needs, the build-to-suit model calls for the development and construction of new buildings that match the trade dress of other stores in a national chain. Think CVS pharmacy, Walgreens and the like...

By Michael P. Guerriero, Esq., as published by Rebusinessonline.com, March 2012

The build-to-suit transaction is a modern phenomenon, birthed by national retailers unconcerned with the resale value of their properties. Rather than simply redevelop existing buildings to suit their needs, the build-to-suit model calls for the development and construction of new buildings that match the trade dress of other stores in a national chain. Think CVS pharmacy, Walgreens and the like. National retailers are willing to pay a premium above market value to establish stores at the precise locations they target.

In a typical build-to-suit, a developer assembles land to acquire the desired site, demolishes existing structures and constructs a building that conforms to the national prototype store design of the ultimate lessee, such as a CVS. In exchange, the lessee signs a long-term lease with a rental rate structured to reimburse the developer for his land and construction costs, plus a profit.

In these cases, the long-term lease is like a mortgage. The developer is like a lender whose risk is based upon the retailer's ability to meet its lease obligations. Such cookie-cutter transactions are the preferred financing arrangement in the national retail market.

So, how exactly does an assessor value a national build-to-suit property for tax purposes? Is a specialized lease transaction based upon a niche of national retailers' comparable evidence of value? Should such national data be ignored in favor of comparable evidence drawn from local retail properties in closer proximity?

How should a sale be treated? The long-term leases in place heavily influence build-to-suit sales. Investors essentially purchase the lease for the anticipated future cash flow, buying at a premium in exchange for guaranteed rent. Are these sales indicators of property value, or should the assessor ignore the leased fee for tax purposes, instead focusing on the fee simple?

The simple answer is that the goal of all parties involved should always be to determine fair market value.

Establishing Market Value

Assessors' eyes light up when they see a sale price of a build-to-suit property. What better evidence of value than a sale, right?

Wrong. The premium paid in many circumstances can be anywhere from 25 percent to 50 percent more than the open market would usually bear.

Real estate is to be taxed at its market value — no more, no less. That refers to the price a willing buyer and seller under no compulsion to sell would agree to on the open market. It is a simple definition, but for purposes of taxation, market value is a fluid concept and difficult to pin down.

The most reliable method of determining value is comparing the property to recent arm's length sales, or to a sale of the property itself. It is necessary to pop the hood on each deal, however, to see what exactly is driving the price and what can be explained away if a sale is abnormal.

Alternatively, the income approach can be used to capitalize an estimated income stream. That income stream is constructed upon rents and data from comparable properties that exist in the open market.

For property tax purposes, only the real estate, the fee simple interest, is to be valued and all other intangible personal property ignored. A leasehold interest in the real estate is considered "chattel real," or personal property, and is not subject to taxation. Existing mortgage financing or partnership agreements are also ignored because the reasons behind the terms and amount of the loan may be uncertain or unrelated to the property's value.

Build-to-suit transactions are essentially construction financing transactions. As such, the private arrangement among the parties involved should not be seized upon as a penalty against the property's tax exposure.

Don't Trust Transaction Data

In a recent build-to-suit assessment appeal, the data on sales of national chain stores was rejected for the purposes of a sales comparison approach. The leases in place at the time of sale at the various properties were the driving factors in determining the price paid.

The leases were all well above market rates, with rent that was pre-determined based upon a formula that amortizes construction costs, including land acquisition, demolition and developer profit.

For similar reasons, the income data of most build-to-suit properties is skewed by the leased fee interest, which is intertwined with the fee interest. Costs of purchases, assemblage, demolition, construction and profit to the developer are packed into, and financed by, the long-term lease to the national retailer.

By consequence, rents are inflated to reflect recovery of these costs. Rents are not derived from open market conditions, but typically are calculated on a percentage basis of project costs.

In other words, investors are willing to accept a lesser return at a higher buy-in price in exchange for the security of a long-term lease with a quality national tenant like CVS.

This is illustrated by the markedly reduced sales and rents for second-generation owners and tenants of national chains' retail buildings. Generally, national retail stores are subleased at a fraction of their original contract rent, reflecting pricing that falls in line with open market standards.

A property that is net leased to a national retailer on a long-term basis is a valuable security for which investors are willing to pay a premium. However, for taxation purposes the assessment must differentiate between the real property and the non-taxable leasehold interest that influences the national market.

The appropriate way to value these properties is by turning to the sales and leases of similar retail properties in the local market. Using that approach will enable the assessor to determine fair market value.

Michael Guerriero is an associate at law firm Koeppel Martone & Leistman LLP in Mineola, N.Y., the New York state member of the American Property Tax Counsel. Contact him at This email address is being protected from spambots. You need JavaScript enabled to view it..

Taxpayers should review their individual property tax records maintained by the county tax assessor to determine whether the specific facts of their property are accurate. Is the amount of acreage or square footage accurate and up to date, including any additions or demolitions that have occurred?

By Lisa Stuckey, Esq., as published by National Real Estate Investor - Online, March 2012

In this era of computer-generated recordkeeping, Georgia taxpayers should be aware of several areas in which accurate records are critical in the proper valuation of their properties for ad valorem tax purposes. While software and online filing save time, these tools also increase the opportunity for inaccuracy and unfairly high tax bills.

The importance of accurate written records begins with the initial purchase of the property. Georgia law requires property owners to report real estate sales on a PT-61 form, which is filed online with the clerk of the county superior court. This form is transmitted to the county tax assessor, who is required to consider sales in determining the fair market value of property.

Taxpayers should ask themselves if there has been a proper allocation between real and personal property. Examples of personal property include furniture, fixtures and equipment for the operation of hotels. Has there been a proper allocation of tangible vs. intangible property?

A new statute in the Georgia property tax code requires that tax assessors exclude the value of intangible assets such as patents, trademarks, trade names and customer and merchandising agreements. If the reported sale price of a real property contains these intangibles, then inflated tax valuations are likely to occur.

Sometimes there is no allocation in county records of the underlying business being acquired as part of a property transaction. For example, portfolio purchases of convenience stores or daycare centers may reflect only the aggregate purchase price and not a proper allocation of the individual components being acquired. Has there been a proper allocation of specific assets in a multi-property sale transaction? Inaccurate sale price allocation among properties purchased as a portfolio often results in improper tax valuations.

A purchaser with ownership and control of a property must make certain that internal recordkeeping is accurate, for both real and personal property. Inaccuracies can expand over time throughout the length of ownership and life of the property. For instance, owners of personal property may carry pieces of property on their books and ledgers that have been sold, disposed of, moved from the county to another facility owned by the taxpayer, or which are obsolete or no longer in use.

County tax assessors rely upon taxpayers to accurately report property held by the taxpayer in the county on Jan. 1 of each tax year by filing the business personal property tax return. If owners carry over historical purchase prices of personal property without analyzing the facts surrounding current ownership, location, and use of the individual pieces of property, the inaccuracies will result in improper tax valuations of personal property by the county tax assessor. Each passing tax year can compound problems if additional pieces of property are disposed of or moved but continue to be reported to the tax assessor as being held in the county by the taxpayer on Jan. 1.

Real property owners should periodically review and make sure their internal records are accurate. For instance, for office, apartment, retail and warehouse properties, does the software used by the taxpayer to maintain rental records accurately reflect both actual contract rents and the current market rent of the property? Dated and inaccurate market rental rates can be misleading to county tax assessors, who review taxpayer rent rolls to obtain market information used to value commercial properties.

Similarly, for hotel properties, is the actual and market room rate data accurate in all fields of the software, or have record-keepers merely carried over historical market rates that could mislead the tax assessor and cause improperly inflated valuations?

Another area of proper record-keeping involves the actual county tax records. The new Georgia statute requiring county tax assessors to issue annual tax assessment notices to every real property owner places an even greater burden on the tax assessor than in years past, which may result in more factual errors in the county property tax records.

Taxpayers should review their individual property tax records maintained by the county tax assessor to determine whether the specific facts of their property are accurate. Is the amount of acreage or square footage accurate and up to date, including any additions or demolitions that have occurred? Does the county have the correct age for the property, including all of the portions of the improvements, which may have been built at different times?

Along that line, does the county have the appropriate percentage breakdown for the various areas of use at the property, such as office vs. warehouse or rentable area vs. common area? Are the wall heights correct for all portions of the property? These are just a few examples of the type of data maintained by the county tax assessor which must be correct to assist in the accurate valuation of a taxpayer's property.

Electronic records offer many advantages. But savvy property owners invest some of the time they are saving through modern technology, and make sure that inaccurate records related to their property aren't contributing to an overstatement of their tax burden.

Lisa Stuckey is a partner in the Atlanta, GA law firm of Ragsdale, Beal's, Seigler, Patterson & Gray, the Georgia member of American Property Tax Counsel, the national affiliation of property tax attorneys. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

It is well understood in economics that, outside of the margins, the more you tax something the less of it you get, and the less you tax something the more of it you get.

By Scott B. Cryder, Esq., as published by National Real Estate Investor - Online, February 2012

A city is unlikely to maximize its potential without attracting and retaining families with children. Yet attracting and retaining such families is perhaps the greatest obstacle the District of Columbia will face over the next several decades as it seeks to navigate the region's ongoing population boom. And while it may not seem obvious, the real estate tax code may be an effective tool to meet the challenge.

A good problem to have

According to the 2010 Census, the D.C. metropolitan area grew by 16 percent over the last decade. Among the 10 largest metropolitan areas, this was the largest percentage increase of any non-Sunbelt metropolitan area. Growth extended beyond the suburbs, as the District itself stemmed a 60-year population decline by adding nearly 30,000 new residents.

Buoyed by government spending, related contracting, a robust legal and professional field and growing technology and biomedical industries, the D.C. area is well positioned to maintain this growth over the coming decades. In fact, a recent study by the Center for Regional Analysis at George Mason University predicts that over the next two decades the population of the greater D.C. area will increase by 1.67 million people, a 30 percent increase over the current population of 5.58 million. Compared with the problems facing shrinking metropolitan areas such as Detroit and Chicago, the District is fortunate. Nonetheless, this projected growth presents significant challenges to state and local governments.

A city of hipsters and empty-nesters?

Though the District may be spared from some of the more implacable transportation issues facing its suburban neighbors, it faces its own unique set of challenges. The most glaring, long-term impediment to growth in the District is its dismal public education system. The dearth of quality public schools renders the District inhospitable to large numbers of families with school-age children. These families, who would otherwise prefer to live in the District, are forced either to decamp for the suburbs once their children are of school age or enroll them in private schools, an option that is beyond the reach of a large swath of the populace.

This lack of quality public education effectively restricts the District's appeal to a narrow demographic group of new residents—a fact that has not been lost on the multifamily developers who increasingly dominate D.C. residential development. Reacting to market conditions, these developers are focusing on delivering smaller, more affordable units in amenity-laden buildings. These units are, however, largely impractical for families with school-age children.

Attracting these families presents a Catch-22 conundrum, however: The quality of public schools will improve if more diverse families move into the District, yet these families are hesitant to move into the District because of the lack of quality public schools. Solving this challenge requires innovative thinking by the District government. Policies must be enacted that simultaneously incentivize individual families to move to the District and incentivize residential developers to provide the necessary housing stock, especially in the multifamily segment. This is where a simple tinkering with the real estate tax code could pay big dividends.

It is well understood in economics that, outside of the margins, the more you tax something the less of it you get, and the less you tax something the more of it you get. This same basic principal should be applied to attracting and retaining families with school-age children. Specifically, the District should implement a child property tax credit of $1,000 for each child enrolled in D.C. public or charter schools. This credit could be claimed by either owner-occupants or landlords where the child lives.

By making this credit available to both owners and landlords, the District would not only directly motivate families to move to the District and enroll their children in D.C. schools, but it would also incentivize developers to provide the new housing necessary to support these families. This simple, easily administered tax credit would address two difficult issues simultaneously, in an efficient manner with little regulatory overhang. If the District wishes to reach its potential, it will need to enact precisely these types of policies.

Scott B. Cryder is an associate in the law firm Wilkes Artis Chartered, the District of Columbia's member of American Property Tax Counsel.

"External obsolescence may be market-wide or industry-specific, international, national, or local in origin. It can be temporary or permanent, but in most cases, the property owner is unable to fix the problem..."

By Benjamin A. Blair, Esq., as published by rebusinessonline.com, December 2012

Shopping center owners often find that factors beyond their control detract from the marketability and profitability of their investments, particularly in the current depressed market. Economic change and evolving technology, for example, have altered the way retailers and property owners transact business. While lenders keep a tight grip on potential financing, brick-and-mortar retailers must compete against an increasingly global, virtual marketplace.

Despite — and indeed because of — this bleak picture, property owners have reason for optimism. Several states and localities, including Chicago and Indiana, are in the midst of systematic property reassessments. Because this cycle of reassessments falls during a time when retailers are still struggling under the effects of the recession, property owners have an opportunity to reap tax savings from this market turbulence and increase the property's bottom line.

The goal of a property tax assessment is to apply the tax rate to an accurate property value. This value is generally set at either market value or at the property's value-in-use. A property's value, however it is set, can be affected by any number of factors, the most important of which for retail properties is the property's ability to earn rental income.

Real-life scenario

Imagine a neighborhood shopping center with leaking roofs and peeling paint. Perhaps the tenant spaces are awkwardly shaped or poorly constructed. An investor would value this property less than an otherwise comparable property in better condition. This depreciation, called physical and functional obsolescence, is due to the physical condition or flaws in the construction of the property.

But just as a property can suffer from physical and functional obsolescence, a property can suffer depreciation from sources external to the property itself. This depreciation, termed economic or external obsolescence, is a usually incurable loss in value caused by negative influences outside the property. External obsolescence may be market-wide or industry-specific, international, national, or local in origin. It can be temporary or permanent, but in most cases, the property owner is unable to fix the problem.

In order to use external obsolescence to reduce a property's tax assessment, the owner must first identify whether external obsolescence is present. Then the owner must quantify the effect of the obsolescence on the property. Unsupported claims of obsolescence are unlikely to impress an assessor and encourage a reduction in the property's assessment.

To quantify the obsolescence, the owner must know its source. Shopping centers in today's market are subject to external obsolescence from a variety of sources. General economic conditions have reduced the demand for leases and have resulted in fewer tenants. Existing tenants, feeling pressure from lower-overhead competitors, are seeking lower rents to reduce strain on their business. Many retail lease rents are based on a percentage of sales, and as sales fall, so does rental income.

As a result of the real estate boom in the middle of the last decade, many markets are oversupplied with competitive properties, and some uncertainty exists as to the future of brick-and-mortar retail. Further, buyers and sellers are still cautious while engaging in sales, and lenders continue to restrict available capital. Changes in interest rates, inflation, capitalization rates, and elected officials can all have an effect on property value.

Proving cause and effect

After identifying the source of the property's obsolescence, the owner must be able to show the impact of the obsolescence on the property. For example, if the owner has lowered rents in order to keep or attract tenants, the valuation of the property should reflect that lowered income earning potential. Decreased demand from investors, whether because of financing restrictions or lower income potential, should reduce the assessment to reflect the smaller market for investment properties.

And when determining value by comparing the sale of similar properties, owners should emphasize the differences in market conditions, which reduce the value of the property.

For most properties, the largest expense after debt service is the property tax bill, so any reduction in that tax burden can drastically improve the property's profitability. Thus, while the economic climate may be turbulent for some time, prepared and informed property owners can use the nuances of external obsolescence to help weather the storm.

Benjamin A. Blair is a tax associate in the national law firm of Faegre Baker Daniels, the Indiana member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

Assessors Often Overvalue Centers, Ignoring Vacancies and Other Issues

"Landlords must diligently review property taxes yearly, looking at assessments based on current marketplace conditions."

Most shopping center owners are being overtaxed and do not even know it. Or they do not realize it until they get their tax bill. The problem is in the way taxes are figured by local assessors- a methodology that was only adequate, at best, during good times, but which has become a severe handicap to landlords during this lengthy economic downturn.

In most states assessors take a mass appraisal approach, trying to determine as quickly and ubiquitously as possible the fair market value of all the shopping centers within a tax district using existing data. The assessor is looking at the market value of the property based upon fee-simple value, which is the value of the real estate without encumbrances - that is, what it would sell for if it were vacant and available for sale or lease at market rates.

"The reality is, there are few cases of commercial property selling where you have a vacant building for sale without encumbrances," said Kieran Jennings, a Cleveland-based partner at Siegel, Siegel, Johnson & Jennings. "Typically, it is partially occupied, fully occupied, et cetera. Often there are deed restrictions in place." Jennings is a member of the Washington-based American Property Tax Counsel, which assists property owners in the U.S. and Canada with tax issues.

"Assessors will look at a market, they will review published sources on cap rates, et cetera, to come up with a model that will be used on shopping centers across the board," said Darlene Sullivan, a partner at Austin, Texas-based Popp, Gray & Hutcheson, and also a member of the APTC. "They have to get their numbers out quickly and apply the model without looking specifically into any condition."

Assessments are levied in similar fashion in Michigan. "In Michigan, as in most states, value is based on market as opposed to contract rent," said Michael Shapiro, a Detroit-based partner at Honigman Miller Schwartz and Cohn, and an APTC member. "In general, the assessor uses a cost approach that has not adequately accounted for obsolescence in the market, reduced demand for property, greater vacancies and increased cap rates. All these factors have a negative impact on value. "There are two general ways overtaxing occurs. The first is the time-lag effect of a slumping market, and the second involves the lease adjustments often made to keep tenants in place, but which assessors do not take into account.

Indiana landlords were being victimized by the calendar until laws there were changed, says Stephen Paul, an Indianapolis-based partner at Baker & Daniels and an APTC member. "Our assessment date is a year behind our value date," Paul said. "For example, the assessment date was March 1, 2009, but the valuation date was January 1, 2008, and the market changed dramatically. On March 1, 2009, market conditions were worse than at the value date. People were taxed currently, but based on values when the market was much better."

The more common failure in tax assessments is the inflexibility of assessors or their inability to consider the lease inducements necessary to keep tenants. "I have a number of clients that are regional and local shopping center owners," said Jennings. "Since the fall of the real estate market, there has been tremendous pressure on them to keep tenants in place. So they have gone from net leases to gross leases, put in buildouts and removed square footage."

All these things mean that actual rents are less than what they appear to be to the assessor. Jennings gives one example where tenants will stay in place, but take up less space. To keep tenants, landlords will allow them to halve their space, which means they have effectively cut income in half. "Now when the assessors come along, they see all of your storefronts are occupied, but many of the tenants have reduced space," said Jennings. ''The landlord has pockets of dead space that will probably never be used again. The assessor is assessing you at rents that are $15 to $20 a square foot, but only half that space is being used, so the effective rent is really $7.50 to $10 a square foot. And it is not showing up in any published data, and assessors can only work from what is published."

That problem rarely gets rectified because, for competitive reasons, shopping center owners are reluctant to share information, which means, of course, that the assessors are working from incomplete data. "Shopping center owners are not amenable to giving out information to assessors," said Paul. "The landlord doesn't want to give out the details of a lease, so the assessor will say: 'If I'm not entitled to look at the lease, I have to make my own assumptions, which will be done on incorrect information. Afterward the taxpayer has to file an appeal against the assessment and layout the reasons why it was excessive."

Overtaxing is a problem not just for the shopping center owners, but for the tenants as well. Most leases are triple-net, which means that taxes are passed through to tenants, so a lower tax will benefit the tenant in the end, Sullivan says. "Tenants need someone to be aggressive for them to keep those triple nets down," she said.

This can also be problem with competitive shopping centers. Consider two similar shopping centers across the street from each other, each with the same type of vacancy. One center is valued at $100 per square foot, and the other at $130 per square foot. Because of triple net, tenants will be enticed to the center taxed at the lower rate, because all things considered, the expense of leasing will be lower.

An assessor equipped with nothing more than the cost approach will find it difficult to quantify value losses without going through a detailed income approach, something that assessor is going to lack the time to do. Most appeals processes will recognize this and adjust accordingly.

In Michigan when an appeal is filed, the parties generally get together and discuss the specifics, and usually the matter is resolved without a hearing or trial, says Shapiro. "We have handled many shopping center appeals, and in recent years we have not gone to trial on a shopping center. Some get resolved while preparing for trial, and some get resolved when a formal, independent appraisal is submitted.

"Not every place is so easy. In Ohio and Pennsylvania third parties such as school systems have joined the fray: fighting to keep assessments high because so much funding comes from levies. Lower assessments mean less revenue for the school districts. "In the event, you are able to convince the assessor to reduce taxes based on, say, half the leased space used," said Jennings. "The school districts in Ohio and Pennsylvania can come in and file their own tax appeal to raise the value of a given property." Landlords must diligently review property taxes yearly, looking at assessments based on current marketplace ' conditions, Shapiro says. "My clients are fighting assessments," he said, "because assessors were ignoring the function obsolescence of their properties, which in some cases meant a 50 percent reduction in value."

Tim Schooley, Pittsburgh Business Times Reporter covers the case lead by APTC Pennsylvania Member - Sharon DiPaolo, Esq., as published by Pittsburgh Business Times January, 2012

The owners of the Robert J. Casey Industrial Park on the North Side are petitioning the Allegheny Court of Common Pleas Judge R. Stanton Wettick to ensure commercial property owners have to same opportunity to appeal their reassessments as residential property owners in Allegheny Count, according to a court filing.

The petition to intervene in the ongoing legal challenge of the reassessment values for Allegheny County is the latest plea to argue for uniform standards to tax the value of real estate in Allegheny County in a legal battle in which the issue of uniformity has been upheld by Wettick.

The family ownership of the eight-parcel industrial park saw its reassessed value jump by 340 percent, according to court documents, rising from a little more than $2.6 million in its 2011 assessed value to a reassessed value for 2013 of $11,864)00.

Sharon F. DiPaolo, a lawyer who represent the owners of the Robert J. Casey Industrial Park, argued in her petition that Allegheny County currently provides no information online regarding comparable sales to determine new assessments or other pertinent information used.

"The interests of commercial property owners are not adequately represented by the current parties and intervenors in the instant action", she wrote.

Of major concern for DiPaolo and her client is the ability to pursue an informal hearing before the Board of Property Assessment Appeals and Review, where a broader a discussion of a property's relative worth can be discussed, rather than a formal appeal before the county's board of viewers.

So far, the reassessment appeals process has been negotiated over between Allegheny County, the plaintiffs, who represent residential property owners, and Pittsburgh Public Schools, which convinced Wettick to delay implementation of the new assessed values

until 2013 so that reassessment appeals can be established to determine how to reset tax rates.

According to court documents, the reassessed values of commercial properties in Pittsburgh rose by 71.08 percent while the city's residential property increased by 46.89 percent.

"If this process were to be adopted, a commercial property owner which files an appeal before the Board of Property Assessment Appeals and Review could be entirely deprived .... by its adjudication by a taxing body's unilateral request to move the appeal to the board of viewers," wrote DiPaolo. "If this procedure were to be adopted, it would violate commercial property owners' right to due process."

At a hearing on Thursday morning, Judge Wettick agreed to consider the petition for next Thursday's scheduled hearing, said DiPaolo.

She added that the owners of the industrial park as well as other commercial property owners expressed the concern that the scale of the increased assessments on their real estate could force them out of business.

She emphasized the importance of the informal review process for commercial property owners, noting a commercial appraisal costs $5,000 to $10,000. A successful voluntary review can result in immediate tax relief, she added, further explaining that a burden of proof shifts to the taxing body after a successful informal review as well.

"If the commercial owners have to pay on their new assessments before it gets adjudicated it's really going to hurt," she said.

Tim Schooley covers retail, real estate, small business, hospitality and media. Contact him at This email address is being protected from spambots. You need JavaScript enabled to view it. or (412) 208-3826.

Sharon F. DiPaolo is a partner in the law firm of Siegel Siegel Johnson & Jennings, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

The "new normal" for Phoenix is likely a prolonged era of deleveraging as the market absorbs these distressed assets. For Arizona property owners, the decline in real estate values has not always translated into a commensurate drop in taxes, however. This has occurred for three reasons..."

By Douglas S. John, Esq., as published by National Real Estate Investor Online, January 2012

As 2012 begins, the real estate collapse ravaging Phoenix continues. Phoenix real estate prices have fallen from their height in early 2008 by 28 percent for retail, 52 percent for industrial and 71 percent for office, according to Navigant Capital Advisors, a Chicago-based investment bank. Phoenix ranks No. 7 on Real Capital Markets' list of the most distressed U.S. markets for commercial real estate.

The city's delinquency rate for commercial mortgage-backed securities (CMBS) loans is the third-highest in the nation, accounting for 3.6 percent of total U.S. CMBS delinquencies. And Phoenix's delinquency count is expected to increase next year.

The "new normal" for Phoenix is likely a prolonged era of deleveraging as the market absorbs these distressed assets. For Arizona property owners, the decline in real estate values has not always translated into a commensurate drop in taxes, however. This has occurred for three reasons.

First, the general decline in assessed property values has not kept pace with the actual decline in asset prices. Second, even though taxable property values have dropped, Maricopa County, where Phoenix is located, has increased its property tax rates: for fiscal 2011, tax rates increased by 18 percent from the previous year.

The third and final reason stems from Arizona's unique system of calculating property tax liability from two statutory values — a full cash value and a limited property value. A property's full cash value can decline while its limited property value, determined statutorily, increases, causing an escalation in tax liability.

Taxpayers must be diligent to ensure they are paying no more than their fair share of taxes. Consider the following points before deciding whether an appeal may be beneficial.

Start early

Arizona's property tax system is complex, difficult to navigate, and requires perseverance. Tax year 2013 property tax notices will be mailed in February 2012. The system entails multiple forms and filing deadlines which, if missed, will result in a taxpayer losing appeal rights.

The process will conclude in October 2012 with State Board of Equalization hearings. Owners should start planning now to challenge their 2013 tax assessments. To do so, they should pay close attention to how their properties are assessed.

Mass appraisal?

To determine if a property has been overvalued, it is important to understand that assessors use computer-based statistical models to derive value. These models have several limitations that can result in a property being over-valued.

First, the assessor's valuation of an individual property is only as accurate as the data and assumptions used in the statistical model to generate a value for a given submarket. The value created by a mass appraisal system may not account for the specific characteristics of a property, which may make it less valuable than predicted by the mass appraisal model.

Second, the mass appraisal system is dependent on correct, complete, and current property data. Oftentimes, the data that assessors use is not only incorrect but outdated by as much as six to eight months, which can inflate assessments. Part of the reason for outdated data is the existence of statutory cut-off dates for collecting data.

Valuation approach

While appraisers use three generally accepted approaches to value - the cost approach, the sales comparison approach, and the income capitalization approach - the appropriate valuation method depends on the property type. In Maricopa County, assessors value 70 percent of commercial properties using the cost approach, which measures the current replacement cost of the improvements minus depreciation, plus the value of the site. But the application of the cost approach in real estate transactions is limited and is rarely used by investors to determine market value.

In a depressed real estate market, the use of the cost approach typically results in an assessment that exceeds market value unless all forms of depreciation, especially obsolescence, are deducted.

Market value vs. property tax value

Even if an owner believes the assessor's valuation is reasonable based on his/her understanding of market value in the business world, the property may still be overvalued. Market value as commonly understood differs from property tax value in two key respects. First, Arizona law requires assessors to determine full cash value based on a property's current use, rather than its highest and best use. In many instances these two value concepts produce radically different values.

Second, market value for property tax purposes is limited to the value of the real estate. Arizona law prohibits the inclusion of personal and intangible property in the assessor's valuation.

Limiting assessments to real property is crucial to lowering the taxes of businesses such as hotels, assisted living facilities, and shopping centers and malls, which derive significant income from personal property and intangibles.

Because of the many deadlines, procedures, and valuation methods used, owners should begin reviewing their property tax values now to maximize their chances for success.

Douglas S. John is an attorney in the Tucson, Ariz. law firm of Bancroft & John, P.C., the Arizona and Nevada member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..