Consider each of these proven strategies to minimize ad valorem tax bills.
Record-breaking commercial real estate trading activity during 2021 is having a marked impact on property values in 2022. Transactions in 2021 were up 88% from 2020 and were 35% above 2019 levels, according to Ernst & Young. The large number of sales in 2021 extended to all categories of real estate, and many commercial property types experienced significant price increases.
Market values are the basis for property tax assessments in most taxing jurisdictions. As post-pandemic market values fluctuate due to higher prices, property owners need to adopt strategies to keep their assessed property values down. As we emerge from COVID-19 here are seven key considerations to minimize property tax assessments even as prices increase.
1. Report Property Operating Metrics. A commercial property's market value is based on its financial performance. A weak property will have poor performance indicators, such as excessive vacancy or below-market rental rates. Poor performance is usually the basis for a reduced assessment and a lower property tax bill. Where possible, property owners should report these types of performance indicators to taxing authorities each year before assessed values are set and tax bills go out.
2. Allocated Prices in Real Estate Portfolios Are Not Market Values. A buyer purchasing a real estate portfolio will typically allocate the total price paid over all the acquired real properties as well as other, non-real-estate assets. Investors create these portfolio purchase allocations for income tax, accounting, financing or other purposes, and they may commission an "allocation" appraisal for bookkeeping or underwriting purposes. Allocations of total portfolio price or value to individual properties in a portfolio are rarely a good indication of a property's market value, however. Likewise, allocation appraisals are unhelpful or even detrimental in determining taxable market values because they may not account for the unique aspects of an individual property.
3. Transaction Type May Affect Value. Market values can also be impacted by the nature of the transaction and its participants. For example, REITs set purchase prices for real estate portfolios based, in part, on income tax considerations. Similarly, when a transaction involves the acquisition of an entity that holds various types of assets, the price paid will include payment for assets other than real estate alone. Non-real-estate motivations for purchasing properties and non-realty components of a transaction must be removed in order to determine the market value of the real estate alone. Otherwise, the values for the real estate will be above market.
4. Only Real Estate Is Subject to Property Taxation. As previously mentioned, property portfolios will sometimes convey with other assets. These can include personal property, such as fixtures and equipment, or intangible assets and rights like contracts, licenses and goodwill. Market values for these non-real-estate items are evaluated differently from real property and some, such as intangible assets and rights, are not subject to property taxation at all. In addition, any "synergy" or "accretive" value from a portfolio sale is intangible and should be excluded when assessing a specific property's value for property tax purposes.
5. Properties May Not Stabilize at Pre-Pandemic Levels. Properties that were hardest hit by changes related to COVID-19 may take years to return to pre-pandemic performance levels, and some may never fully recover. Awareness of a particular industry's recovery will be key to understanding whether market values and property tax assessments for that property type will return to pre-2020 levels. Uncertainties about time to stabilization reduce real estate values. The knowledge that some properties may never achieve pre-pandemic performance levels puts long-term investment value into question, which decreases the current value of those properties and lowers their taxable value.
6. Leasehold Interest Values May Not Match the Market. Investors buy and sell commercial properties based on the net income they produce. However, if the leases generating that income are above or below market, the value derived from rents will not be at market. In addition, lease rates from synthetic or operating leases used to finance the purchase of a portfolio of properties will not produce market value for individual properties unless those lease rates happen to be set at market levels.
7. If All Else Fails, File a Property Tax Appeal. Taxpayers who work proactively with their local tax assessor are often able to achieve reduced assessed values and lower property tax bills. Property owners should address each of the previous six points with the local assessor. Nevertheless, there will be times when attempts to reduce assessed values are unsuccessful. In those cases, property owners should be prepared to file an appeal by the deadline and pursue it, preferably with the assistance of a knowledgeable property tax advisor.