Appraisals designed for lenders often inflate assessments of seniors living real estate for property taxation.

Appraisal methodologies for financing seniors housing properties factor in more than real estate to produce amounts that exceed property-only value. That means seniors housing owners may be paying real estate taxes on non-real-estate assets.

Everyone can agree that a seniors living operation—whether independent living, assisted living, memory care, skilled nursing or some combination—consists of a variety of assets. There are real estate assets (the land and building), personal property assets like furniture and kitchen equipment, and intangible business assets such as the work force, tenants, and operating licenses. These multiple assets and asset types present a challenge when developing an appropriate ad valorem tax valuation.

To appropriately value this asset type for property taxation, an owner must show the assessor the real estate's stand-alone value. Most states acknowledge that business assets are not subject to property tax, so the intangible business assets and their respective values must be identified and excluded.

The International Association of Assessing Officers, in its guide, "Understanding Intangible Assets and Real Estate: A Guide for Real Property Valuation Professionals," has developed a four-part test to help determine whether something intangible rises to the level of an asset. The IAAO test is as follows:

1. An intangible asset should be identifiable.

2. An intangible asset should have evidence of legal ownership, that is, documents that substantiate rights.

3. An intangible asset should be capable of being separate and divisible from the real estate.

4. An intangible asset should be legally transferrable.

The Appraisal Institute's current, 15th edition of "The Appraisal of Real Estate" recognizes the valuation methodology of separating the components of assets in a business or real estate transaction. Potential intangible business assets identified in the text include contracts for healthcare service, contracts for meals, and contracts for laundry assistance, all of which represent income streams or businesses. An assembled workforce is an intangible business asset with a quantifiable value. How long would it take an operator to staff-up a property prior to opening? What are the carrying costs during that time?

Many seniors housing owners and investors feel that the entire value associated with seniors living real estate is attributable to the business. While this may be a firm belief, the real estate must have some value. For fair taxation, the taxpayer must differentiate and value both the tangible and intangible components of the asset.

Multifamily comparisons

For 30 years, Ohio law has permitted appraisers to reference data obtained from traditional multifamily properties to value just the real estate in seniors housing. The theory has been that traditional apartments are primarily real estate and lack much of the associated business value that comes with seniors living assets. Therefore, an appraiser who takes the gross building area of a seniors living property can select, analyze, adjust, and apply multifamily data to determine fair market value.

This approach presents at least two issues. One, seniors living designs differ from traditional apartments. For instance, seniors living units are typically smaller, lack full kitchens, and require wider hallways to accommodate wheelchairs. Two, the multifamily market has generally prospered in recent years while seniors living properties have struggled to recover from pandemic-related losses.

This means Ohio appraisers are comparing seniors living properties to multifamily assets selling at higher and higher dollars per unit. Multifamily properties generally experience lower vacancy, credit loss, expenses and capitalization rates than do seniors housing assets. In short, these two product types often move in opposite market directions.

Difficulties with financing data

More and more, county assessors and school board attorneys throughout Ohio rely on appraisers who value seniors living properties as if done for lending purposes. While these going-concern valuations may satisfy lenders' needs, these same techniques are not reliable or accurate enough to support a state's constitutionally protected valuation and assessment process.

Going concern appraisal reports back into a real estate value. After first developing a total value for all assets present, the appraiser attempts to extract the business value.

There are several techniques routinely used in appraisals for financing that are inappropriate for determining taxable value. These include the lease fee coverage ratio approach, a management fee capitalization approach, and the cost residual approach. These appraisal techniques have been approved by banks, but they are largely untested in courts.

These approaches are tainted from the start because they look first to the total going concern value. That inherently requires an evaluation of business income, which should not be considered when determining a fee simple value of the real property.

Of the going concern methodologies, the cost residual method appears best suited to assess taxable property value. However, challenges and subjectivity abound when identifying and determining all aspects of depreciation that may impact market acceptance of the real estate asset, especially for an older property.

Starting with the business is problematic given the dollars involved in seniors housing resident services. Median asking rent for a conventional apartment was $1,000 per month in the Federal Reserve's 2022 Survey of Household Economics and Decision Making. By comparison, the median monthly rate for assisted living is $4,000, according to the American Health Care Association/National Center for Assisted Living. Importantly, that $4,000 excludes fees for additional services like medication management and bathing assistance.

Service fees constitute significant revenue in most seniors housing operations. A 2019 CBRE Senior Housing Market Insight report found that 65% of the revenue in assisted living properties comes from services provided above and beyond pure rent. The 2023 JLL Valuation Index Survey found that the average "Majority Assisted Living" asset class saw an expense ratio of 71%.

Owners and appraisers must closely examine operating statements to develop and support their opinions of value. Appraisers should consider looking at properties as having multiple income streams to verify whether their opinion of value for the real estate is reasonable and supportable. Operators and investors should be open and honest about return expectations.

Because the income generated by intangible business assets at seniors living properties are taxed in other ways, assessors must continue to carefully review seniors living real estate to ensure fair taxation. 

Spencer Fane's Michael Miller on the critical steps for finding tax relief.

This is a challenging time in the property tax world. Pandemic-era federal assistance programs have dried up, increasing communities' appetite for tax dollars to deal with crime, homelessness, transportation and other issues. Recognizing that inflation has put taxpayers under pressure, governments may offer tax relief to homeowners, their voters, but not to the commercial property owner.

In Colorado, a November ballot issue would reduce the valuation of a residential property by $40,000 and of a commercial property by $50,000. This will be little help to an owner of a $2 million commercial property.

Relief for the commercial property owner must instead come from a deep dive into the assessor's valuation, best performed by the property owner and an experienced property tax professional working as a team. What follows are key stages for preparing an appeal.

1. Understand and observe all filing deadlines.

Every state has a deadline for starting the appeal process. If a taxpayer misses that deadline, they lose the right to appeal. In some states, after paying their tax, a taxpayer might be allowed to file for an abatement sometime later.

It is important to provide the property tax professional with relevant information in sufficient time to analyze it before filing the appeal. This is a challenge in many cases, such as when the taxpayer receiving tax notices is out of state and their advisor is local. Contacting the advisor before tax notices go out can provide a head start, often enabling the advisor to find the property's taxable value before the notice arrives.

2. Critically analyze the assessment basis.

By itself, a substantial value increase does not qualify as a reason to appeal. Often, the assessor will justify the increase based on the general market strength shown in substantially rising prices. The taxpayer must ask, is this for the entire county, or for this specific type of property in this specific location?

A recent example illustrates how assessors' generalizations can overstate an individual property's value change. As our firm appealed a client's assessment in an expensive resort area, the local newspaper quoted the assessor stating that prices had increased 50% or even more. Available sales of comparable properties all occurred at least a year prior to the valuation period, while one was near the valuation period.

The assessor trended the earlier sales to the valuation period by making a 50% adjustment to each sales price. However, our team compared the most recent year-ago sale with the current sale of a comparable property in the same location, showing that the price per square foot only went up 14%. It was clear the 50% increase was a mass appraisal number covering the entire county, while prices in the subject property's submarket increased at a much slower pace. This deep dive yielded results in the appeal.

3. Analyze the assessor's comparable sales.

Most jurisdictions require assessors to value the fee simple estate, the real estate alone. Assessors have attempted to debate what this means, but what it clearly does not mean is a sale price based upon the income generated by a lease. Nor can the taxable value be based on the success of the business operated from the property.

Simply stated, fee simple value must be limited to the real estate, not the business. When applying this to an owner-occupied property, this means a fee-simple buyer would be purchasing a vacant property. Value is based on the price at which a willing buyer would buy, and a willing seller would sell, the property. And in the sale of an owner-occupied property, there is no lease.

Often in this situation, the assessor will nevertheless use the sale of a leased property as a comparable. It is not comparable, because the buyer is buying the income stream from the lease, not just the bricks and mortar. Moreover, the rent seldom reflects current market rent. Possibly the lease was signed when rents were higher than today, the lease escalated rents automatically, or the landlord agreed to build the property according to the tenant's specifications and increased the rent by the amortized cost. Every lease is unique. The sale of a leased property is simply not the same as the sale of a property without a lease.

While examining income properties within the assessor's comparable sales, be sure to analyze the income's source. Taxable values of income-producing properties are based on income derived from the real estate and not income derived from other sources.

A hotel buyer, for example, is buying not only the bricks and mortar, but also the flag or brand, and the hotel's reputation. These are intangibles included in the acquisition price. However, intangible value is not subject to a property tax.

Another example of this concept is seniors housing. Seniors housing has numerous profit centers beyond rent for the room. It may have a beauty shop, a physical therapy center, a recreation facility such as a bowling alley, special medical services and many other offerings. The resident pays rent, but also pays extra for the many services. For property tax purposes, the income used to determine value must be separated between business cashflow and income generated from the real estate.

Property tax in the current environment can indeed present a challenge, but it need not be overwhelming. The taxpayer must analyze the assessor's value in depth to find factors that would result in a successful appeal. It may start with sticker shock over the assessor's notice, but an experienced tax professional's analysis can level the playing field between the assessor aggressively pursuing increased funding and the property tax owner looking for tax relief.

Not long ago, assessors' student housing properties valuations generally struggled keeping pace with the rising market.College enrollment was high, rent growth outpaced expenses and student expectations lined up with most newer facility amenities. However, the COVID-19 pandemic and its fallout changed the game.

Property taxes are often the single highest expense on a property's profit and loss statement. When market changes make student housing less profitable, the tax burden should not be allowed to remain high. When this occurs, the assessor's property valuation needs to be challenged and reduced.

Projecting Income:Look Forward, Not Back

Many jurisdictions assess student housing properties' value using a cost approach.A computer system estimates the cost to build the property new, then deducts physical depreciation based on the property's age. Due to skyrocketing construction costs, those depreciation deductions are outpaced by base cost increases. It is common to see cost-based values increase despite struggles facing the real estate market. Owners can combat increases by appealing the assessor's value.

When a student housing property owner files an assessment appeal, the appeal review board often evaluates the three prior years' operating income. This allows the appeal board to develop an income model intended to represent stabilized operations. Then the net income is capitalized, producing an estimated market value. When the market rises and rent increases, looking at the past three year's performance is probably a favorable method for taxpayers. However, in a flat or falling market, determining value based on past success proves unfair. Property values' steady upward trajectory, by and large, has stalled out given the gut-punch of 2022 interest rate hikes. Capitalization rates have risen along with the interest rates, though it becomes difficult to see clearly because sales transaction volume slowed to a trickle. Sellers would rather sit on their property than swallow the loss the current market forced on them.

For student housing specifically, it is not uncommon for brokers to cite 15% to 20% market value declines from early 2022 to early 2023. In addition to general market woes, some developers expect college enrollment to drop in the near future due, in part, to fewer students graduating from high school.This will make leasing more difficult and put downward pressure on rents and occupancy. Falling rental income should be taken into consideration by the board or tribunal hearing a property tax appeal.

Projecting Expenses: The Compounding Costs of COVID

Waves of new development during the late 1990's and mid-2010's saw student housing units grow exponentially.At the time, they were state-of-the-art facilities with all the amenities a student could desire. For some, common areas evolved from utilitarian waiting rooms to shared workspaces or workout gyms.For others, bathrooms were no longer shared with a full suite, but only a single roommate.

When the property's design fails to meet changing tenant expectations, that produces functional obsolescence. Many boom-time properties now suffer functional obsolescence.Worrisome trends that predated COVID-19 have been fast-tracked by the pandemic, becoming major problems.

Most people, including future college students, were quarantined for months and developed new tastes and behaviors. Student tenants are not as tolerant of sharing a bathroom with a roommate. One-to-one bathrooms are no longer a luxury in most markets, but trying to retro-fit a property to achieve the best bed-to-bath ratio often fails the cost-benefit analysis. When a design deficiency can't feasibly be corrected, it is known as incurable functional obsolescence.

Online shopping became a near-necessity during quarantine, reshaping our consumer habits long-term. When a building full of button-clicking students receives more Amazon boxes than envelopes, there better be package lockers or another delivery management system to handle the volume. Maybe some unutilized common area space presents an easy opportunity to convert, making this type of obsolescence curable. Even so, the cure does not come without landlord expense.

Not all new expenses involve obsolete building design. New cleaning protocols originated during the pandemic but have not receded with the COVID case count. The "janitorial" line item has swollen, further narrowing landlord margins.

Even if the building is clean, it may not be tidy. Kids who were forced to stay home for meals tend not to go out as frequently. They order-in, and they party-in, too. That creates a lot of trash. Kids do not appreciate having to haul trash down a flight of stairs or ride with it down an elevator. Trash chutes appease them, but not if the building doesn't have one.

Rising operating costs are not all associated with COVID. For example, HVAC systems that use a coolant being phased out by new regulations will have to be upgraded to comply. Also, insurance, payroll, and other outside service costs have increased with general inflation.

Increasing operating expenses drive down a property's net income and should be accounted for by tax appeal decision-makers.

Question the Assessor's Valuation

When property owners appeal their assessment based on a drop in income, "bad management" becomes the common refrain heard from assessors. This implies the property is worth more than the income indicates, because it has been poorly operated. Sometimes this is true, but if a property suffers lackluster performance caused by unavoidable market changes, the assessment should account for that. Taxpayers would be wise to seek seasoned property tax counsel for advice as to what relief may be available.

The wrong method could leave owners with bigger bills than they should have.

Because industrial properties vary in design and function, not all valuation methods approaches apply to every property. When assessors choose an unsuitable method that inflates taxable value, the taxpayer's best appeal strategy may be to show flaws in the appraiser's approach by explaining the appropriate appraisal methodology.

Industrial properties are typically designed for a specific owner's use in manufacturing, distribution, research and development, or heavy industrial activities. These include standalone flex buildings, multiuse industrial complexes, high-tech facilities, steel mills, timber mills and other subtypes.

The basic valuation premise for property taxation is to determine what the property would sell for in an open-market transaction between a willing seller and willing buyer. Most buyers and sellers in the industrial market would have a thorough understanding of a property's best use before transacting a sale, but an assessor with a limited perspective may treat all industrial real estate as having uniform valuation characteristics.

Taxing authorities often overlook appraisal principles, that if properly applied would reduce the market value of industrial properties. Taxpayers should review their assessments to determine the assessor's valuation approach and evaluate if the appropriate input data was used and the calculations reflect the appropriate adjustments to value.

The appraiser must consider the highest and best use of the property when selecting the appropriate valuation method, considering what is legally and physically permissible and financially feasible for the property as of the valuation date. They will use one of three primary appraisal methods, which are the cost approach, sales-comparison approach, and income-capitalization approach.

Cost Approach

The cost approach is based on theory of substitution, would a prospective purchaser buy this property at a depreciated value or simply build a new facility? Using this approach, an appraiser determines the cost to build a new facility less all forms of depreciation.

A willing buyer would consider not only physical depreciation, but the property's functional operation and any external forces limiting its use. External or economic obsolescence are forces outside the property owner's control, such as government restrictions, consumer demand, or the availability of a raw product or steady labor force.

Functional obsolescence is value loss due to physical or functional deficiencies, such as an outdated building design, inefficient production layout, inadequate infrastructure or outdated equipment.

Most assessor cost models stop at physical depreciation and ignore external and functional obsolescence. They simply add up the component costs of the building, land, and equipment.

This typical cost model fails the "willing seller and willing buyer" test because a potential buyer is not going to evaluate a manufacturing facility by tallying the value of the property's components. A buyer will focus on output capacity, available raw product, available labor, and the market for the product. How many widgets can the facility produce as of the assessment date, and at what cost?

Thus, the often-missed analysis in the cost approach is to really look at theory of substitution. Would a new facility with new equipment and a better layout have higher production capacity? An appraiser should not simply reproduce the same equipment for the cost model if modern equipment offers benefits such as reduced labor, higher speed, or increased output. The appraiser must know the industry and the equipment capabilities of both the older, existing equipment and the new, technically advanced equipment.

Comparing apples to apples in the cost model seldom provides a reliable value. An example would be a plywood and veneer mill built in the 1960s that an assessor values by counting costs invested in the various add-ons and rebuilding of equipment. Simply trending the values would not capture rebuilt equipment or used-equipment purchases, overvaluing the equipment.

The appraiser should determine the cost for the widget capacity of the present facility as of the date of value and compare that to how many widgets a new facility could produce and at what cost. Next, the appraiser should consider all three forms of depreciation to arrive at the proper taxable valuation. Omitting these steps in the cost approach will overvalue the property and overtax the owner.

Sales-Comparison Approach

The sales-comparison approach compares the subject property with property that is similar to the subject. Appraisers often use this approach for single-use real estate with a high degree of market transferability such as warehouses and distribution centers. The appraiser must consider not just the comparable property's floor plate, type of construction and square footage, but also its location, market access and number of loading docks.

The sales comparison model is difficult to use for properties that lack a ready market or that suffer from external or functional obsolescence. Consider the research and development campuses built in the 1980s to house all a company's processes, from research to manufacturing and distribution. Most manufacturing and distribution moved overseas in the 2000s, leaving these campuses half empty.

Adapting these buildings for reuse depends on land-use restrictions, the market for alternative uses, available labor, and the functionality and cost feasibility of conversion. When searching for comparable sales, the appraiser should evaluate what is legally permissible and financially feasible and weigh external forces that impact demand and functional use. After selecting like-kind properties, the appraiser must adjust the sales to reflect the reality of the subject property, or it will be over-valued.

Income- Capitalization Approach

The income-capitalization approach estimates a property's value based on the income it generates, using a capitalization rate from comparable sales or market data. This approach is used for properties with long-term tenants or stable cash flows. The appraiser is to look not at what the value is to the owner, but at what a willing buyer would pay for the property. This requires carefully selected market data and proper adjustment to reflect market value.

Clearly, appraising industrial properties requires a thorough understanding of their unique characteristics and uses, as well as an awareness of economic and functional obsolescence. A knowledgeable appraiser can help the taxpayer ensure their property assessment is consistent with the marketplace to avoid overpaying property taxes. 

Cynthia Fraser is Co-Chair of Foster Garvey's Litigation Practice and the Oregon Representative of American Property Tax Counsel (APTC). The firm is the Oregon member of APTC, the national affiliation of property tax attorneys. Lisa Laubacher is a CMI and Director at Popp Hutcheson PLLC, the Texas member of APTC.

Here are the steps to start an informal discussion with the assessor that may lead to a tax reduction.

Owners of large commercial real estate portfolios typically have internal staff to deal with assessed property values and the resultant taxes on a regular basis. But what about owners of small or medium-value properties?

How can a taxpayer, without knowledgeable staff or outside assistance, determine whether their assessment is fair or if they should seek an adjustment? And if seeking a reduction seems appropriate, going it alone through discussion with the Assessor may be productive.

Any such informal review or discussion should be the result of careful consideration and preparation. The following points are essential in that review and will help the taxpayer build and present a strong case for a reduced valuation.

Getting started

A government representative, usually the county collector, issues a property tax bill based on the value the county assessor has placed on the taxpayer's real estate. The property owner may launch an appeal to contest that assessed value. However, in many states, the tax bill arrives after the due date for appealing the assessor's valuation.

Owners should review their property's assessed value each year. Begin the process as soon as the assessor posts new values to its website, usually in January. If there has been no increase, the assessor won't provide a statement of the assessed value until it is included in the tax bill sent later in the year, at which time the appeal period will have ended in most jurisdictions.

If the assessor's value opinion is less than the taxpayer believes it should be, they can simply pay the taxes due and plan to revisit the assessor's website the next year. If the assessor's opinion is approximately the same or greater than the property owner's value estimate, however, the taxpayer should investigate further and consider whether to seek a meeting with the assessor followed by an appeal.Some jurisdictions (states) have cycles of more than one year so the valuation for tax purposes may extend beyond the first year's valuation date into the following year or years.

Know dates and procedures

Missing the filing deadline is fatal to any potential relief from property tax. Most jurisdictions will notify taxpayers of an assessment increase and provide the timeline for review on appeal. Even when an assessed value is unchanged from previous years, the owner may still deem the assessment to be excessive and worth appealing.

While the owner is entitled to appeal an unchanged valuation, in most states there is no obligation for the assessor to notify the owner of altered assessed value—at least not until the time for appeal has run out.

Learn the lingo

Appraisers, assessors, attorneys, real estate brokers and other professionals dealing regularly with property tax matters frequently use words and phrases unique to the valuation of real estate. These terms and their interpretations fill volumes of legal writing and serve as linchpins in court decisions and business transactions.

Taxpayers who familiarize themselves with valuation lingo will be better prepared to discuss value with assessing officials. (For a list of key terms and definitions, see Property Tax Terms.)

Call the assessor

Most assessors or members of their staff will meet for informal discussions prior to, and sometimes during, a formal appeal. Call to request a meeting and provide the assessor with a heads-up about which property or properties will be discussed. This will save time by ensuring the assessor's team has an opportunity to review their work and supporting data for an informed discussion.

The meeting will be informal. The assessor or representative will be prepared to defend the assessed value. It is important for the taxpayer to realize that value was probably, in whole or in part, generated by a computer.

Bring relevant materials and documents in duplicate so that a set can be left with the assessor's office. They may not want to accept them but give it a try.

The informal meeting is often the property owner's first opportunity to show the property was overvalued in the assessment. The owner will need to support their proposed value using at least one of three standard approaches to valuation, which are cost, income, and sales comparison.

Of these, a non-appraiser is most likely to apply a sales comparison. While adjustments may be necessary in the application of a comparative sales calculation, it is less complex and dependent on expert analysis than either the cost or income approach. For the non-professional, the fewer adjustments required, the better.

For example, developing an informed opinion of a single-family home value based on the sale of two nearly identical homes on the same street does not present a great challenge. The further away the sales occur and the more they differ from the subject property, however, the greater the challenge and the less reliable the sales become as comparatives.(comparables is the term appraisers use)

The cost approach, unless it reflects the actual and recent construction cost plus the land value of the property in question, requires the application of factors best left to professionals in the valuation field. The income approach is even more complex, drawing a value conclusion not from actual rent at the subject property but by applying market rents to the initial rates of return that provide the basis for prices paid for acquisition of similar properties.

Like the cost approach, income-based valuation is best left to the experts. However, an owner who owns and invests in income-producing properties may very well be able to show a lower valuation using their own formulas learned through experience and practice. If such be the case, present that opinion and back-up information to the assessor.

Escalate as needed

Assuming informal discussions fail to achieve a value reduction, the taxpayer must file a timely appeal or accept the assessor's opinion. Filing requires the owner to know and conform to the prescribed filing date. The taxpayer must also decide when or if they will engage an attorney to pursue the appeal.Jurisdictions vary on the point at which an attorney is required to pursue a formal appeal.Filing dates and the required point to seek expert assistance are critical and vary by state. It is up to the taxpayer to learn these dates for their area, and to act while there is sufficient time remaining to file and win an appeal.

Property Tax Terms

A general understanding of real estate valuation terminology is intrinsic to discussions with the assessor.

Assessed Value: The taxable percentage (usually set by statute) of the assessor's opinion of fair market value.

Fair Market Value: What a willing and informed buyer would pay to a willing and informed seller. Fair market value is not value in use, sentimental value, or personal value unique to the owner.

Deferred Maintenance: The property needs a paint job, roof replacement or similar repairs, in which case the cost of correcting the deficiency is deducted from the property's value.

Obsolescence: A curable problem of which the anticipated cost to cure is deducted from the value of the property without the problem.

Incurable Obsolescence: A problem on the property that can't be cured at any cost, such as loss of parking or loss of access due to a road project.

Owners can use the hurting office market to their benefit.

It's no secret that the real estate market suffered in the COVID-19 pandemic, and no property type was hurt more than office buildings. While hospitality and entertainment properties nearly suffocated, their post-quarantine rebound has been impressive. Real estate professionals who projected multiyear recoveries for hotels and movie theaters back in 2020 and 2021 have been proven wrong. Offices, however, have not been so lucky.

The pandemic hastened a work-remote trend that was already leading office tenants to downsize their spaces, and the shift soon stifled any countervailing influx of tenants that landlords could have relied upon to stabilize their properties. Tenants have also realized that if they are using remote workers anyway, they can employ overseas workers for significantly less pay and with zero office requirements. As a result, many landlords have seen their occupancy and rents drop. Some have been able to maintain rent levels by giving away major concessions or tenant improvements. Some have not.

Falling rents and occupancy deflate property values. A trending loss in property value means it's time to review the tax assessor's value of an organization's property, and to challenge the assessment if appropriate.

Why care about the office market?

Perhaps your company owns or leases a building that it fully occupies. The difficulties of the post-COVID office market are unfortunate, but they don't impact you. Your building is full.

Wrong.

Most jurisdictions value the fee-simple property rights of an income-producing property. Basically, that means valuation is based on capitalization of the income stream that the property would produce if leased at market levels.

This is true for owner-occupied offices, too. If the property is leased after a build-to-suit or sale-leaseback transaction, those typically above-market rents or extended terms are irrelevant to a fee-simple analysis.

If the assessor values a property for property tax purposes based on fee-simple property rights determined using a market-derived income stream, and if current market rent levels and occupancy rates are dropping, then the property's tax assessment should be dropping, too – even if the building is full.

Inflation and interest rates

The problems specific to office buildings are not the only ones for the taxpayer to consider. Inflation has made it more expensive to do just about everything, and that includes operating an office building. Payroll, utilities, insurance: All of these costs are steadily rising, even for owner-occupied buildings.

Local governments are feeling the squeeze, too. Their budgets often depend largely on property tax revenue. When inflation reduces a budget's effectiveness, there will be pressure on the assessor to find ways to dig deep and expand the tax base.

The Federal Reserve's solution for inflation was an aggressive program of interest rate hikes over the course of 2022. The rising cost of money has a significant impact on capitalization rates, which investors and appraisers use to value a property's income stream. The higher interest rates go, the higher cap rates go. The higher cap rates go, the lower property values go.

Where are the sales?

The problem with attempting to demonstrate the impact of rising interest rates on cap rates is the sheer lack of sale transactions. Banks aren't bullish on office lending right now, and sellers would rather hang on to a struggling property than sell it for less than it would be worth if stabilized. How can a taxpayer know what kind of price an office building's income stream will bring if office buildings aren't selling?

This is where the assessors will use sales of office properties to support high values. In many markets, an office property that sold in 2021 is worth significantly less today. But today, there often aren't enough comparable office sales occurring to prove declining value. Assessors can point to the most recent office sales, albeit a few years old, and justify their value on a comparative basis.

What those older sales do not reflect is the more recent plague of dropping rents and rising vacancy. The taxpayer needs a way to discount those old sales and prove what the value is today, not three years ago.

Is it time to appeal?

Consider your office property. Could it sell today for the price it sold for two or three years ago? Probably not. Maybe the organization recently bought it, or even built it, for more than it could sell for today. This is not an uncommon problem anymore.

In many jurisdictions, the best way to challenge an office property's assessed value is by using the income approach. If the building were leased at market rent, what would that look like? If the building were occupied at current market occupancy levels, how much vacancy would there be? The taxpayer may need to talk to a broker or two to answer these questions.

The taxpayer may need help to turn market data into a viable appeal strategy. A property tax professional can prepare a fee-simple income approach and help estimate the current market value of the property. In the present situation, there is a good chance property tax relief is available, even if the office building is fully occupied.

Tax assessors are quick to increase self-storage property valuations when market conditions are strong, but they're much slower to adapt to factors that negatively impact an appraisal. Here are some items to understand and present as evidence when making the case to lower your tax assessment.

Until recently, many self-storage owners had grown accustomed to strong market conditions that resulted in steady increases to their property-tax assessments. However, now that industry fundamentals have begun to cool nationwide, they're finding that assessors don't recognize a downturn in property valuation nearly as quickly. To help defend against excessive valuations, you need to educate yourself on market trends and the impact of rental rates, capitalization (cap) rates and sales transactions on facility value.

For a decade or more, the self-storage industry has seen exponential growth in demand that ushered double-digit increases in rental rates and decreases in vacancies. Tax assessors were quick to account for this growth, pushing facility valuations higher. But now the major metropolitan markets are starting to report stagnant rates and mounting vacancy. At the same time, interest rates are rising, which depresses real estate prices and property values. Assessors should—but may not—recognize these conditions when calculating a market value.

In anticipation of an assessor's unrealistic interpretation of market conditions, self-storage owners should be ready to combat inflated assessments. You can prepare by learning your local assessment date and arming yourself with market data relevant to the valuation period.

When to Press the Assessor

Assessors use various tools to determine a property's market value, but there's subjectivity in how these resources can be used. Self-storage properties are traditionally evaluated based on their income-producing potential via a pro forma. An analysis begins with a study of market rental rates, typically derived from surveys and commercial real estate publications. Assessors will then estimate potential income using financials at comparable properties, or draw quoted rental rates from a facility's website.

As a taxpayer, you should vigilantly analyze an assessor's income-based valuation, specifically regarding the initial rental rate used. Assessors often overestimate potential income based on inaccurate survey information or by applying a rental rate that's associated with an inappropriate property classification. For example, they may classify a property as "superior" based on its location or perceived quality of construction. In reality, the facility could be "average" based on the actual rents achieved.

Potential vs. effective income is an important distinction property owners should be quick to flag. Assessors often overestimate potential rent and fail to recognize a proper vacancy factor. If helpful, you can present profit-and-loss statements as well as rent rolls to provide a true understanding of your asset's actual performance in contrast to assumed figures from unreliable sources. Doing this can lead to a substantially lower income-based assessment.

The assessor's final step in an income-based valuation is to apply a cap rate to net operating income. A cap rate is the initial, annual rate of return a buyer would receive on a property's purchase price. It measures risk and is tied to market dynamics in an ever-evolving economy. The lower the cap rate applied in an income pro forma, the higher the indicated value will be.

Assessors will always err on the side of aggressiveness by choosing low cap rates from the market. In fact, they usually derive these rates from market sales and secondary surveys, using data that often goes unvetted or is simply inaccurate. You should press appraisers to show support for the cap rates they use. Scrutinize sale data and highlight differences between your facility and the property that sold.

Be prepared to combat superficial survey information with real-world examples of how rising interest rates, inflation and other economic factors increase the risk associated with acquiring a self-storage property. Perhaps the most effective strategy for achieving a reduced assessment is to fight an assessor's aggressive cap rate with data that reflects the true risk associated with your property.

Market Value and Timing

In most jurisdictions, "market value" is tied to the concept of a willing buyer and seller. Self-storage owners should be mindful of how a purchase price will affect their valuation, as assessors will always assume that purchase price equals market value. Some states mandate sale-price disclosure to the assessor's office while others abide by non-disclosure rules. Regardless, assessors will adamantly pursue a property's sale price to support a tax assessment.

The timing of the purchase is important in relation to the assessment date. For example, if the state or county valuation date is Jan. 1, a sale subsequent to that date may not influence the valuation for that assessment period. Conversely, the basis for the assessor's valuation will likely be a sale or sales that occurred prior to the assessment.

You need to remind assessors that a sale price doesn't always represent a property's true market value. Examples of this are 1031-exchange transactions or portfolio acquisitions with prices allocated to component properties.

Remember, too, that assessors are typically tasked with finding a property's fee-simple market value. Facility purchases often include business value that is intangible and not taxable to the fee-simple estate. So, be prepared to describe the nuances associated with a sale to any assessor who makes value assumptions based on recent purchase prices.

Appraisals aren't an exact science, and assessors often turn the subjectivity inherent in the valuation process to the taxpayer's detriment. Self-storage owners and investors should be vigilant in monitoring the marketplace, their property's economic performance and transactions within their jurisdiction. This will arm them with the relevant data needed to combat aggressive valuations.

Blas Ortiz and Andrew Albright of Popp Hutcheson PLLC offer tips for decreasing liabilities.

For property tax purposes, commercial property owners concern themselves primarily with the administrative appeals and real estate taxes, while often ignoring corresponding business personal property. By doing so, those owners forfeit many tax-saving opportunities when complying with state filing requirements for and appealing taxes on business personal property. Since the majority of states tax business personal property in some form or fashion, commercial owners should follow several tax saving tips when preparing annual compliance filings.

Conduct the personal property test

Commercial property owners must realize that personal property tax savings begin during the compliance phase when formally rendering personal property value to the local assessor. This typically starts with what is reflected on the fixed asset list. In many states, taxable personal property represents anything that's not real estate, is income-producing, and not considered intangible. Generally speaking, the primary test to determine whether an asset is personal property rests on the answer to the following question: If the asset were removed from the real estate, would the real estate be irreparably damaged? A yes answer means the asset would likely be real estate. Removing real estate line items becomes crucial. Otherwise it amounts to double taxation if an asset more appropriately characterized as real estate also gets taxed as personal property. Properly delineating each asset line item as personal property or real estate is a vital first step to lowering personal property taxes.

Classify assets properly

Taxpayers will find that proper asset classification holds another key to decreasing tax liability. Certain assets may be depreciated on shorter age-life schedules if described and classified properly when reported to the business personal property assessor. The North American Industry Classification System, along with various cost estimator and valuation services provide general classification and age-life guidance when finding acceptable depreciation schedules for a company's fixed assets. A local property assessor or state department of revenue may also provide personal property classification and depreciation schedules, though it may not always be clear how that information was derived. If applicable, include potential obsolescence factors that may affect the final opinion of value. Many states periodically audit tangible personal property returns, so be prepared to explain any deviation from the assessor's depreciation schedules and the inclusion of obsolescence or inutility factors.

Understand depreciation

Commercial owners must also keep in mind that the net book value of assets on a fixed asset list, although pertinent for accounting purposes, is not considered when calculating ad valorem property tax liability. Accounting guidelines allow for depreciating assets differently than property tax depreciation. For accounting purposes, an asset is usually depreciated at a set amount each year over the asset's total typical life until it depreciates to $0. Those items often remain on the books even if the assets have been disposed of because they no longer have accounting value and, therefore, do not impact the overall book value.

However, for property tax purposes, assets are never fully depreciated to $0 value. Instead, they are depreciated to a residual value anywhere between 5 percent to 20 percent of the original cost. That being the case, when reporting assets, the preparer may look to the local assessors' asset depreciation schedules to determine each asset's depreciated value based on the asset's current age. As a corollary to that, the preparer should also confirm whether any disposed or "ghost assets" remain on the books, and if so, remove them from the fixed asset list before rendering.

Consider intangibles

The removal of intangible property continues to be a fundamental step often overlooked when reviewing fixed asset ledgers for the purpose of filing self-reported personal property renditions and returns. In certain states, items such as software and warranties are nontaxable. While being mindful of each state's specific guidelines for intangible property, consider embedded intangibles which might be identified within an asset's total capitalized cost. Removing intangible personal property line items, in accordance with state and jurisdictional laws and guidelines, can preserve potential front-end tax savings for many years.

File properly and on-time

Knowing when to report is just as important as knowing how to report. To avoid late filing penalties, be aware of the filing requirements and methods for each specific jurisdiction, such as postmark and submission deadline rules. Be aware that many assessors and appraisal districts are shifting to electronic filing vs. traditional hard copy filing. Additionally, be certain to properly identify the property by identification number, owner name and address.

Business personal property should not be ignored when determining a company's property tax liability. Following consistent and informed methodologies when filing tangible personal property compliance can create viable tax savings opportunities year after year.

Developers should understand the property tax implications before attempting to repurpose buildings in downtown Washington, D.C.

With office vacancy rates in the District of Columbia at 20% and climbing, officials believe that converting office buildings to residential space is an important component of revitalizing Downtown Washington.

These complex projects pose both practical and administerial challenges, however. For developers, one important consideration of such a redevelopment is its real estate tax implications.

High hopes

District leaders announced earlier this year that they hope to add 15,000 residents to the central business district over the next five years – an ambitious goal. The hope is that bringing residents to live downtown will create a more vibrant neighborhood where people live, work, and dine.

The stark reality is that the District of Columbia has one of the lowest return-to-office rates in the country. Actual occupancy in the D.C. metro was only 43% in mid-April and drops below 25% on Fridays, according to Kastle Systems, which tracks office occupancy. Workers simply aren't returning to Downtown D.C.

While residential conversions may be one piece of the puzzle in addressing D.C.'s downtown woes, converting an office building into a residential property is no small feat. Here are a few important factors relating to real estate taxes to keep in mind when considering an office-to-residential conversion.

Real property tax rates

Real property tax rates in the District vary considerably from residential to commercial real estate. Residential properties, including multifamily apartment buildings, are taxed at a 0.85% rate. The commercial tax rate, which is used for office buildings, is more than double that rate at 1.89% for properties assessed over $10 million.

To the extent a property contains both residential and commercial space, D.C. will apply a mixed-use tax rate based on the pro-rata allocation of residential versus commercial space. Consequently, how the District classifies a property can have an immense impact on tax liability and carrying costs.

Timing of reclassification

A costly misstep would be to assume that the tax rate will immediately change from 1.89% to 0.85% after an office property is acquired for residential conversion. In fact, if there is any commercial use continuing at the building, the commercial tax rate will still apply.

Moreover, the District historically has been inconsistent in its application of when a building should "convert" from commercial to residential for purposes of tax classification. Although the D.C. Code provides a property should be reclassified when there is no current use and the property's highest-and-best use is residential, some assessors have taken a more aggressive approach and argued that the property should not be reclassified until the redevelopment is more than 65% complete.

Property acquisition

An additional hurdle lies in the acquisition process itself. When an office building is acquired for a residential conversion, higher transfer and recordation taxes apply. For commercial and mixed-use properties, the transfer and recordation taxes are 5% of the sale, as opposed to 2.9% for a purely residential building.

The mayor's proposed 2024 budget would allow the higher transfer and recordation tax rate to expire later this year, but the D.C. Council had not adopted the measure at the time of this writing and may or may not allow the higher rate to sunset. Under the current code, there is no exception for the acquisition of an office property that is being purchased for purposes of a residential conversion.

Abatements

Finally, in an effort to spur redevelopment, the mayor has announced her intention to offer tax abatements for office-to-residential conversions that meet certain criteria. At this point, it is difficult to determine the financial implications of the tax abatement program for a specific redevelopment because there is no set formula for deriving the amount of an abatement.

What is known, however, is that there are specific requirements to qualify for the abatements. Among other conditions, these include:

• Affordability. 15% of the housing units must be affordable.
• Location. The redevelopment must be within a specific geographic area.
• Designated contractors. 35% of the construction contract must go to specific business enterprises that have been certified by the District.

These requirements further complicate the already challenging task of successfully executing an office-to-residential conversion.

In short, the real estate tax implications of an office-to-residential redevelopment are highly dependent on the unique facts and circumstances of each case, and the varying tax rates can have huge implications for a property's development budget. A developer considering such a conversion should contact experienced counsel early in the process.

Minnesota Supreme Court affirms decision barring use of airport concession fees in income-based property valuation.

A recent Minnesota Supreme Court ruling requires tax assessors to exclude an airport's concession fees from rent-based valuations for property tax purposes. The case offers a flight plan to lower taxes at many of the nation's transportation hubs, and underscores the importance for all taxpayers to exclude business value from taxable property value.

Every major airfield collects fees from food and beverage providers, retailers, banks and other businesses that provide goods or services on airport property. Concessionaires commonly pay these charges in addition to rent owed for the real estate where they operate. Many of these businesses are also responsible for property tax that passes through to tenants in a commercial lease.

The cases leading up to the March 29 state Supreme Court decision involved two car rental companies that challenged their 2019 tax assessments, claiming the assessor's office had overstated their property values by including the concession fee in its income-based valuation.

High-flying fees

Both Enterprise Leasing Co. of Minnesota and Avis Budget Car Rental pay a concession fee equal to 10 percent of gross revenues in addition to real estate rent for their operations at Minneapolis-St. Paul International Airport. The tax assessor for Hennepin County had historically valued the auto rentals for property tax purposes by including the concession fee in its income-based approach to valuation.

The auto rental companies challenged the valuations on their 2019 taxes in the Minnesota Tax Court. Law firm Larkin Hoffman, which represented both taxpayers, argued that the concession fees are not rent and should not be included in the income approach for property tax purposes.

The rental agencies prevailed in tax court. The court found that the concession fee is not real estate rent and that the county substantially overstated market values by including the fee in its calculations. Correcting the assessor's calculation reduced Enterprise's value from $34.873 million to $21.107 million, or 39 percent less than the initial assessment. Avis' property value dropped 39 percent as well, from $20.565 million to $12.497 million.

The county appealed the tax court's decision to the Minnesota Supreme Court, arguing that the concession fee is rent that must be used in the income approach. The Court affirmed the lower court's decision, however, holding that "the concession fee is not rent for purposes of the income approach."

Fee-simple principles

The rental agencies' case stood on fundamental precepts of fee-simple valuation. Minnesota is a fee-simple property tax state, meaning valuations for property tax purposes must value all property rights as though they are unencumbered.

Additionally, the leased-fee interest, or landlord's rights subject to contractual terms, should not be used for property tax valuations. Per the state Supreme Court, rents attributable to specific leases are disregarded except to the extent they represent market rent. It follows that business income should not be included in valuations for property tax purposes.

Taxpayers doing business at airports across the country often pay concession fees or other charges based on their revenues or business performance. Many states, like Minnesota, require those same properties to be valued on a fee-simple basis, which should neutralize any impact of business value.

In representing the rental car agencies at all stages of their appeal, Larkin Hoffman stressed the importance of these valuation concepts and how the very definition of a concession requires its exclusion from calculations of taxable property value. A concession is a "franchise for the right to conduct a business, granted by a governmental body or other authority," according to the Dictionary of Real Estate. Accordingly, if a concession fee is a payment for the right to conduct business and not for the right of occupancy, then it is a business revenue.

The county argued that because the rental agencies' concession agreements included the phrase for "use of the premises," then the concession must only be for the real estate. However, the tax court found that the concession fee was consideration for access to the airport car rental market rather than the real estate.

The tax court reasoned – and the Supreme Court affirmed – that the concession fee was not for the real estate because:

Concession fees were also paid by off-airport rental car companies, indicating that the fee is a business revenue rather than rent;

Inclusion of the concession fee in the income approach would inflate the value to 10 times greater than the cost approach, which would be clearly unreasonable; and

Inclusion of the concession fee in the county's income approach distorted other inputs.

It is well established that a fee-simple property tax valuation should exclude business value. Now, Minnesota courts have also acknowledged that when a concession fee is for the privilege of accessing the airport market rather than for the real estate, that fee represents business value.

To prevent erroneous inclusion of business value, and since airports are special-purpose properties, the court gave primary weight to the cost approach. With this decision, Minnesota's highest court has confirmed that concession fees are not rent for real estate and instead represent business value that should be excluded from the income approach.

For taxpayers in any jurisdiction that taxes property based on its fee-simple value, the recent decision is a reminder to ensure that assessors are excluding business value when calculating taxable property value. For businesses that also pay concession fees in addition to rent, the Minnesota case may provide an impetus to learn how those fees affect their own property values. And if those inquiries spur taxpayers to appeal their assessments, then the Minnesota case law may provide a valuable example and support for their arguments.

Three key factors can help owners successfully appeal excessive taxes.

Those are the assessments on a mobile home community south of Austin, Texas, that in just two years increased nearly 200% in taxable value. This near-doubling rate of annual increase has become commonplace across the state, largely due to three practices tied to appraisal district methodology.

Taxpayers who understand and can show the inherent flaws in these trends will be better prepared to argue for a reduction in their assessments.

Cost or income?

The first factor that has brought significant changes to assessed value in recent years is that county appraisers have largely changed their valuation method from the cost approach to the income approach. Rather than calculating market value by summing up the land value with the value of any onsite infrastructure, some county appraisers are using Freddie Mac and Fannie Mae appraisals to support their value conclusions.

From these leased-fee appraisals, the appraisers attempt to derive income assumptions including site lease rates, utility reimbursements, and expense ratios. This is problematic because often the appraisals they are sourcing include more than the real estate value alone and may not reflect actual sales occurring in the marketplace.

Homes or vehicles?

The second factor that has resulted in changes in assessed value is that assessors value recreational vehicle (RV) parks and mobile home communities, two fundamentally different property types, using the same income model. This presents several challenges.

Typically, both community types lease lots for placement of tenant-owned units, but the similarities end there. The amount of business value differs between the two property types.

Established RV parks such as Yogi Bear's Jellystone Park Camp-Resorts, with name recognition and amenities, draw significantly more visitors than local parks that lack name or brand recognition. An established RV park could be compared to a Marriott or Hyatt hotel, reflecting their tenants' short-term rentals and because they inherently include untaxable business value when sold.

On the other hand, a mobile home community might be compared to an apartment property with longer-term tenants and minimal, if any, business value beyond real estate. Mobile home communities have little need for name recognition or amenities when the tenants own their homes. Due to the cost of moving a unit, it is a challenge for mobile home residents to move, thus leading to higher stabilized occupancy and minimal turnover.

Infrastructure also varies between the two property types, with mobile home communities requiring more substantial utilities than RV parks. These significant differences confirm the importance of using separate models to assess the market value or taxable value of the two asset classes.

In the spotlight

The third factor that has affected assessed value is the increasing attention county appraisers have given to these two property types. In recent years, investment in mobile home communities and RV parks has risen in popularity nationwide as investors seek reliable and steady cash flows. Additionally, the supply of well-located mobile home parks has dwindled as cities have grown and changed the highest and best use of land in their path. This has increased land values, resulting in higher assessed values – a trend that will continue in the future.

As county appraisers rework their models for these asset types, they often create discrepancies between how a property has been assessed in the past and what is physically on the property, namely the total number of units and the mix between mobile home sites and RV sites. Many of these discrepancies likely still exist going into 2023, which may provide an opportunity for property owners to contest their assessed values and argue successfully for a reduction.

Historically, RV and mobile home park owners have not felt the need to protest tax assessments as often as owners of other commercial real estate asset classes. That may be changing in 2023, making this the first year many owners file a protest on their assessments.

A guide to effectively challenge and reduce bloated tax valuations.

Nobody enjoys paying property taxes, especially when a property is over-valued. Single-tenant, net-leased properties seem especially prone to inconsistent and unfair assessments.

But challenging those valuations can be exhausting in a time when assessors are fearful and obsessed with the dreaded "Dark Store Theory." They vehemently oppose using sales of vacant properties to value their jurisdiction's store, the one with the full parking lot.

How can the taxpayer shut down the hype and bring the assessor back to the table for a reasonable negotiation? Well, that depends. Here are essential points to consider in forming a protest strategy.

Know Your State's Value Standard

Common sense tells us an appraiser must know what they are valuing before they value it. Yet, the failure to identify the property rights being valued often causes disagreement and confusion in tax appeals. These misunderstandings commonly hinge on the difference between fee-simple and leased-fee value.

The fee-simple estate of an income-producing property is essentially the value of the net income stream based on market-level rents, expenses and other variables. If the property benefits from a long-term, above-market lease, that revenue is irrelevant to the fee-simple value.

Before I finished that last paragraph, my phone rang. The caller was outraged because an assessor revalued his property at its recent purchase price. The property was clearly not worth what the taxpayer paid for it, he said, because the price was based on a net lease.

Maybe. Maybe not.

Before the caller purchased his property, it was exposed to the open market for willing buyers to make offers to the willing seller. The competitive process culminated in an arm's-length sale reflecting market value. How is that not what the property is worth?

That brings us to the second value standard, the leased-fee estate, which is essentially the value of the income stream from the actual lease in place. The caller's purchase price was exactly what the property's leased fee was worth.

So, before getting angry with assessors for relying on leased-fee sales, taxpayers should learn which property rights their state is valuing for taxation. If the state values the leased-fee rather than fee-simple estate, the taxpayer may not have a basis to complain.

Sales Won't Sell It

The "Dark Store Theory" is the term assessors apply to the use of vacant property sales in valuing occupied properties. From an appraisal theory standpoint, only vacant sales are appropriate for valuing the fee-simple interest in a leased property, because sales of leased properties exclude the right of occupancy, an essential right within the fee-simple estate.

This appraisal standard should be a boon to taxpayers challenging inflated assessments on leased properties. It's great to be right, but there's a problem. Using vacant buildings to value occupied buildings is a very tough sell to a tax panel, appeals court or other arbiter. The decision-maker's gut will turn.

Huge tax reductions have been achieved using vacant sales, so it can be done. It is spectacular in the moment, but legislatures and higher judicial bodies are likely to respond negatively. Legal victories that inflame assessors and politicians are not stable long-term solutions.

What About The Cost Approach?

Cost doesn't equal value, but sometimes estimating a newer property's replacement cost less depreciation is a good test of whether an assessment is reasonable. A cost calculation may support a value reduction, so it is worth considering in a protest strategy.

A common problem with the cost approach in net-lease tax appeals is the conspicuous difference between cost-based value conclusions and those based on income or comparable sales. If the property can't be leased or sold at a rate of return that supports its depreciated cost to build, the numbers will not line up, because there is obsolescence to account for. The decision-makers that hear tax cases dislike big obsolescence deductions, especially if the taxpayer quantifies those deductions using vacant property sales.

Many assessors use cost systems for mass appraisal, so understanding how the local system was developed is helpful. Sometimes assessors use base cost data purchased from third-party services and then tweak that information before entering it in their own systems. Tweaks can involve stretching out the useful life of properties in the source data to unreasonable lengths, or bumping default grades used for certain building types from, say, "average" to "good." Little modifications add up and may be solely to increase tax revenue.

Market Rent Is King

In a fee-simple system, a good way to approach a net-lease tax appeal is with the income approach. All net-lease properties are leased, meaning they produce income. It isn't hard for an assessor to convince a decision-maker in a tax case that the property should be valued by capitalizing its income.

The most crucial element of a fee-simple income approach is the market rent. To win a net-lease tax appeal based on income, the taxpayer must prove this one thing.

"But there is no market rent for my property type," the taxpayer says. "What am I supposed to use for rent?"

That's a real issue, because net leases almost always seem to be the product of a build-to-suit or sale-leaseback transaction, with no regard for the local market. So, how can the taxpayer prove market rent?

Go for Broker

Consider this: Commercial real estate brokers are opinionated about their markets. They know rent because it's how they feed their families. They can speak with credibility about the rent a building would command on the open market. Nobody knows market rent better, and they make powerful rebuttal witnesses who keep any off-base testimony by the assessor in check.

A broker can also be a helpful resource for the taxpayer's appraiser. They can point to meaningful, sometimes hidden information.

The combination of an appraiser's formal analysis with a broker's testimony about realistic market rent is potent and convincing evidence in a tax appeal.

Let's Be Reasonable

As the taxpayer's protest strategy takes shape, subject it to the old "reasonable man" standard.

Would a reasonable decision-maker look at the taxpayer's long list of vacant properties, compare it with the subject property that is open and thriving, and feel good about reducing the value?

Would a reasonable decision-maker look at an income approach based on a reasonable expectation of market rent for the subject building and feel good about reducing the value?

Pushing for the former may be zealous advocacy, but appearing unreasonable to both assessor and decision-maker is unhelpful. And even a victory, if it smells like overreaching, risks a legislative response. Resolving a net-lease tax appeal using a reasonable income approach is a superior long-term strategy.

Legal covenants often cause excessive property taxation for mall owners that are looking to redevelop.

Repurposing malls and anchor stores is a popular topic in community development circles, but legal restrictions make redevelopment extremely difficult. Often locked into their original use by covenants, malls and anchor stores are often grossly over-valued for property tax purposes. In pursuing a redevelopment, taxpayers should ensure the properties are fairly assessed and taxed.

Debilitating obsolescence

It is difficult to overstate the plight of malls and anchors. Gone are the halcyon days when the mall was everyone's shopping destination. There is even a website, deadmalls.com, devoted to failed malls. Credit ratings of most anchor store operators have fallen below investment grade. Commentators usually blame the retail apocalypse on ecommerce and shifting consumer spending habits.

COVID-19 exacerbated these trends and mall foot traffic has been slow to recover. Some chains, including Neiman Marcus and JCPenney, filed bankruptcy. Ecommerce volume surged in 2020 and 2021 before tapering in 2022. Ecommerce and brick-and-mortar sales have not yet reached an equilibrium.

One in five American malls have fully closed and remain "zombies" without a redevelopment plan, estimates Green Street Advisors, a commercial real estate analytics firm. A December 2022 Wall Street Journal article describing the "long death" of the White Plains Mall noted there is no shortage of dying malls. The article observed that converting enclosed shopping centers to other uses remains a "difficult feat." Repurposing, while much discussed, has not really happened.

The question is why. The answer relates, at least in part, to legal challenges inherent in changing the property's use.

Tied hands

Any property valuation begins with a highest and best use analysis. A basic assumption about real estate directs that the price a buyer will pay reflects that buyer's conclusions about the property's most profitable use. Competitive forces within the local market shape a property's highest and best use, but that use must reflect practical and legal restrictions.

Many people incorrectly assume that governmental requirements pose the only legal restrictions on use. Zoning ordinances may impose barriers, owners of neighboring properties may object to redevelopment proposals, or there may be other hinderances to changing the property's use.

Zoning limitations pale in comparison to restrictions in recorded easements and unrecorded operating agreements between mall owners and anchor department stores. While zoning may permit non-retail uses, private agreements generally do not.

Malls would be economically unfeasible without department stores and inline stores that symbiotically drive traffic to each other. Generally, anchors own their pads and inline tenants lease space from the mall owner. A typical mall is subject to two levels of private restrictions designed in an earlier day to promote the efficient functioning of the mall for retail stores.

Recorded operating restrictions or restrictive easement agreements (REAs) impact the entire mall and its anchors and are generally binding for 40 years or longer. Typically, substantive amendments to the REA require the consent of all parties, and their economic interests are not always aligned.

Unrecorded operating agreements govern the relationship between individual anchors and the mall owner. Terms typically address tenancy, hours of operation, required years of operation under a specified tradename and the size of each anchor and the mall. Operating agreements also generally restrict the size and construction of improvements on the anchor pad and regulate usage.

A simple example involves anchors using stores as a delivery point for ecommerce, a concept known as buy online, pick up in store (BOPIS). Many REAs and operating agreements severely limit implementation of this concept.

But what if the mall's highest and best use is no longer retail? Ecommerce and changed consumer practices undermine the REAs' and operating agreements' ability to ensure the property's success, but those private agreements are understandably focused on preserving retail usage.

The common party to these agreements is the mall owner, making the mall owner the logical purchaser when an anchor looks to sell. The potential economic return on any proposed redevelopment must be sufficient to encourage an entrepreneur to take the redevelopment risk for the mall and/or anchors.

Legal risk escalates the economic risk. For example, owners of some anchor properties seek conversions to multifamily or industrial use as salvation from the retail apocalypse. Even if they overcome zoning objections, attempts to change REAs and unrecorded operating agreement restrictions may require unanimous consent among owners with competing economic interests.

The anchor pad may not even be worth its unimproved land value since its use is restricted under the REAs and operating agreements to retail.

Property tax implications

While mall owners and anchors struggle to remain viable in the changed retail environment, ad valorem property taxes pose an immediate challenge. Most states value property as what a willing buyer would pay to a willing seller, but the pre-ecommerce glory of malls and anchors generally encourage high property tax valuations.

Assessors performing an income-based assessment seldom recognize how anchor chains' plunging credit ratings affect value. The sales-comparison approach is equally challenging, as anchor property transaction volume has plummeted since 2006.

Most sales involve a change to non-retail use and thereby require unanimous consent. Consent is easier to obtain when the new use increases foot traffic to the remaining inline tenants and anchors, but it is easy to envision anchors holding the process hostage in an attempt to force the purchase of their failing stores.

REAs and unrecorded operating covenants make calculation of an anchor's value extremely difficult. They also call into question the comparability of previous transactions to repurpose anchors in the same mall, since those anchors may have agreed to one specific new use but may object to another.

REAs and operating agreements often hamstring mall and anchor redevelopment. Most were signed before ecommerce and did not envision retail losing its vitality. The parties to these covenants often have divergent economic interests and perspectives, and the natural party to lead redevelopment – the mall owner – must overcome these hurdles. In the short term, however, owners should address highest and best use with assessors to reduce property tax burdens until the zombie can be brought back to life.

Amid talk of a downturn, Rachel Duck and Nick Machan of Popp Hutcheson PLLC offer some guidance.

As interest rates rise to combat inflation, recessionary pressure is the highest it's been since 2009. Moving into 2023, shifting market conditions have pummeled real estate values, many of which had experienced dramatic upswings during the prior 18 months. With market uncertainty and recessionary conditions bearing down upon them, property owners across the country may hope to see some relief in property tax assessments.

But does a recession equal falling property tax liability? To answer this question, it is essential to understand how a recession could influence assessed values of the various property types.

How Recessions Impact Market Values

During a recession, interest rates typically continue to climb. In commercial real estate, rising debt costs can translate to reduced transaction volume and price contraction as capitalization rates reflect buyers' increased risk. Worsening job markets and weak consumer spending may impact the demand for various property types.

Multifamily tends to be less sensitive than other property types to recessionary market conditions. During downturns, risk-averse individuals tend to prefer rental housing over homeownership. Additionally, inflationary costs can delay multifamily construction and limit supply, which helps avert supply surges that can lead to steep drops in rent and occupancy. To illustrate, while office, industrial, and retail rent fell between 14 percent and 17 percent during the last recession, multifamily rent only declined 8 percent overall.

Retail property responses to a recession vary by type, but market growth rates will likely slow across all types. Brick-and-mortar stores were already facing a potential "retail apocalypse" prior to COVID-19 as consumers increasingly shopped online. Traditional shopping malls could be the most severely impacted retail properties in a recession. Many Class B and C malls already face closure, driving many owners to repurpose them into industrial, multifamily, distribution, and even healthcare space.

Hospitality is among the most vulnerable property types in a recession, and hotel performance has been one of the most volatile over the last few years. Revenues for many properties cratered during the pandemic and some have been slower to recover than others. However, many hotels had recovered to near pre-pandemic levels in 2022, with some year-end 2022 revenues surpassing 2019 levels. Moving into a recession, pent-up leisure demand could help balance out the decline of business travel as businesses cut costs. Perhaps the biggest question marks in predicting the impact of a recession on hotel performance involve business travel volume and hotels' ability to sustain high average daily rates they adopted to increase revenue per available room and combat falling occupancy.

How Do Market Fundamentals Affect Assessed Values?

Assessors in most jurisdictions base assessments on some variation of market value, which is fundamentally the value at which the property would transact on the open market. Assessors weigh cost, income, and sales data to determine their initial valuations. They must, however, also value thousands of properties quickly, and therefore rely on mass appraisal techniques that may omit factors affecting individual properties.

Recessionary market conditions affect all three of the valuation approaches but will vary by property type, geographic area, and individual property metrics. For these reasons, a property owner's first step after receiving their assessments should be to determine whether the valuation is reasonable based on the individual market factors impacting their property as of the valuation date.

Assessors in most jurisdictions must also consider the equity of property values. Many states have laws protecting the equitable value of comparable properties, and assessors are generally intent upon making fair assessments.

Tricky Tax Rates

In addition to assessed value, the second piece of a property owner's tax liability is the tax rate. Should 2023's overall appraisal roll or tax base decline, property owners should not necessarily expect an equivalent decline in their tax liability.

Most taxing entities set their rates separately from, and usually after, assessors' determination of property values. Typically, there is an inverse relationship between a jurisdiction's tax rates and the tax base. If total valuations fall significantly, it is possible—and maybe even likely—that tax rates will rise.

As an example, imagine you own a small apartment building outside of Dallas, Texas. Due to market factors, your property's value fell to $9 million as of the Jan. 1, 2023, valuation date, down 10 percent from $10 million a year earlier. Excited, you prepare to pay a correspondingly 10 percent smaller amount on your 2023 property taxes.

The overall appraisal roll declined as well, however, and your applicable 2023 tax rate increased from 2.4 percent to 2.472 percent as a result. Instead of a 10 percent decrease, your liability shrinks 7.3 percent to $222,480, down from $240,000 the year before.

No one can predict tax rates with certainty, but owners would be wise to budget conservatively for anticipated tax liabilities. A 40 percent decline in revenue may not translate to a 40 percent decline in the assessed property valuation or ultimate tax liability for the tax year ahead. Partnering with an experienced, local property tax advisor can give owners peace of mind as they navigate the shifting market in this tumultuous year.

Tennessee's appeal process allows Nashville taxpayers to challenge the complicated assessment of new construction.

Over the past decade, Nashville has enjoyed a baffling explosion of growth that sent cranes shooting up all over the city, festooned with developer names like Bell, Clark and Giarratana. Highrise towers of glass and steel rose out of the old rail yards like the emerging monolith in the opening scene of "2001: A Space Odyssey" multiplied in a funhouse mirror.

The Metropolitan Government is eager to add new projects to its tax rolls, and its Assessor of Property decides when and how that happens. The assumptions made by the Assessor's office about a project's cost and timing dictate how quickly and how much a new building is taxed. So, as always, taxpayers need to keep an eye on what the assessor is doing.

The assessor's difficult job has become even more complicated in the post-COVID quagmire of supply chain failures. Twelve-month projects have stretched into 24-month projects, and the assessor's assumptions about completion times have been thrown out of whack. To make matters worse, Tennessee's property tax statutes were not designed to give relief for construction delays or lengthy projects, and the clock is ticking.

New Construction Assessed at Material Cost

The last Davidson County reappraisal was in 2021, and the next will be in 2025. Normally, the assessor's values remain unchanged over the four-year cycle, but new construction is an exception to that rule.

Under the statute for assessing projects under construction, if a new improvement is partially complete on Jan. 1, the assessor is to value the property for that year at land value plus the cost of materials used in the improvement as of that date. This materials-only value favors taxpayers because it excludes labor costs.

The construction documents that are generally accepted as evidence of project costs do not typically segregate labor versus material costs, however. Those costs are most often listed as combined totals, making the exact material costs difficult to determine.

One example from a recently reviewed document described work that included a $279,000 line item for "caulking." Unless labor and materials are both included in that number, that's a heck of a lot of white goop! Rather than demand proof of exact material costs, assessors will sometimes allocate material costs based on a pre-established rule of thumb.

Substantially Complete?

Now for the tricky part. The new construction statute allows assessors to pick up new improvements after Jan. 1, so long as the structure is "substantially complete" prior to Sept. 1 that same year. So, for example, if a building is 50 percent complete at Jan. 1 and 100 percent complete at Sept. 1, the assessor will prorate at the 50 percent value for eight months of the year, and at the 100 percent value for four months of the year. If the improvements are not "substantially complete" by Sept. 1, the assessor must wait to pick up the as-complete value in the following year.

Tennessee has no statutory definition of "substantially complete" for purposes of adding the full value to the tax rolls, but cases make it clear that tenant finish-out and certificates of occupancy are not required. In the absence of simple, objective standards for completion, assessors make subjective judgments about completion that may not favor the taxpayer. Taxpayers can challenge those judgments through an administrative appeal.

Adding Insult to Injury

Under Tennessee law, new improvements may not be valued as incomplete for more than one year after construction began. Now, your immediate reaction might be, "That's ridiculous! How can you value an incomplete property as complete just because it took longer than 12 months to construct!?"

The assessor in Davidson County has taken the position that the statute prevents them from using the taxpayer-favorable, materials-only value in the second year a property is incomplete. They will likely still use the cost approach to determine the appraised value but add back the cost of labor that was taken out in the first year, greatly increasing the tax burden before the property is generating income. The legislature has not acted to provide relief from this further insult to developers already injured by increasingly protracted construction timelines.

The Good News

Tennessee assessors are only authorized to reassess a property at specific times, but taxpayers can appeal the assessor's Jan. 1 value of Nashville property to the Metropolitan Board of Equalization every year. If the assessor issues a prorated assessment for a new construction project later in the year, the taxpayer can appeal that value directly to the State Board of Equalization.

In light of the complexity of Tennessee's law on the assessment of new construction, owners of new projects in Nashville should seek counsel as to whether their assessments are fair and legal and avail themselves of the right to appeal if appropriate.

The 'work from home' revolution has devastated office building values.

Of all the property types, office buildings may wrestle with the pandemic's damaging consequences the longest.

The fallout from COVID-19 will clearly have a lasting economic impact. During the government-mandated shutdowns, businesses — including brick-and-mortar retail stores, restaurants, movie theaters and gyms — suffered tremendous losses.

With everyone except first responders and essential workers stuck at home, office occupancy rates plummeted as business districts, commercial developments, roads and public gathering places emptied. Many companies could not survive the shutdowns and were forced to lay off employees or permanently close their doors.

During the throes of the pandemic, companies that remained in business were compelled to adapt and learn how to effectively put their employees to work from home. Virtual meetings eventually became commonplace and routine. Then as the pandemic waned, companies began to demand that employees return to the office. While some workers ventured back to the workplace, many expressed a desire to continue to work from home.

This widespread sentiment has persisted. In fact, nearly 40 percent of workers would rather quit their jobs than return to the office full-time, and more than half would take a pay cut of 5 percent or more to retain their workplace flexibility, according to a recent survey by Owl Labs.

Given the tightening job market and the need to retain workers, many companies complied with employees' demands and either permitted them to work remotely or allowed hybrid arrangements. Little did these employers know that allowing employees to work from home would have a profound effect on the appraisal of office buildings for property tax appeal purposes.

Office valuations suffer

Property taxes are the largest single expense for most office landlords, and most property taxes in the United States are ad valorum, or market-value based. In other words, higher-valued properties have greater property tax levies. Therefore, property owners frequently file tax appeals to reduce this expense.

In the context of a real property tax appeal, the valuation of office buildings can be complex. Typically, an arms-length or comparable sale is the best evidence of value in a tax appeal proceeding. Since there aren't many arms-length purchases of single office buildings today, they are commonly valued by capitalizing the property's rental income stream minus property-based expenses. As a result, the actual rents collected are critical to the building valuation.

And rents have suffered. The mass exodus from office buildings to remote locations significantly lessened the demand for dedicated office space. With employees working remotely, many companies have realized they can function as well as before while occupying much less space. Thus, as leases expire, the tenants that choose to renew their leases are requesting a much smaller footprint with lower overall rents.

Compounding the decreased demand for office space, building expenses have skyrocketed. Rapid inflation has helped to propel insurance and general property maintenance costs, which have surged upward by more than 15 percent since 2020. Furthermore, lingering COVID-19 health concerns have led to enhanced cleaning protocols and upgraded air filtration systems, which have likewise raised building expenses.

Simultaneously, the Federal Reserve has raised interest rates to combat inflation. These higher interest rates, meanwhile, have further reduced property values by increasing the cost of financing. Mortgage interest rates and the risks on the equity side have also increased. This has a negative effect on the market valuation of office buildings as higher capitalization rates generate much lower appraised market values.

Challenge unfair assessments

Altogether, reduced office space demand, weakened cash flows, higher building expenses and rising interest rates do not bode well for the U.S. office sector. Landlords are being forced to offer concessions such as free rent or are paying for extensive interior buildouts to attract tenants.

This large shift in lease renewal rates, occupancies, expenses and capitalization rates have produced the equivalent of the four horsemen of the apocalypse for office building valuations, driving property tax appeals and raising a distinct possibility that many office buildings will become stranded assets. Experience indicates these changes can result in a 10 percent to 30 percent drop in market value from pre-pandemic levels.

A good rule of thumb would be that if a building's net operating income has dropped, the real estate tax levy should go down correspondingly. Most municipalities, however, have not reduced assessments to reflect the economic downturn.

Consequently, now more than ever, property owners must be vigilant to avoid paying excessive property tax bills. Conferring with experienced counsel, questioning assessors' property valuations and challenging tax assessments will help to ensure an office building's current real property taxes are based on this new valuation reality.

Legal covenants often cause excessive property taxation for mall owners that are looking to redevelop.

The repurposing of malls and anchor stores is a popular topic in community development circles, but legal restrictions make redevelopment extremely difficult. Often locked into their original use by covenants, malls and anchor stores are often grossly overvalued for property tax purposes.

In pursuing a redevelopment, taxpayers should ensure the properties are fairly assessed and taxed.

Debilitating obsolescence

It is difficult to overstate the plight of malls and department store anchors. Gone are the halcyon days when the mall was everyone's shopping destination. There is even a website, www.deadmalls.com, devoted to failed malls. Credit ratings of most anchor store operators have fallen below investment grade. Commentators usually blame the retail apocalypse on e-commerce and shifting consumer spending habits.

COVID-19 exacerbated these trends and mall foot traffic has been slow to recover. Some chains, including Neiman Marcus and JCPenney, have filed bankruptcy. E-commerce volume surged in 2020 and 2021 before tapering in 2022. To date, e-commerce and brick-and-mortar sales have not yet reached an equilibrium.

One in five American malls have fully closed and remain "zombies" without a redevelopment plan, estimates Green Street Advisors, a commercial real estate analytics firm. A December 2022 article from The Wall Street Journal that detailed the "long death" of the White Plains Mall noted there is no shortage of dying malls. The article observed that converting enclosed shopping centers to other uses remains a "difficult feat." Repurposing, while much-discussed, has not really happened.

The question is why. The answer relates, at least in part, to legal challenges inherent in changing the property's use.

Tied hands

Any property valuation begins with a "highest and best use" analysis. A basic assumption about real estate directs that the price a buyer will pay reflects that buyer's conclusions about the property's most profitable use. Competitive forces within the local market shape a property's highest and best use, but that use must reflect practical and legal restrictions.

Many people incorrectly assume that governmental requirements pose the only legal restrictions on use. Zoning ordinances may impose barriers, owners of neighboring properties may object to redevelopment proposals, or there may be other hinderances to changing the property's use.

Zoning limitations pale in comparison to restrictions in recorded easements and unrecorded operating agreements between mall owners and anchor department stores. While zoning may permit non-retail uses, private agreements generally do not.

Malls would be economically unfeasible without department stores and inline stores that symbiotically drive traffic to each other. Generally, anchors own their pads and inline tenants lease space from the mall owner. A typical mall is subject to two levels of private restrictions designed in an earlier time period to promote the efficient functioning of the mall for retail stores.

Recorded operating restrictions or restrictive easement agreements (REAs) impact the entire mall and its anchors and are generally binding for 40 years or longer. Typically, substantive amendments to the REA require the consent of all parties, and their economic interests are not always aligned.

Unrecorded operating agreements govern the relationship between individual anchors and the mall owner. Terms typically address tenancy, hours of operation, required years of operation under a specified tradename and the size of each anchor and the mall. Operating agreements also generally restrict the size and construction of improvements on the anchor pad and regulate usage.

A simple example involves anchors using stores as a delivery point for e-commerce, a concept known as buy online, pick up in store (BOPIS). Many REAs and operating agreements severely limit implementation of this concept.

But what if the mall's highest and best use is no longer retail? E-commerce and changed consumer practices undermine the REAs' and operating agreements' ability to ensure the property's success, but those private agreements are understandably focused on preserving retail usage.

The common party to these agreements is the mall owner, making it the logical purchaser when an anchor looks to sell. The potential economic return on any proposed redevelopment must be sufficient to encourage an entrepreneur to take the redevelopment risk for the mall and/or anchors.

Legal risk escalates the economic risk. For example, owners of some anchor properties seek conversions to multifamily or industrial use as salvation from the "retail apocalypse." Even if they overcome zoning objections, attempts to change REAs and unrecorded operating agreement restrictions may require unanimous consent among owners with competing economic interests.

The anchor pad may not even be worth its unimproved land value since its use is restricted to retail under the REAs and operating agreements.

Property tax implications

While mall owners and anchors struggle to remain viable in the changed retail environment, ad valorem property taxes pose an immediate challenge. Most states value property as what a willing buyer would pay to a willing seller, but the glory of malls and anchors before e-commerce generally encourage high property tax valuations.

Assessors performing an income-based assessment seldom recognize how anchor chains' plunging credit ratings affect value. The sales-comparison approach is equally challenging, as anchor property transaction volume has plummeted since 2006.

Most sales involve a change to non-retail use and thereby require unanimous consent. Consent is easier to obtain when the new use increases foot traffic to the remaining inline tenants and anchors, but it is easy to envision anchors holding the process hostage in an attempt to force the purchase of their failing stores.

REAs and unrecorded operating covenants make calculation of an anchor's value extremely difficult. They also call into question the comparability of previous transactions to repurpose anchors in the same mall, since those anchors may have agreed to one specific new use but may object to another.

REAs and operating agreements often hamstring mall and anchor redevelopment. Most were signed before e-commerce and did not envision retail losing its vitality. The parties to these covenants often have divergent economic interests and perspectives, and the natural party to lead redevelopment — the mall owner — must overcome these hurdles.

In the short term, however, owners should address highest and best use with assessors to reduce property tax burdens until their zombies can be brought back to life.

J. Kieran Jennings was quoted in the December 14 digital issue of the Wall Street Journal's Property Report, Page B6, titled, "Falling Building Values Spur Tax Appeals." 

Mr. Jennings is a partner in the law firm Siegel Jennings Co., L.P.A, the Ohio, Illinois and Western Pennsylvania member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. 

Land use changes can subject unwary landowners and developers to massive property tax bills.

For real estate developers in Texas, the purchase and development commencement dates on a land project may have heavy tax implications that could make or break a deal.

Agricultural Exemptions

The Texas Property Tax Code allows some landowners to benefit from special property valuations for wildlife management, agriculture, or open-air uses, commonly referred to as agricultural exemptions. Depending on the valuation and exemption in place, a landowner may be excused from paying large amounts of taxes.

Under an agricultural exemption, tax liability is based on the land's productive agricultural value, as opposed to market value. The agricultural exemption supports and promotes the land's agricultural or wildlife- use by providing a discounted land value for use in calculating property tax liability while the land is being used for approved agricultural purposes.

Securing an agricultural exemption is not necessarily an easy process or a guaranteed result for a landowner in Texas. To qualify, land must have been primarily used for agriculture at least five of the past seven years. Accepted agricultural purposes include crop production, raising livestock, beekeeping, timber production, wildlife management, and similar activities. Additionally, many counties set minimum acreage requirements, and some consider the agricultural activity's degree of intensity.

Triggering Rollback

An agricultural exemption does not attach to the land forever, and some developers may be unaware of the rollback tax. This somewhat vague provision of the state's tax code can impose a heavy tax burden when a piece of agricultural land is purchased for development, and/or when the land use changes. This tax burden may be more onerous than simply losing the exemption moving forward.

Appraisal districts maintain two values on the appraisal roll for agricultural land. Similar to how homestead exemptions are recorded, the appraisal roll lists the land's market value and the lower valuation reflecting its wildlife or agricultural production. When appraising agricultural land, the assessor will determine and record both its market value and the value of its capacity to produce agricultural products.

When an assessor calculates the amount of tax due on the land, he/she will also calculate the amount that would have been required had the land not benefited from an agricultural exemption. The difference in the amount of tax imposed under the exemption and the amount that would have been due without an exemption is called the additional tax for that year.

If land that has been designated for agricultural use in any year is sold or diverted to a nonagricultural use, it triggers a rollback tax. The taxes due under this provision include the total amount of additional taxes for the three years preceding the year in which the land is sold plus interest at the rate provided for delinquent taxes. This rollback tax is in addition to the larger, non-exempt tax burden moving forward from the sale.

The chief appraiser determines whether the land has been diverted to a nonagricultural use. A tax lien attaches to the land on the date the usage change occurs to secure payment of the additional tax imposed, as well as any penalties and interest incurred if the tax becomes delinquent.

The lien favors all taxing entities for which the additional tax is imposed. If the usage change applies to only part of a parcel, the additional tax applies only to that portion of the tract and equals the difference between the taxes imposed on that section of the property and the taxes that would have been imposed had that part been taxed on market value.

Monitor Exemptions 

The county appraisal district may have incomplete or incorrect information about a particular property's change in use. It could be that the use is diverting from agricultural use to wildlife management, and the exemption may still apply. This means that an agricultural exemption could be erroneously removed from a property that would still qualify.

This happens most often when a change of ownership and a deed newly recorded with the county triggers the removal of the special valuation. Owners must be diligent in submitting to the county a new application for agricultural or wildlife management use by April 30 of each year to ensure that their exemption stays in place.

Review Annual Assessments

Landowners should not grow complacent about protesting assessments annually. If agricultural owners don't file protests to keep their assessed land value down year over year, they may be on the hook for more taxes when they sell the land to a developer.

A taxpayer may protest a property valuation each year for the current tax year, but many Texas counties do not increase land values every year unless property transactions prompt them to do so. Few taxpayers protest when their assessments do not increase from the previous year, and the protest process is even more likely to be overlooked when the landowner has an agricultural exemption.

Repercussions for the landowner become apparent when they receive a compelling offer to sell. The landowner may make a sweet deal with a developer, but this will always trigger a change of use and the rollback tax. The buyer and seller will need to reach an agreement about satisfying the tax payment upon closing.

This becomes even more difficult for the landowner to manage if their properties are in counties that do not send a notice of appraised value when the value rolls over unchanged from the prior year. Therefore, it is still important and worth the effort to protest the valuation of agricultural land each year, even when the value is unchanged or minimally increased.

To accurately forecast potential property tax liabilities for development projects, landowners and developers alike must be aware of both the taxable and market values of land under consideration for sale or development. The rollback tax provision can be a bit complicated, but the right property tax team can help to navigate the process and avoid pitfalls that could disrupt the project's profit potential.

Fighting for laws that produce equal, uniform taxation best serves taxpayers and state governments.

It has been said that the people who complain about taxes can be divided into two classes: men and women. While we all complain, taxes ensure various levels of government have funds to perform essential functions—to keep society civil and in, more or less, working order.

A tax must be fair to be supported, however. In countless instances, a taxpayer's first complaint about an assessor's valuation is that the amount exceeds their neighbors' valuations. In essence, the property owner claims that the property valuation and resulting tax liability is unfair or non-uniform.

Too many jurisdictions lack an efficient mechanism to address non-uniform taxation. Fortunately, several states specifically require tax uniformity, and two offer legal remedies to help taxpayers combat unfair assessments.

A constitutional concept

Most taxing jurisdictions seek to assess real property at market value, which is the amount the property might sell for as of a certain date. Many states even address the legal requirements of taxation in their governing documents.

Ohio's constitution, for example, requires that "Land and improvements thereon shall be taxed by uniform rule according to value." Virginia's constitution states: "All taxes shall be levied and collected under general laws and shall be uniform upon the same class of subjects within the territorial limits of the authority levying the tax."

• Washington's constitution necessitates that all taxes shall be uniform upon the same class of property within the limits of the assessor's authority, while Missouri's constitution requires that assessments must be based upon market value and be uniform.

• That all four of these sampled constitutions mention the importance of taxation uniformity underscores the importance of the concept. Taxpayers seeking an effective model for opposing an assessment on the basis of unequal treatment can look to two other states: Texas and Georgia.

Ready remedies

Texas and Georgia have taken great strides in establishing the methods to ensure property assessments meet their constitutional goals of equal and uniform taxation. Both states empower taxpayers by setting out specific steps to show an overvaluation. Taxpayers in these jurisdictions are assured the right to have their property assessed for taxation in a uniform and equal manner when compared to nearby comparable properties.

In Georgia, a property owner can challenge an assessor's valuation of their real property based on uniformity.The state's standard appeal forms have a box to check as to whether the appeal is being filed based on value, taxability or uniformity.

Under a 1991 Georgia case, Gwinnett County Board of Tax Assessors vs. Ackerman/Indian Trail Association Ltd., a property owner who can show that numerous similar properties in the same area and county have lower assessed values can use that information as grounds to advocate for a lower assessed value.

Texas property owners can challenge an assessor's valuation by arguing there has been an unequal appraisal.Texas property owners in this position can file a protest if they believe the property is taxed at a higher value than comparable properties.

To prevail in seeking a lower valuation, the property owner can submit sale or appraisal evidence. Alternatively, the taxpayer can prevail by showing their assessed valuation exceeds the median appraised value of a reasonable number of appropriately adjusted comparable properties.

In a 2001 case, Harris County Appraisal District vs. United Investors Realty Trust, a Texas appeals court found that when there is a conflict between taxation at market value and equal and uniform taxation, equality and uniformity prevail. This means it is more important that taxes be equally and uniformly imposed and collected than it is to arrive at the property's market value when the "corrected" value makes the property a taxation outlier in its competitive set.

A pervasive need

For sure, a tax assessor's job of valuing all land and improvements is daunting, and they must use many data points and much subjectivity to assess values. Given the scope of their job, mistakes in valuation will occur—especially if the valuation incorporates inaccurate data regarding gross building area, square footage, age, condition or other variables.

Because mistakes are inevitable, property tax systems must provide taxpayers with efficient and effective methods of challenging overvaluations. All jurisdictions provide taxpayers the right and some mechanism to contest the assessor's valuation through an administrative and/or judicial process. This procedural right gives taxpayers a means to correct apparent overvaluations and to seek fairness—or at least it provides the opportunity to argue for fairness.

Taxpayers' pursuit of that procedural right most often revolves around valuation and ignores the constitutional requirement of uniformity. Or worse, the available procedure conflates uniformity with valuation by stating that if the assessed value reflects market value, that equates to uniformity. This thinking is only accurate in theory, as achieving market value assessments for all is aspirational but elusive.

If taxpayers in every jurisdiction could argue a solution along the lines of Texas' defense, it would ensure uniform and equal taxation for all.

Many times, an appeal board hearing a valuation complaint will require either evidence of a recent sale of the subject property or an appraisal report before it will adjust an assessor's valuation. However, sales are often unavailable and appraisal reports can be expensive. Given the cost of appraisals, owners of lower value real estate must often weigh cost versus potential tax savings before deciding whether to hire an appraiser and contest an unfair assessment.

Fairness across the assessor's jurisdiction must be the paramount goal. The defenses or means of redress provided by Georgia and Texas are vital to ensure that taxpayers have access to a constitutionally mandated equal and uniform valuation. These statutory provisions provide a cost-effective method for taxpayers to challenge an overvaluation.

Constitutions that provide an equal and uniform defense give taxpayers fair and equitable access to assessors' valuation systems and promote equal and uniform taxation. Expanded taxpayer access and improved assessor responsiveness promotes trust in government.

Every jurisdiction should follow these examples to provide taxpayers an equal and uniform defense.

Michigan's Menards case offers valuable lessons to help taxpayers get fair property taxation.

While taxpayers typically pay property taxes based upon their property's market value, assessors frequently misapply evidence or even redefine market value to rake in excessive taxes.

The recently resolved Michigan Tax Tribunal case of Menard Inc. vs. City of Escanaba illustrates several of these efforts to collect excessive taxes and suggests arguments a property owner can use to challenge them.

What is market value?

Market value is the price willing, knowledgeable buyers and sellers in an arms-length transaction would agree the property is worth. Market value differs from insurance value or replacement value because it reflects what a typical buyer would pay for a property as it is. Market value also differs from value to the owner, which reflects how a particular property contributes to the owner's business operation.

Appraisers typically determine market value using one or more of three valuation techniques:

The sales comparison approach adjusts sales of similar property to indicate the likely selling price of the subject property. The income approach values property by considering the present value of the income it would likely earn if rented, whether or not it actually is rented. The cost approach values property by considering its cost of replacement, reducing that cost by all forms of depreciation including physical deterioration, functional obsolescence and economic obsolescence. Such depreciation can and should be quantified by data also utilized in the income and sales approaches.

The Tax Jurisdiction's Evidence

The subject property in the Menard case was a big box retail store, larger than most, with a main floor area over 150,000 square feet and with additional accessory space. The owner used the space as part of its multistate retail business operations and as a delivery point for its internet sales. The building was not subject to a lease.

The tax jurisdiction proposed valuing the store using sales of smaller home improvement stores occupied by Lowe's or Home Depot as tenants pursuant to build-to-suit leases. It also sought to use the rental rates in these build-to-suit leases as evidence of market rent. It claimed that the Menards store suffered no material obsolescence, based on evidence drawn from this build-to-suit data.

As the term suggests, tenants under build-to-suit leases have contracted with a developer to build the store to their specifications. The parties set lease terms before construction even starts, calculating the lease rate to cover all construction costs and provide the developer's expected profit. In essence, such leases recover replacement cost even if market value is less than replacement cost.

Taxpayer's counterpoint

The taxpayer successfully argued such evidence did not reflect the market value of Menards' store. The selected sales reflected the value to the owners of using the stores in their specific retail operations. The lease rates were high enough to recover actual construction costs for each property—not what any other retailer would pay to rent a space not built specifically for its business model. This data, virtually by definition, would not indicate obsolescence in the subject property.

When such stores sold, the taxpayer argued, the sales price reflected the value of a lease to a creditworthy tenant that of course was already using the building in its retail operations. Besides generating cash flow designed to recover construction costs, the specific leases were signed during periods of higher interest rates than on the valuation dates, so that by the time of valuation, the leases provided an above-market return on the original building investment. What the tax jurisdiction called sales of comparable buildings were effectively bond sales from one investor to another secured by a retail building.

A buyer of Menards' property, if it sold, would not receive cash flow from a build-to-suit lease. In fact, it would not receive cash flow from any lease. The tax jurisdiction should have either adjusted the sales to remove the effect of above-market leases, or used sales unencumbered by a lease and for which no lease adjustment would be necessary. Some tax jurisdictions derisively call such transactions "dark store" sales, but they are frequently the best evidence of a building's market value. It is the building that is subject to property tax—not the business operating within the building.

Lessons learned from the Tribunal's decision

The tribunal rejected the tax jurisdiction's build-to-suit lease rates and sales with build-to-suit leases in place.Instead, the Tribunal used the taxpayer's proposed lease rates for conventionally leased buildings in the local area.Such lease rates better reflected the market rent a buyer of the subject property could reasonably expect to collect, and therefore best indicated obsolescence suffered by the subject property.

These lessons apply to valuing any type of building. Build-to-suit rents do not reflect market rent-- except by accident. Alleged comparable sales with build-to-suit leases are typically not comparable to a subject property that is owner occupied.

Even if the subject property is already fully leased with a build-to-suit lease, if local law requires use of market rent, the actual rent from the build-to-suit lease could be given far less or no weight. During the Great Recession, in market lease states, even fully occupied buildings at high contract rent had their values reduced because market rents had fallen. Finally, increased e-commerce volume and changing consumer habits may render many existing retail stores oversized. Office buildings and the tenants' current spaces may be oversized due to higher proportions of people working from home or virtually. Oversized buildings in light of current market conditions suffer from obsolescence that must be reflected in market value.

The Michigan Tax Tribunal resolved the Menard case this year after several years of litigation. Perhaps that resolution can now help other taxpayers to recognize unfair assessment practices, and to build stronger cases as they seek fair assessments for their own properties.

When the early pandemic sent hotel occupancies plummeting and uncertainty soaring, it also created clear opportunities for many hotel operators to reduce property tax bills by appealing their assessments.

Today, however, it can be difficult to know whether appealing an assessment still makes sense. Record selling prices are being reported on a macro level despite increasing interest rates, rapid inflation and ongoing unpredictability in many markets. This gives taxpayers a potentially confusing array of mixed messages affecting valuation.

Hotel operators should heed the real estate adage that "all properties are unique," a saying that certainly rings true in the current hospitality market. To really understand hotel values, it has become essential to delve into what drives demand at each property.

Value Judgments

I recently heard an appraiser sum up the hotel market recovery as follows: "At the beginning of the pandemic, we thought it was going to take five years [for hotels to recover], but it turned out it was more like two to three," he said. "And if a property isn't recovering by now, then it's probably not going to."

This was, admittedly, an oversimplification, but it seems to reflect the reality in many places.

Laurel Keller, an EVP at of Newmark Valuation & Advisory's gaming and leisure division, observed that the recovery has been uneven across different markets and hotel types. "I've seen a range of recoveries, from midscale hotels that recorded their best top-line revenue and profit margins ever last year, to full-service hotels still performing at levels below pre-pandemic," Keller said. "In most instances, average rate growth has been substantial over the past 18-plus months, though occupancy recovery has been slower."

So, how can an owner or operator know if their hotel is fairly assessed?

For property tax purposes, most states recognize that hospitality properties are operating businesses (also called going concerns) of which real estate is only one value component. The other components are the furniture, fixtures and equipment, and the intangible business value.

To reduce property taxes, an owner must challenge the assessor's property value assessment, and that value pertains only to the real estate component. Failing to prove the proper allocation of overall value among the going concern components can result in an owner paying taxes on non-taxable property.

Two Approaches

There is widespread agreement that a lodging operation carries a business value that must be separated from the real estate to determine taxable property value. However, for the past two decades there has been debate about how to tease out those separate values. This ongoing discussion is dominated by two generally accepted valuation methods. The more conservative of the two assumes that the removal of management and franchise fees from the income stream offsets the hotel's business value. That approach gained favor in many jurisdictions in the early 2000s for its straightforward and simplistic nature.

Several prominent court decisions in recent years have endorsed a more robust analysis, however, to ensure that all non-taxable assets are removed from the real estate assessment. This more detailed approach considers the values associated with intangible items such as a trained workforce, reservation systems and brand goodwill.

One expert witness recently described post-pandemic hotel analysis as "granular," and noted that seemingly minor differences between properties have become more important than ever. As an example, he pointed to two properties in his market with the same flag which would have been considered comparable three years ago, but subtle differences in their locations relative to office submarkets, sporting facilities, and hospitals could now make a big difference in performance and valuation. Despite appearing similar on the surface, each property has unique demand factors.

In a similar vein, an owner of hotels throughout the United States used the term "hyperlocal" to describe property performance in 2022. As an example, the owner cited two upscale hotels about a mile apart from each other in the same submarket, just outside of a large metropolitan area. Pre-pandemic performance at both properties was similar and relatively predictable. Today, the property slightly closer to the airport is thriving while the other struggles to get back to 2019 performance levels.

It also can be difficult to make sense of the news around recent acquisitions. Even as billions of dollars are pouring into the extended-stay sector nationwide, owners in some markets are looking to convert their extended-stay properties to apartments. Similarly, 2022 has seen significant investment in hotels along interstate highways despite indications that occupancy may be starting to decline in that subsector.

"Pandemic recovery has varied widely from property to property and market to market and been far more protracted for some hotel assets," Keller said. "More surprisingly, we are now seeing performance decreases at some hotels that experienced a surge in leisure-oriented travel last year. So, the recovery is ongoing, and perceived rapid recovery at some hotels may have been slightly misleading."

Perhaps the key takeaway from all this is that the reported "recovery" in the industry doesn't equate to a recovery for every hotel.

Just as all properties are unique, all taxing jurisdictions have their own rules and idiosyncrasies. Understanding the intersection between accepted appraisal practices and a jurisdiction's particular laws around the assessment of going concern properties is essential to ascertaining whether a particular hotel is fairly assessed.

Operators seeking assistance in evaluating their property tax assessments should lean toward qualified appraisers and tax counsel with local knowledge, which can help identify opportunities to right-size taxes and articulate the narrative behind each property in question.

Assessors often need reminding that property owners are entitled to equal, uniform treatment, notes Stephen Grant of Popp Hutcheson PLLC.

Across the country, state constitutions require that property taxes be equally and uniformly assessed. And thank goodness for that.

Without such constitutional guarantees, local taxing authorities would have the unfettered ability to single out individuals, property types, or categories of property owners for taxation by a different standard, possibly taxing them out of existence.

Fairness Trumps Market Value

Generally, taxpayers can challenge their property tax assessments by arguing that the appraised value of their property exceeds its fair market value. However, if a conflict exists between taxation at market value and equal and uniform taxation, equal and uniform taxation must prevail. Various court cases have upheld this principle and underscore its importance. In short, the guarantee of equal and uniform taxation is designed to protect taxpayers and ensure equal treatment of all commercial and residential property owners.

Despite constitutional protections, unequal appraisal by local taxing authorities persists. There are several reasons for this, including data errors and tax officials' willingness to single out recently sold properties to assign value, commonly referred to as "sales chasing."

Tax assessors continue to appraise recently sold property at or near its actual sales price but leave the taxable values of other, similar properties unchanged. A business cannot compete in its respective market if it is being taxed more heavily than its competitors. Compounding the issue, many commercial leases pass through property tax expenses to tenants who ultimately bear the brunt of higher property tax bills.

Further, a property appraised according to the high end of market values may nonetheless be unequally assessed if other comparable properties are valued at the lower end of the market. Over time, the variation created by that practice would result in affected property owners being saddled with higher assessments and potentially higher tax liabilities than similarly situated properties. At the minimum, this practice raises a question of whether properties within a taxing district are being taxed to an equal and uniform standard.

Taxpayer Recourse

When one parcel is unequally appraised compared to similar properties, what recourse do taxpayers have to ensure equitable taxation?

While most state constitutions require that taxation be equal and uniform, only a few states have adopted a statutory remedy to accomplish that goal. Where available, the statutory unequal appraisal provision permits taxpayers to appeal or protest when an assessor has appraised their property using a different standard than those used for other properties. Accordingly, a property owner can seek relief if their property was treated differently from other properties in the same tax base, even when their appraised value does not exceed fair market value.

Texas has what may be the most robust statutory unequal appraisal remedy in the country. The provision states that a property shall be valued for property taxes based upon the median level of appraisal of a reasonable number of comparable properties, appropriately adjusted.

When selecting comparable properties, it is important to consider several factors, including but not limited to the properties' use, competitive set, neighborhood, and size. While the Texas statute does not define what a "reasonable number" of comparable properties is, consideration should be given to the quality and number of comparable properties used.

After selecting a reasonable number of comparable properties, adjustments are then made to the appraised values of the comparable properties to put them on equal footing. The adjustments account for differences between the selected comparable properties and the subject property, such as location, age, and size. When determining what adjustments to make, the focus should be on elements that directly affect the properties' value.

The final step is to compare the median adjusted value per square foot of the comparable properties and see how they correlate to the subject property. If the subject property has a higher value per square foot than the calculated median, then there is an equity issue.

Fair Fights

The equal and uniform remedy serves as a helpful tool for taxpayers when challenging their property's assessed value. For instance, disputing a property's market value may not be viable in some situations, and a taxpayer's only recourse may be to argue that their property has been unequally appraised.

For example, a hypothetical taxpayer purchased a 300,000-square-foot, Class-A office building for $55 million during the prior tax year. The appraisal district subsequently assessed the building for property tax purposes based upon the purchase price, despite assessing other Class-A office buildings of similar size and location at a lower price per square foot.

By engaging in sales chasing, the appraisal district has unfairly appraised the subject property in relation to its competitors. However, if the state had adopted an equal and uniform remedy, then the taxpayer could challenge the property's value on the grounds that it was unequally appraised even if the assessor deemed the sales price to be fair market value for property tax purposes.

Challenging tax values on an equal and uniform basis is an effective remedy. It addresses the practice of sales chasing, counters assessors' tendency to use high sales prices to raise property taxes across an entire market and offers a coherent alternative to simply arguing that an assessment is excessive.

The unequal appraisal remedy is a readily accessible argument, particularly for homeowners, because it provides taxpayers with a more straightforward option than a market value appeal. It enables taxpayers to forego the high cost of procuring expert appraisers by allowing them to instead build an argument by identifying a representative sample of similar properties from the appraisal district's own website.

In sum, if your state has an equal and uniform remedy—use it. If your state does not have an equal and uniform remedy, consider urging lawmakers to adopt one in your state.

Follow these steps to stop excessive property tax assessments.

In a nation that has faced a host of new challenges since the pandemic began, the seniors housing sector has carried one of the heaviest burdens. COVID-19-related mortality risk for those 85 years old or older is 330 times higher than for those 18 to 29 years old, according to the Centers for Disease Control and Prevention.

Notwithstanding those odds, 51% of all seniors housing properties including independent care, assisted living and skilled nursing reported zero deaths from COVID-19. Yet the industry continues to grapple with increased costs, worker burnout, hiring challenges and occupancy issues that have ravaged their operations.

Like a vaccine that stimulates a stronger immune response, hard times can spur organizations to boost efficiency and fortify themselves against other threats, such as inflation. In this vein, seniors housing owners must identify ways to turn their troubles into positive influences.

As the industry seeks to allocate money from areas that don't compromise care, property tax strategy should be near the top of their lists for potential savings. Moreover, reduced taxes tend to have a long-term impact. When assessments are low, they tend to stay low, which may serve to insulate the industry from the impacts of inflation.

How to reduce property tax liability

Obtaining those property tax savings is not easy, however. Although it seems apparent that the industry has suffered, taxpayers that want a reduction in taxes must prove their property has lost value; they cannot rely on the good will of assessors to adjust the assessment.

Taxpayers must look at their tax challenges in a way that reflects the impact to the business. That said, assessors will want to concentrate on real estate value irrespective of the business. Many will reference sales of properties that were priced on the value of contractual leases to the operator, or assessors may look at the income to the owner based on contract rents. Taxpayers need well-documented arguments to counter these positions.

While separating the real property value from the business value, real estate assessments must also consider the negative effect that a struggling business exerts on the real estate.

Taxpayers can follow a three-step financial feasibility study to help prove the need for an assessment reduction.

1. Determine the net operating income (NOI) under COVID-19 and its legacy. It is important to document the new costs necessary to safeguard and serve residents in this new environment.

2. Separate income associated with services from real estate income. Be sure to remove from income any governmental stimulus that will not be ongoing.

3. Finally, use the resulting real estate NOI to show the effects of that income stream on real estate value.

Step 2 is critical, and it must start with the business. Conduct a forward-looking income analysis that includes all increased costs, from the added costs of employing and motivating a weary workforce to inflation and expenses associated with new health standards.

After documenting the new NOI from the independent living, assisted living, or skilled nursing operation, determine whether that income is sufficient to justify the business. Taxpayers can do this by applying a return to the cost of services. The expenses that are separate from normal real estate operations are associated with the service side of the business, and those outlays are expected to generate sufficient income to create a return on that investment. Remove the return from the overall net operating income, thus separating the income from business and real estate. The result is NOI that reflects more closely that of the real estate.

Perform a similar analysis to determine whether the net income attributable to real estate is sufficient to justify the real estate cost. It is important to remind the assessor that the operating business can only pay rent if there is money available, even if that rent is just a figure used in a formula to determine real estate value. At this point, the taxpayer can apply a capitalization rate to the net real estate income to arrive at the real estate value.

Apply to other valuation approaches

The financial feasibility study described above will also help taxpayers and assessors determine how to adjust the cost approach to valuing real estate. Likewise, the analysis can inform adjustments to comparable sales data. Indeed, that initial financial feasibility will help in all aspects of the tax challenge and should be well documented.

Assessors are not all-knowing, so unless the taxpayer shows them a good reason to change approaches, they will work with their normal procedures. Often, assessors look to the property's construction cost (less physical depreciation based on age), sales of similar properties and/or the income generated from contract rents to determine an assessed value.

Without an initial feasibility analysis, an assessor may focus on construction costs without regard to whether the property's use will justify those costs. Or they may use contract rents for the subject property or competing properties, either of which were likely established with pre-pandemic metrics.

Simplistic shortcuts, such as assuming a percentage of the total net income that should be attributable to business and the other to real estate, are not ideal and may lead to inflated values of taxpayers' properties.

In theory, there should be a greater impact on the value of those properties that require more service. But because of the variations between properties and nuances of seniors housing types, a fresh look is needed for all of them.

A good starting position for the taxpayer is to ask, "what would we pay to acquire the property, knowing what we know today?" Comparisons to sales of other properties are more complicated than in the past and should be adjusted with an eye toward the feasibility analysis. Properties that cannot achieve sufficient occupancy and income to justify operation are not directly comparable to optimally occupied properties.

There are states where a reduction in the assessment may carry forward indefinitely. Approaching assessed value with a strong team will pay dividends for years. Conversely, an approach that is not well thought out will make future attempts to reduce taxes more difficult. But by taking the proper steps, a taxpayer can position themselves to drive the best result and be able to provide the service and living standards that our most vulnerable residents deserve.

New York Court of Appeals rejects lower court decision, affirms that occupiers obligated to pay property tax have the right to protest assessments.

In a far-reaching decision, New York's highest court has affirmed the rights of tenants under a commercial net lease to protest assessments and reduce their real property tax burden. The ruling reversed a State Supreme Court dismissal of a petition on the grounds that only a property's owner can file an administrative grievance with the Board of Assessment Review.

In a net lease, the tenant is responsible for paying real estate taxes and other expenses stated in the lease. In The Matter of DCH Auto vs. Town of Mamaroneck, the Court of Appeals in June 2022 published a unanimous decision stating that tenants contractually obligated to pay real estate taxes and authorized to protest assessments may file tax appeals even when they do not hold title to the underlying real estate.

Restoring a precedent

DCH Auto operated a car dealership in a net leased property in Mamaroneck, New York. Its lease with the owner required DCH to pay the property's real estate taxes in addition to rent.

Commercial tenants with this type of lease commonly file tax appeals to correct excessive tax bills and mitigate operating costs. These occupiers include retailers such as department and big-box stores, office building users, banks, drug stores and other businesses.

In the subject lease, DCH had the express right to challenge the subject tax assessment. Pursuant to the statute, it filed an administrative grievance with the town's Board of Assessment Review. The Board denied the challenge, after which DCH petitioned for judicial review.

The town moved to dismiss, arguing that the petition was invalid because the incorrect party had filed the administrative grievance before the Board of Assessment Review. They alleged that the failure of the property owner to file the administrative appeal precluded judicial review of the board's determination.

The lower court agreed and dismissed the petitions on the ground that only a fee owner may file the initial grievance complaints under the New York statutory scheme. The State Supreme Court's Appellate Division, Second Judicial Department, affirmed the petition's dismissal.

Thus, in one fell swoop, the Appellate Division obliterated over 100 years of precedent, which held that a net lessee that pays the real estate taxes is a proper party to file an administrative complaint challenging the assessment. Prior to the DCH lower court decision, it was never disputed that a net lessee was a proper complainant for filing both an administrative complaint and judicial petition. The lower court's ruling effectively required absentee property owners – who do not pay the real estate taxes and have no skin in the game – to file an administrative appeal before a net lessee can file a judicial petition.

The Appellate Division decision placed in jeopardy thousands of real estate tax assessment appeals filed by commercial net lessees who have relied upon common, accepted practice and precedent, and interposed an owner standard where none is present in the plain terms of the relevant statutes.

Fortunately, the Court of Appeals reversed the lower court's decision.

Who's who?

The case turned on statutory interpretation and analysis of legislative intent. At issue was Section 524(3) of the New York Real Property Tax Law (RPTL), which sets forth the process for the review of real property tax assessments. The provision specifies that an administrative complaint must be made by "the person whose property is assessed." If a complaint is denied, then "any person claiming to be aggrieved" can file a judicial appeal pursuant to Article 7 of the RPTL.

The Town of Mamaroneck's position was that the property owner must file the administrative complaint before any aggrieved person can challenge the result in court.

The Court of Appeals held that DCH and all commercial net lessees with the right to challenge assessments are included within the meaning of "the person whose property is assessed" under RPTL Section 524(3).

In its decision, the Court of Appeals considered the text of the statute and noted that "a person whose property is assessed" is not defined. A comprehensive review of the legislative history ensued, beginning with an analysis of the initial text of the statute as it existed prior to 1896. The original statute permitted "any person" to file an administrative complaint. In 1896, lawmakers amended the wording to "a person whose property is assessed." The Court examined the record, cited the New York State Commissioners of Statutory Revision that addressed the change in 1896, and noted that "there is no change of substance" with the revised wording.

In reversing the lower court's action, the Court of Appeals based its decision upon the evolution of the statutory text and the consideration of the underlying legislative intent. The Court made clear that it was not the legislature's intent to limit the meaning of "a person whose property is assessed" to the owners of real property, and that the reference includes net lessees contractually obligated to pay the real estate taxes.

Notwithstanding the DCH decision, commercial net lessees should ensure their tax appeals are not challenged by making certain that their right to file a tax appeal is clearly stated in their lease.