The seniors housing sector can't seem to catch a break. Owners grappling with staffing shortages and other operational hardships lingering from the pandemic are facing new challenges related to debt and spiraling costs. High interest rates and loan maturations loom over the industry, with $19 billion in loans coming due within the next 24 months, according to Cushman & Wakefield's "H1 2024 Market Trends and Investor Survey" on senior living and care.

Factors driving high costs include wage pressures, inflation and — incredibly — rising property taxes. Despite operational challenges and declining occupancy at many facilities during the COVID-19 pandemic, property tax relief for seniors housing was mixed. Many assessors resisted downward adjustments to taxable values, maintaining that recovery was around the corner. Now, seniors housing operators face property tax assessments that equal or exceed pre-pandemic levels.

As in the hospitality sector, most seniors housing owners understand that their operating properties include more value components than real property alone. In evaluating whether a tax assessment is reasonable and fair, however, owners need to realize that how an assessor addresses their real estate, personal property and intangible assets can drastically affect property tax liability.

Intangibles have value

The Appraisal Institute's "The Appraisal of Senior Housing, Nursing Home, and Hospital Properties" states that the valuation of a going concern in the sector includes real property, tangible personal property and intangible personal property. Real property or real estate equates to fee-simple, leased-fee or leasehold interests; tangible personal property is furniture, fixtures and equipment.

Intangible personal property can include assembled workforces, licenses, certifications, accreditations, approvals such as certificates of need, employment contracts, medical records, goodwill and management.

The Appraisal Institute's text also cites a requirement from the Uniform Standards of Professional Appraisal Practice in stipulating that the market value of real estate must be identified and valued separately, apart from the tangible and intangible personal property. Adopted by Congress in 1989, the Uniform Standards serve as ethical and performance standards for appraisal professionals in the United States.

Assessors and real estate appraisers are familiar with the process of separating real property and tangible personal property for purposes of valuation. Valuing intangible personal property, however, is often less clear.

Top-down vs. ground-up valuation

Appraisers often back into an intangible personal property value by first developing a going-concern value and then subtracting values for real property and tangible personal property. In practice, the whole does not always equal the sum of the parts.

Appraisers frequently opt for this "top-down" approach, so described because the appraiser develops a value opinion for the total going concern and then works "from the top down," assigning values to the various components based on market statistics or other data.

By contrast, some appraisers take a "ground-up" approach by valuing all the components independently and then adding those amounts to value the going concern. If done properly, both methods should yield similar value indications for each component.

For especially difficult property tax cases, taxpayers may find it worthwhile to have two appraisers perform independent appraisals using each method and then present both conclusions to the trier of fact.

Either method can help to demonstrate the considerable investment value imbued in many elements of intangible personal property. The assembled workforce may have taken several months to adequately staff and train, for example, while acquiring and maintaining licenses requires investments of time, capital and effort to overcome regulatory and adherence challenges. The loss of licenses or a portion of the workforce at a seniors housing facility can impair its operation and send effects rippling throughout the business, reaching beyond intangible personal property.

Business appraisers, who are accustomed to valuing intangible assets as part of mergers, acquisitions and similar activities, can provide clarity for taxpayers building a case for a tax assessment reduction on their seniors housing property. A business appraiser can be invaluable in these circumstances, allowing for a ground-up approach to valuing the elements of the intangible personal property and even working alongside real estate appraisers to come up with a clearer picture of the going concern.

Accounting counts

Most seniors housing operators fastidiously follow Generally Accepted Accounting Principles (GAAP) and strive to maintain compliance with accounting rules from the Internal Revenue Service (IRS) and Securities and Exchange Commission (SEC). These taxpayers would be wise to include a fourth consideration for their accounting team, which is to understand how their state and local governments define taxable real estate.

Tax definitions may vary slightly from one jurisdiction to another. Thus, it is possible to have one allocation for IRS, SEC or GAAP guidelines while having a different allocation for property tax purposes that corresponds to tax practices in the area. This type of nuance is one of the reasons seniors housing owners or operators can improve their odds of success in a property tax dispute by working with an adviser who understands both local case law and the area assessor's approach to valuing components of seniors housing properties.

In several states and municipalities across the country, assessors will simply increase a property's assessment to the purchase price entered in county records. This can lead to sticker shock when an operator receives their first tax bill after an acquisition.

By working with tax professionals and valuation experts during the due diligence and acquisition process, and by documenting the consideration paid for each component of an acquired asset's value, operators can limit upside exposure for future increases in property taxes and retain the necessary documentation to support these allocations.

Property assessments change. Are you keeping up with them?

Benjamin Franklin has been credited (dubiously) with the saying, "in this world nothing can be said to be certain, except death and taxes." The Greek philosopher Heraclitus has been credited (also dubiously) with the saying, "the only constant in life is change." To synthesize dubious quotes from two brilliant minds, "you will certainly have to pay taxes, and they will constantly change."

With property tax bills subject to constant change, property owners hoping to predict and plan for future tax liability have their work cut out for them. Here are the chief factors taxpayers should consider in tax planning.

Track reassessments

Governments base property taxes on two things: assessed value and tax rate. Both elements change on a regular basis, and it can be mind-boggling for taxpayers to stay on top of just exactly when and by how much their properties' taxes will increase.

Reappraisal systems vary. While most jurisdictions reappraise either annually or on a regular, multiyear cycle, some jurisdictions do not. Famously, California's Proposition 13 requires reappraisal based on changes in ownership and other triggers, rather than on any regular cycle.

A jurisdiction's reappraisal history is no guarantee of its future cycle. For example, the Arkansas Legislature amended its reappraisal statute in 2023, transitioning from counties being on either 3-year or 5-year cycles to mandated 4-year cycles for all. However, even this information is not enough to know when a particular county's next reappraisal will be, because the transition will be phased to reach a substantially equal number of counties reappraising each year.

Various variables

While knowing the jurisdiction's reappraisal cycle is important, the taxpayer's team has many other local rules to follow, including potential caps on annual increases. For example, in Alabama, which reappraises properties annually, the legislature recently capped annual increases at 7%, effective in Tax Year 2025.

Once the taxpayer knows a jurisdiction's reappraisal cycle and methodology, there is still the question of how much assessed values will change from one reappraisal to the next. For jurisdictions that have longer cycles, value changes can be drastic.

For example, Tennessee assessors reappraise properties on a cycle of four, five, or six years, depending on the county. Nashville, one of the fastest-growing cities in the country, will undergo a reappraisal in 2025 for the first time in four years. Based on the exponential growth that has occurred in that interim, property owners will likely experience sticker shock once assessments come out in May.

Across the United States, all taxpayers receiving revised assessments in 2025 face uncertainty about how current events will affect new valuations. How Donald Trump's election and initiatives will affect the real estate market is unclear.

The Federal Reserve reduced the fed funds rate three times in 2024 after more than a year of tightening, but the future impact of their tinkering is uncertain. Office market fundamentals have deteriorated to an alarming degree, and multifamily transaction volume has slowed from a firehose blast in 2024 to a trickle today. Will the assessors of America take macro-economic changes into account, or will they fixate on conditions in early 2022, before interest rate hikes and the decimation of the office market?

Rate watch

After assessors establish taxable value, taxpayers still face the question of the tax rate. Rates can change in any year, whether there is a reappraisal or not. However, one important thing to know about any jurisdiction undergoing a reappraisal is whether it has a truth-in-taxation law.

These laws aim to ensure transparency by requiring local governments to inform taxpayers in advance about potential increases. Tennessee, for example, requires local governments in a reappraisal year to certify a tax rate that will result in revenue remaining neutral, or equal to the previous tax year's revenue. Then, if leaders wish to increase the tax rate to generate more revenue than the prior year, they must take a separate vote later.

Typically, values increase greatly in the reappraisal and the tax rate plummets to generate neutral revenue, due to the truth-in-taxation law. This prevents local governments from obscuring a potential tax windfall following reappraisal, because they must vote to increase the tax rate before anticipated revenue can exceed the neutral amount.

In the end, every jurisdiction is different. Staying on top of a portfolio's upcoming reappraisals requires the taxpayer or their advisors to understand and follow a host of variables, from the reappraisal cycle to potential caps, exemptions, truth-in-taxation laws and more. A seasoned, local advisor can help property owners understand current laws, monitor proposed changes, maintain relationships with local assessors, and identify the most effective strategies for limiting potential overassessments due to reappraisals in each property's jurisdiction.

Can incentives cure the city's property market funk?

The City of New York's tax assessment valuations remain on an upward trajectory that compounds the burden on property owners. In stark contrast to this fiction of prosperity and escalating valuation, real estate conditions tell of a growing threat that menaces all asset classes across the city.

Pharmacies, retail stores and restaurants with deep roots in the community are vanishing at astonishing rates, victims to changes in consumer habits post COVID-19, competition with e-commerce, and rising costs associated with labor and supply chains.

Remote and hybrid work practices have taken a heavy toll on commercial office buildings. Submarket vacancy rates in the sector are cresting 20 percent, while individual office properties wrestle with vacancies ranging from 50 percent to 100 percent.

While hotels have improved due to demand for temporary migrant housing, they still have not fully recovered to pre-pandemic occupancy levels. Meanwhile, multifamily rents continue to rise, straining the budgets of long-term residents and driving many renters to an affordable housing sector where supply remains insufficient to meet the needs of an expanding population.

Despite the challenging market conditions, the city's property tax bills continue to increase, driven by a host of underlying factors.

Assessments ascending

Taxable, billable assessed value citywide increased by 4.2 percent this year to $298.9 billion. Assessments climbed 4.5 percent for co-ops and condominiums, but also increased in hard-hit commercial sectors. Retail valuation climbed 1.6 percent, and total valuation for office properties grew 2.5 percent from the previous year.

Why the disconnect between challenges in the real estate market and the rising burden of property taxes? Several factors could be pressuring assessors to increase assessment values. Here are just a handful:

Need to raise revenue. Property taxes represent approximately 30 percent of the city's budget, and the municipality's financial obligations continue to grow. The city continually seeks additional revenue to fund employment agreements, pension obligations, expenses associated with homelessness and migrant populations, and other expanding costs.

Market myopia. Property taxes are based on annual valuation updates that may not accurately reflect the quick shifts the market is experiencing, such as skyrocketing vacancy rates and the need to make costly building improvements to attract and retain tenants. As a result, property owners may face tax bills that do not correspond to the current economic environment

Debt, disregarded. The city's property assessments ignore debt service, leading to overestimations of taxable value. Commercial real estate sectors are facing growing pressures related to renewing existing debt, especially at today's high interest rates. Debt service obligations on many commercial properties now exceed the asset's market value, making it increasingly difficult for property owners to refinance, operate or sell their properties at a profit.

Dated data. Even where there is increased vacancy, the assessors still use outdated estimates of market rents and occupancy to impute income for vacant spaces, thus keeping assessments artificially high.

Tax relief options

Amid these mounting challenges, a property owner can often mitigate their tax burden by contesting the assessor's conclusions and arguing for a reduced assessment. Alternatively, or additionally, taxpayers can apply for relief under the city's abatement and exemption programs. An adviser experienced in the property tax law and local practices for the subject property's jurisdiction can be a valuable aid in identifying and pursuing tax relief options.

Here are the major real estate tax programs the city offers to provide property owners with relief while incentivizing investment in the community:

The Industrial and Commercial Abatement Program (ICAP) provides property tax abatements for businesses that make capital improvements in commercial and industrial properties. For both renovations and new construction, it provides a 10- or 12-year benefit for renovations in Manhattan below 59th Street, and 15 or 25 years of benefits above 96th Street and outside of Manhattan. By renovating and repurposing older, underutilized properties, ICAP helps generate productive spaces and revitalize neighborhoods. Without these incentives, the cost of construction and renovation is often prohibitive for the property owner.

ICAP was set to expire next spring, but the State Legislature recently extended the program to April 1, 2029. While this is a great program to encourage property rehabilitation, it hinges on the owners' ability to pay for substantial capital improvements and to secure tenants at market rents. Not all properties can fit that profile.

The Affordable Housing from Commercial Conversions program offers tax exemptions for owners who convert commercial properties into residential rental units. Also known as the 467-m program, this initiative seeks to increase the supply of residential housing and is a boon to owners of some outmoded office properties who seek to revitalize their buildings through a change in use.

The benefits are great – owners pay zero taxes during construction and 90 percent of normal taxes for 35 years after completion. However, 25 percent of the units must be offered at affordable rents.

The problem with this program is that many office buildings are poorly suited to residential conversion under current residential building and zoning codes. Achieving workable apartment layouts and window locations can be challenging, and in some cases, conversion may exceed the cost of new multifamily construction.

The Affordable Neighborhoods for New Yorkers program, or 485-x, incentivizes the creation of affordable rental housing across the city and is the successor to the 421-a program. Developers of buildings with more than 11 rental units, and who make 20 percent to 25 percent of the property's units affordable, are eligible for property tax exemptions for up to 40 years.

485-x is a critical tool in expanding the city's affordable housing stock as rising rents displace long-time residents. The affordable component remains in effect beyond the benefit period, however, which deters many developers.

The snapshot of NYC's assessment quandary is this: The market is demonstrating lower valuations, but tax assessments remain stubbornly high. The incentive programs require substantial new capital outlays for construction, and the end product needs to be economically viable.

As in all stories, time will tell how New York addresses its property tax dilemma. But if market conditions continue to decline, the current incentives will not resolve the problem of excessive property taxation. 

Property tax assessors in nation's capital city ignore post-COVID freefall in office pricing, asset values.

Commercial property owners in the District of Columbia are crawling out of a post-pandemic fog and into a new, harsh reality where office building values have plummeted, but property tax assessments remain perplexingly high.

Realization comes slowly

Immediately following the pandemic, many office property owners adopted a wait-and-see attitude toward the volatility permeating the sector, clinging to hopes that the rising popularity of remote work and similar office worker practices would prove temporary. Once the Federal Reserve began raising interest rates to combat generational inflation in 2022, however, hopes for a "return to normal" vanished and a grim reality set in.

Recent transactions involving office properties in the District clearly indicate that investors recognize the negative impact these market forces have exerted on office building valuations and are now pricing those changes into the amounts they are willing to bid for acquisitions. These recent sales show office building values have declined by more than 50 percent from pre-pandemic levels.

The other shoe began to drop on office market pricing in early 2023 with a rise in distress transactions, in which the office owner sells or forfeits the property to resolve some form of trouble, typically financial. These turnovers in ownership have continued to increase and now exert a growing influence on office pricing and valuations. Although properties have continued to transfer by traditional, arm's length transactions, the occurrence of foreclosures, deed-in-lieu arrangements, and lender takebacks is increasing. The proliferation of these non-standard transfer mechanisms is irrefutable and has a direct effect on the overall office market.

Denying reality

So, how has the District of Columbia adjusted its methodology to properly value office assets in this new and more challenging environment? In short, it hasn't.

A quick look at the 2025 tax year's assessment values (valued as of Jan. 1, 2024) shows the District largely ignored any change to the market. Among properties that traded in 2023 and 2024, the District's assessment-to-sale-price ratio is close to 200 percent! In other words, the District's methodology is producing assessments that are twice the values those properties are trading for.

This divergence from market evidence is perplexing, given that District of Columbia Courts have ruled that a recent purchase price provides the best indication of a property's value. In its 1992 decision in Levy vs. District of Columbia, the D.C. Superior Court observed that "a recent arms-length sale of the property is evidence of the 'highest rank' to determine the true value of the property at that time."

How does the District get around this decision when valuing office properties today? By ignoring any sales that it finds inconvenient and disqualifying them from inclusion in its assessment model.

Setting aside the impropriety of disqualifying these marketed, arm's-length transactions, the District has also excluded distressed transfers from its model. These exchanges of property, which may involve a lender's sale of real estate obtained through foreclosure, may not involve a sale between a conventional buyer and seller but they nevertheless establish value for the transferred real estate.

When non-standard transfers have become standard, as they have in the post-pandemic office market, assessors should include these transfers in their valuation models. That's according to the International Association of Assessing Officers (IAAO), which provides guidance on the topic in its Standards on Verification and Adjustment of Sales (2020 edition).

The publication states that when non-standard sales become more common, sales "in which a financial institution is the seller typically should be considered as potentially valid for model calibration and ratio studies if they account for more than 20 percent of sales in a specific market area."

The IAAO's Standards echo this qualification when addressing short sales. In that section, the IAAO states, "these sales should be treated like other foreclosure-related sales and considered for model calibration and ratio studies when, in combination with other foreclosure-related sales, they represent more than 20 percent of all sales in the market area, but only after a thorough verification process for each sale."

This 20 percent threshold is the IAAO's acknowledgement that when the market evolves, mass appraisal models must reflect the market's change. That means the District of Columbia can no longer ignore distressed transfers and should recalibrate the mass appraisal model used to value commercial properties in the District to include these types of transactions.

Despite these non-standard transfers representing well over 20 percent of DC's office market, the District has failed to adjust its model in accordance with IAAO guidance. As a result, assessors overwhelmingly base assessments on years-old data that does not reflect current market conditions.

Next steps

Moving forward, the most effective avenue for change will be aggressive advocacy by office market participants. Owners of commercial properties in the District must continue to engage with elected officials and actively appeal their assessments.

Fortunately, independent third parties administer the Real Property Tax Appeals Commission and D.C. Superior Court – two of the three levels of real property tax appeals in the District. If the District is unable or unwilling to change with times, the tax appeal process gives taxpayers the opportunity to force its hand.

Commercial property owners can maximize returns by minimizing property taxes, writes J. Kieran Jennings of Siegel Jennings Co. LPA.

Investing should be straightforward—and so should managing investments. Yet real estate, often labeled a "passive" investment, is anything but. Real estate investment done right may not be thrilling, but it requires active management, particularly in controlling one of the largest ongoing expenses, property taxes.

In recent years, the real estate industry has faced numerous challenges that harbored opportunities for savvy investors. From the COVID-19 pandemic and interest rate spikes to the work-from-home trend and increased vacancies, these disruptions were not just problems to solve—they were openings to reassess strategies, particularly regarding property taxes. Investors who seized these moments to reduce their tax burdens likely reaped significant benefits.

Consider the advice of the late judicial philosopher, writer and judge Learned Hand, who famously said: "Anyone may so arrange their affairs that their taxes shall be as low as possible; they are not bound to choose that pattern which will best pay the Treasury. There is not even a patriotic duty to increase one's taxes."

For real estate investors, this principle underscores the importance of addressing their largest tax expense: annual property taxes. These taxes not only erode returns year after year but can also negatively affect refinancing terms and eventual sales prices.

The best time to act? Now

Opportunities to reduce property taxes arise from shifting markets, new tax laws, court decisions, and even turnover among local assessors and prosecutors. Staying proactive means regularly reviewing these factors to determine whether each new assessment warrants a challenge.

To illustrate how market conditions and legal frameworks create opportunities, consider the following scenarios. Although these are hypothetical, they derive from true situations and case histories.

Tax is for tangibles: Soon after an investor purchased a hotel in Florida four years ago, the local assessor valued the property at 80 percent of its purchase price—a reasonable valuation for tax purposes at the time. Recent case law casts that value in a different light, however. Assessors must now exclude intangible business value, which can constitute up to 50 percent of a hotel's total value, from property tax liability. Ensuring the assessor valued their property correctly under the new directive enabled the subject property's owner to achieve a substantial reduction in the hotel's taxable valuation, saving tens of thousands of dollars annually.

Interest rates reconsidered: A multifamily complex acquired in 2021 was assessed at 90 percent of its purchase price. Although the owners had secured favorable interest rates at the time of acquisition, the taxpayer was still able to obtain a 30 percent assessment reduction in 2023. How? By citing the impact of rising interest rates on market conditions, which had suppressed property values due to buyers' increasing cost for debt financing. This assessment reduction helped improve the owners' cash flow and property valuation during refinancing negotiations.

Advanced to obsolescence. A newly constructed industrial facility in Ohio built to serve a rapidly developing industry faced obsolescence challenges as the needs of its intended tenant base changed in the evolving subsector. Under Ohio law, such properties are classified as special-use and must be assessed based on value to the user. The owners demonstrated significant economic obsolescence, effectively reducing the property's valuation. Additionally, the owners showed that many fixtures the assessor had initially included in the valuation were personal property. With strict adherence to legal definitions in revisiting the assessment, the assessor excluded the personal property from taxation. Understanding the legal definitions of assessable property and providing evidence of obsolescence enabled the owners to achieve meaningful tax savings.

These three examples highlight how market shifts and legal precedents create opportunities to lower tax burdens, even when the immediate need for action isn't obvious.

How to recognize a fair assessment

The methods for determining whether a property is fairly assessed depend on local and state laws, which vary widely and change frequently. Staying informed requires continuous monitoring of tax laws and local tax authority practices.

A taxpayer or tax advisor determined to stay current on local tax conditions should be sure to follow three key steps as part of their inquiries:

1. Understand local laws and definitions. Assessors calculate fair market value based on jurisdiction-specific guidelines.
2. Identify potential exemptions. Elements such as business fixtures might be reclassified as personal property and excluded from taxation.
3. Evaluate risks. Be aware that challenging an assessment involves risks, which can range from minimal to significant, depending on local laws and circumstances.

Combining a thorough understanding of jurisdictional laws with an analysis of property-specific facts is critical. This approach ensures taxpayers know what evidence to produce and will know when they're being fairly assessed.

The bottom line is that commercial property owners must exercise vigilance, expertise and a proactive mindset to manage their property taxes effectively. By viewing challenges as opportunities, property owners can minimize expenses, maximize returns, and protect the long-term value of their assets. Regardless of whether an assessment appeal requires an attorney, thinking like a lawyer will yield dividends.

Anemic transaction volume complicates taxpayers' searches for comparable sales data.

Evaluating the feasibility of a property tax appeal becomes increasingly complex when property sales activity slows. While taxpayers can still launch a successful appeal in a market that yields little or no recent sales data, the lack of optimal deal volume does require a thorough understanding of valuation methods beyond the sales-comparison approach.

This article will provide critical information for taxpayers in a low-transaction-volume market to successfully contest property tax assessments directly or to better vet industry experts to assist in those appeals. Many of the concepts are valuation-oriented, underscoring the need for an in-house or outsourced expert to guide appeals that venture outside the parameters of conventional, comparison-based valuations.

Brave new markets

The market for commercial office space changed, perhaps irrevocably, during the COVID-19 pandemic. Occupier demand in the sector has steadily decreased since then. The widespread adoption of remote work, space sharing and similar practices have persisted and, as a corollary, physical and economic occupancy rates for office space have plummeted, along with rents.

Much of the recent transaction volume for office properties has been by distressed sellers forced to sell due to their inability to refinance. Moreover, assessment boards or courts generally reject these sales as poor evidence of fair market value.

Conversely, at the high end of the market there has been a flight to quality; historically, the top-scale properties have always found both buyers and tenants. Valuing buildings that occupy the middle space between these two extremes is perhaps the most challenging, however, and demands a more complex approach suited to the scarcity of comparable market transactions.

Dealing with data

The key to establishing value under these circumstances can be to expand the geographical area of the transaction search and to include less-recent sales for comparison. While those may seem like easy solutions, as in most nuanced situations, the devil is in the details.

These details include the need to vet the accuracy and defensibility of the appraiser's adjustments once a wider net has snared potentially comparable sales. Or more generally, how should the appraiser adjust expanded sales areas and older deals to demonstrate accurate value for the building in the current market?

In a sales-comparison approach, an appraiser can expand the geographic area for current sales beyond the immediate vicinity of the subject property. There is no hard-and-fast rule that comparable sales need to be in the same city, or county, for that matter.

Real estate appraisers often establish a market area that includes not only the county of the subject property but also several surrounding counties, as long as they are "similar." For most commercial properties, similarity for valuation purposes depends on key geographic and demographic qualities.

The appraiser may use analyses of population data, household incomes and traffic patterns to justify adjustments to expanded sales areas for the current market. These are universally accepted valuation elements for retail properties but can also apply to other property types to aid in adjusting market areas.

Sales from previous calendar years, such as those going back five years or so, can still be relied upon to establish current market value if the properties share similar structural and geographic qualities. Using these older sales as a starting point, the appraiser must make critical adjustments for changes in the market conditions which have occurred since the date of the prior sales.

Needed adjustments typically include allowing for current market occupancy rates, both economic or leased rates and physical, onsite occupancy. Elevated levels of unleased space or leased but underutilized offices create a major risk to buyers, driving them to demand higher capitalization rates (and lower asset prices) to reflect increased risk.

In valuation, rising cap rates trigger downward adjustments in overall market value. Also, operational costs have increased markedly in the past few years, especially for insurance. Appraisers must reflect these additional costs in their adjustments to older transaction data.

Complementary approaches

Appraiser training teaches multiple valuation methods, providing alternative methods for establishing value when deal volume is low. These include surveying of market participants, analysis of brokers' for-sale listing volumes, length of market exposure, and analysis of rent or net-income differentials. When taken together, this data will provide reliable information that enables an appraiser to make accurate adjustments and demonstrate current market value for a subject property.

In addition to the sales-comparison approach, commercial property owners can and should consider other valuation methods to establish the current market value of their property. With knowledge of current market rental rates, expense ratios, lending requirements and capitalization rates, an owner can value their commercial property using the income approach, for example.

The more recent the respective leases were negotiated and signed, the more indicative of the current market rental rate. Current expense statements and capitalization rates can be used to ultimately present a credible, current market value of the property.

Taxpayers deciding whether to appeal a property tax assessment may be frustrated or confused by the market's low deal volume. Property tax professionals are equipped to provide advice and assessment appeal strategies in any market type, however. That means tax relief may be available despite the difficulty the current market has placed on the sales comparison approach to valuation.

Understand the issues in filing strategic property tax appeals to reduce property tax.

Data centers are the current darling of CRE – which makes them a targeted sector of commercial real estate on which local assessors are laser focused. Due to the nature of the investment, there is less political heat for putting the tax burden on data centers. These taxpayers comprise a distant-faceless corporation, unlike other real estate classes who either have local employees or residents who can be affected by higher taxes. Combine the political ease with the fact that it is one of the few sectors that seems to have a clear growth forecast for the next several decades, ensuring that it's in for a tough battle with assessing offices. But the growth flurry in this marketplace shouldn't cause taxpayers to be unfairly taxed.

Data centers are a relatively new sector, compared to office, industrial and retail. The majority of assessors have likely had few, if any, of this property type in their townships. Thus, the probability that assessors have the understanding and expertise regarding the nuance and specialization of this property is highly unlikely, and a recipe for illegal taxation. It is critical that owners annually fight to keep their taxes at a reasonable level. A compelling argument, focusing on depreciation, business value and personal property allocation is critical.

Accelerated Depreciation

As Artificial Intelligence, AI, enters into its Golden Era, new requirements for data centers have exploded. The convergence of AI, autonomous driving vehicles, and smart residential properties will more than double the need for global storage capacity by 2027, according to JLL's Data Centers 2024 Global Outlook. But second generationcenters will have a difficult time getting their piece of the windfall.

AI clustered servers are much more powerful than previous servers and emit significantly more heat.Thus, the electrical and cooling requirements will be markedly different from the data center designs of the past. Energy efficient designs, locations in areas with affordable and reliable power supplies, sustainable power supplies, as well as local development incentives, will be the main drivers of demand moving forward.But as the new design requirements evolve in the future, the older centers will lose value quickly.

Depreciation is much more rampant on special use properties like data centers. Typically, an industrial building has as economic life of 50-60 years, with 2% annual depreciation. However, data centers will depreciate 5-10% annually. This is due to functional issues associated with the special use, according to Ed Kling, MAI Appraiser at Caton Valuation.

For example, the requirements of the mechanical and electrical hardware will be out of date within 15-20 years, according to Malcolm Howe, critical systems partner at engineering consultancy Cundall. Accelerating depreciation on 30% to 50% of the capitalized costs is typically achievable. Factors such as the level of security, the complexity of cooling systems, the number of redundant systems, and site improvements will determine this percentage.

Business Value

Assessors will wrongly assume that the rents associated with data centers, or their value in the market, is solely based on the bricks and stick of the real estate itself. However, as any operator is well aware, one can't disregard the business reputation of the owners and operators, as well. Much like hotels and self-storage, where the value differentials in many cases are due to the level of service, data center operators are known for their expertise. Users base their choice of vendors on criteria such as scalability (how can your needs grow with this provider), reliability (what is the historical uptime of the provider), deployment efficiency (can your infrastructure be set up timely and efficiently), network ecosystem (simplicity of multi-cloud interconnection and management) and financial stability (does the provider have a strong history or could it close within a year).

Unlike other commercial real estate, data center operators are actively monitoring every aspect of their properties to ensure that the client's data is secure. Generally speaking, if any building system fails in another real estate sector in the short term, the harm to the commercial tenant is minimal. However, short term system failure in data storage could mean the complete operations of an organization could be decimated permanently. Therefore, much like the energy costs to operate, the insurance costs are extremely high due to the multitude of risks inherent in providing services.

Similar to Hotels and Self Storage, data center owners are allowed to have a "return of" and a "return on" their personal property and operations investments, as well as deductions for management and reserves for replacement. Thus, some profits should be deducted with other expenses in calculating Net Operating Income.

But more importantly for the savvy operator, the appraiser should account for the stellar reputation of the operator compared to the general market. Logically, a provider with excellent business practices, highly functioning property management and historical success should be able to garner higher rents than other operators. But that escalated rent is due to the business of the operator, not the real estate itself.

Taxation as Personal Property

Data center operators also need to thoughtfully identify real property from personal property for taxation purposes. Forgoing this exercise may result in double taxation in states with personal property tax, or over taxation in states without personal property taxes where such property is wrongfully taxed by local assessors.

And the time is... now

Based on the strategies listed above, owners of data centers must thoughtfully appeal their assessed valuations on an annual basis. This sector must be looked at through a completely different lens than any other property type, due to the accelerated depreciation issues, strategic business value integrated into the property and potential for double taxation. Investors must work with seasoned professionals who understand the complexities of this product type and present the nuanced argument thoughtfully and convincingly to assessing official, or else the bottom line will be unfairly affected.

State's replacement-cost valuation methodology skews some property assessments, thwarting uniform and equal taxation.

Pivotal property tax rulings by the Nevada Supreme Court presume that strict adherence to valuation methodology ensures that similar properties are assigned similar taxable values. But what if the state's required valuation methodology results in differing taxable values for similar properties?

Uniform and Equal

The Nevada Constitution protects property owners from arbitrary tax assessments by requiring the Legislature to "provide by law for a uniform and equal rate of assessment and taxation" and "prescribe such regulations as shall secure a just valuation for taxation of all property, real, personal and possessory."

Twenty years ago, in what was called a "tax revolt," property owners in Incline Village relied on this provision of the Constitution to successfully challenge the methodology the Washoe County Assessor used to value their properties. The revolt found its way to the Nevada Supreme Court, which ultimately issued two opinions.

In State, Board of Equalization vs. Bakst, the Nevada Supreme Court in 2006 rejected the assessor's property valuation because the methodologies he used had not been approved by the Nevada Tax Commission, were not applied uniformly in Washoe County, and were not the same as the methods used by assessors in other counties. The Court noted "the Constitution clearly and unambiguously requires that the methods used for assessing taxes throughout the state must be 'uniform'."

In 2008, the success achieved in the Bakst case was reaffirmed in State, Board of Equalization vs. Barta, where the court stated that "like properties' taxable values must be obtained using uniform assessment methods." In the same ruling, the Court elaborated that "a property value determined using unconstitutional and nonuniform methods is necessarily unjust and inequitable."

An Imperfect Process

In Nevada, the taxable value of improved property is calculated using a replacement-cost approach that is defined by state law. Under this statutory approach, assessors value the land component and improvement component separately. The land component is valued "consistently with the uses to which the improvements are being put," while the improvement is valued at replacement cost, less depreciation.

Assessors must determine replacement cost using Marshall & Swift cost manuals. And, instead of relying on market-derived depreciation, state law requires assessors to depreciate improvements at the rate of 1.5% per year for 50 years. Assessors compute a parcel's final taxable value by adding the value of the land component and the value of the improvement component.

In Barta, the Court expressed an assumption underpinning both the Bakst and Barta cases when it stated that this replacement-cost approach, if "properly applied, will necessarily produce the same measure of taxable value for like properties."

Does it, though? If this assumption fails to prove consistently true, then the statutory replacement-cost approach is burdening some property owners with more than their fair share of property tax.

Inequity in Action

To test whether this is the case we compared the taxable value of two homes which recently sold in Washoe County. We chose single-family residences because of the availability of sales data, but the conclusion we draw from this data should be just as applicable to commercial properties.

One property sold for $1 million, and the other for $975,000. The attributes of the two homes were different but their market values were roughly equivalent.

One would expect the taxable values of the two homes to be similar as well, but that is not what we found. The house which sold for $975,000 is assigned a taxable value which is more than twice the taxable value of the home which sold for $1 million.

More likely than not, the difference in the taxable value assigned to the two properties is the result of strict adherence to the statutory replacement-cost approach. That approach requires the assessor to reduce the value of a home by depreciation, even if the home is appreciating in value.

In our example, the house which sold for $1 million was built in 1970 and is assigned a taxable value which is 26.2% of its sales price, while the one which sold for $975,000 was built in 2021 and is assigned a taxable value which is 58.0% of its sales price.

Similar examples abound. Among the sales we reviewed, the average sales ratio (calculated by dividing taxable value by sales price) for homes built before 1971 is 31.6%, while the average sales ratio for homes built after 2012 is 65.5%.

This problem extends to all property types including commercial, because the assessor is required to follow the same statutory replacement-cost approach.

What does this mean for taxpayers? Property owners with improvements constructed relatively recently should evaluate whether the taxable value of their property is unreasonably high when compared to the taxable value of other properties put to the same use.

If an assessment is inequitable, redress is available by filing a timely protest. The county boards of equalization have the authority to reduce the taxable value of property where it has been assessed at a higher value than other property with identical usage and a similar location.

In summary, adherence to the statutory replacement-cost methodology is not resulting in evenly measured taxable values for like properties. Instead, the methodology has created systemic inequality. Properties with older improvements which have appreciated are systematically undervalued. As a result, some properties are assessed at less than half the value of comparably priced properties with newer improvements.

This disparity calls into question whether Nevada is achieving its Constitutional promise of a just valuation and uniform and equal taxation. Property owners should make certain their tax assessment meets the constitutional requirements of uniform and equal or seek help from a property tax professional to make that determination.

As rising interest rates and other challenges worry commercial property owners with loans nearing maturity, a running theme in the real estate industry is to "survive until '25." For hotel owners, however, the year-to-year struggle to stay afloat has been ongoing.

Hoteliers that survived the industry's downturn from the COVID-19 pandemic may have thought their troubles were ending, only to be slammed with record-setting inflation and skyrocketing interest rates. During the pandemic and the uncertainty it unleashed on hospitality operations, many jurisdictions across the country provided hotel owners with some form of property tax relief. For example, one jurisdiction removed all improvement value from hotel assessments and only applied land value in determining property tax liability.

Relief measures are winding down, however. Many jurisdictions have begun to value hotel properties as they did prior to COVID, claiming that the hospitality industry has rebounded.

While in many instances, industry statistics such as occupancy and revenue per available room or RevPar show some markets recovering, it is important to know that each hotel property is unique. That's why it is critical for property owners to review individual property tax assessments annually and determine whether the asset may be a good candidate for a reduction.

Competing approaches

Many jurisdictions have recognized that hospitality properties are operating businesses, with real estate serving as only one component of the overall valuation. Property owners typically must prove the proper allocation of that real estate component when challenging their tax assessments.

Over the last two decades, appraisers, tax assessors and property owners have employed two competing methodologies to allocate value to the real estate component of hotel properties in calculating taxable value. Those are the Rushmore Method and the Business Enterprise Value Method.

Taxing jurisdictions often value hospitality properties using the Rushmore Method, which removes management and franchise fees from the income stream as part of an income-based assessment. Proponents of this method argue that removing management and franchise fees offsets the business value, and that all remaining income should be applied to the real estate value.

By contrast, the Business Enterprise Value Method applies a more in-depth analysis to identify income streams attributable to each component of a hotel's going-concern value. The appraiser or assessor can then capitalize the remaining income stream, which is attributable to the real estate alone, to determine taxable property value.

A hotel owner should be sure to differentiate and clearly communicate the business' various income streams on a profit-and-loss statement. This will ensure that their property tax counsel and appraiser adequately understand and allocate income to appropriate components of the business.

While these methodologies may seem foreign to some hotel owners or taxing jurisdictions, they are familiar to business valuation professionals. These experts apply similar methods to valuing business components during mergers or the outright acquisition of a business.

In a conventional, income-based real estate valuation, an appraiser applies a market capitalization rate to a property's income stream to determine value. In the valuation of a business, experts can develop an appropriate capitalization rate for components of the business' income by taking the weighted average cost of capital, less an appropriate long-term growth rate, such as an inflation forecast. A similar approach can derive a going-concern or valuation of non-realty components from individual income streams within a larger hotel operation.

On top of analyzing the income streams for a hospitality property, it is important for the taxpayer's appraiser to analyze property improvement plan requirements. Hotel owners report anecdotally that as the effects of COVID have waned, hotel brands have grown stricter in enforcing post-COVID property improvement plan requirements.

Taxing jurisdictions often review building permits pulled during these renovation periods to gauge improvements made to the property. This often translates into higher property tax assessments. Depending on a jurisdiction's laws, however, these improvement plans carried out for brand compliance do not necessarily increase real estate value.

Business Enterprise Value advances

Rushmore was taxing authorities' go-to method for valuing hospitality properties for a long time because of it simplistic and straightforward nature. Over the past decade, however, significant legal decisions have found the Business Enterprise Value Method preferable over the Rushmore Method.

The first major decision in this area was SHC Half Moon Bay LLC vs. County of San Mateo. In this 2014 California case, the court found that the county's real property valuation methodology failed to properly exclude business values for the hotel's workforce, the hotel's leasehold interest in the employee parking lot, and the hotel's agreement with a golf course operator.

The second major decision occurred in 2020 in Florida. In Singh vs. Walt Disney Parks and Resorts U.S. Inc., the court found that in using the Rushmore Method, the county's appraiser failed to remove all intangible business value from the real property assessment.

Although taxpayers have notched key victories in employing the Business Enterprise Value Method to allocate value to the real estate component of hotels, there are still jurisdictions that steadfastly apply the Rushmore Method to hotel property tax assessments.

Hospitality owners seeking to improve their odds of success in a property tax dispute should consider working with tax counsel that intimately knows both the case law in their jurisdiction and the differences between competing valuation methodologies. This knowledge is critical to communicating strong arguments to tax tribunals and assessors.

Commercial property owners may still reduce taxes based on COVID-era interest rate cuts, but that window may be closing.

The Federal Reserve finally delivered a much-needed reprieve for investors by lowering the federal funds rate by 0.5% on Sept. 5. This reduction is especially welcome after an extended period of rapid interest rate hikes. For commercial property owners, however, a window may be closing on the opportunity to reduce property tax assessments based on the low interest rates that reigned during the COVID-19 pandemic.

Mortgage rates have eased slightly this year from a peak in October 2023. The average 30-year mortgage rate reached a 23-year high of 7.79% the week ending Oct. 26, 2023, marking the end of its climb from a staggering historical low of 2.66% in December 2020, according to the Freddie Mac Primary Mortgage Market Survey.

This striking contrast is crucial for commercial property owners, particularly those who bought their properties between early 2020 and the summer of 2022. That's when historically low interest rates had the 30-year mortgage rate bouncing along as low as 2.10%.

An investor who purchased commercial real estate in this timeframe may still be enjoying a favorable mortgage rate locked with their acquisition. By the same token, the property tax assessment on that transaction might still reflect an inflated purchase price from those years, owing to the effect that ultra-low-cost debt was having on market pricing at the time.

Today, taxpayers in this position may be able to argue that current market conditions no longer support that valuation, providing an opportunity for an assessment reduction and tax savings.

Learn the law on assessments

A taxpayer deciding whether to appeal their assessment should begin with an understanding of the objectives and legalities governing the assessor's actions. Most jurisdictions assess property based on a percentage of its fair market value at a specific date, often Jan. 1 of the tax year.

Assessors frequently rely on market sales data to estimate value, giving significant weight to recent sales involving the subject property. But the sharp change in interest rates, coupled with stricter lending standards, recently has led to a significant slowdown in commercial real estate transactions.

Because the assessor relies on sales data, this lag in transaction activity means they may not fully capture the impact of today's financial environment on current pricing and property values. For taxpayers, this presents an exciting opportunity to argue for reduced assessments.

To successfully claim a reduction, it is critical for the taxpayer to understand how the assessor valued their property and how current market conditions differ from those at the time of acquisition. For instance, if the property is being taxed based on transaction values from 2020-2022, the taxpayer could reasonably argue that its worth has since decreased due to inflation, the rise in interest rates, and tightened lending standards.

In preparing arguments for a reduced assessment, the property owner should be ready to show how conditions and trends that drive commercial real estate value support their call for a lower valuation. Several key factors are weighing down real estate values today, including rising interest rates, inflation, elevated operational costs, and anemic rent growth.

Vacancy rates remain high across many commercial sectors and rent growth has slowed. Lenders are adhering to strict terms on allowable loan-to-value ratios, reserves and other requirements, even after the Federal Reserve's recent rate cut. The Federal Reserve's July 2024 Senior Loan Officer Opinion Survey reflects that tighter lending standards and limited demand for commercial real estate loans are still in effect.

Commercial property prices fell by 7% over the past year and are down 21% since March 2022, according to Green Street's Commercial Property Price Index. Taxpayers can leverage this valuation decline when seeking a property tax assessment reduction.

Show effects of change

When meeting with the assessor or tax review panel, demonstrate the property's decreased value by comparing the lending environment and market conditions from the time of purchase with those at the most recent assessment date. Additionally, present any other salient factors, like the inflationary pressure on insurance, maintenance, and operational costs. While rents may have risen, assess whether that increase is sustainable or inflated considering today's higher tenant improvement costs.

Taxpayers should decide whether they need third-party experts to support their case. An experienced appraiser can provide an objective valuation and serve as an expert witness if necessary.

Even taxpayers who believe they have a good grasp of their property's worth can benefit from the advice of a recognized third-party expert, who can strengthen their case by explaining and substantiating the data to the assessor. An appraiser who is educated about the local submarket and who can convey that knowledge in a format this is easily digestible will likely raise the chances of success.

The window is closing

This opportunity will not last long. The further removed the assessment year is from the low-interest-rate period associated with the property's inflated assessment, the less relevant those conditions will be in seeking and supporting a property tax reduction. Moreover, the longer a property's assessed value remains unchanged, the harder it becomes to argue for a reduction.

Taxpayers can increase their chances of success by working with knowledgeable local appraisers and advisers familiar with property tax law in the subject property's jurisdiction. Preparing for a possible trial will often lead to a favorable settlement before reaching that stage.

Taxpayers should seize this chance now to secure the tax savings they deserve, before the opportunity is gone.

Highest and best use analysis can be a key to reduced property tax valuations, observes Timothy A. Rye of Larkin Hoffman.

Ad valorem property taxes reflect real estate value, and in most states, assessors value a subject property at market value based on its highest and best use. Although assessors often assume the current use is highest and best, taxpayers who analyze their property's usage may discover an opportunity to reduce their assessment by showing its optimal use has changed.

What is highest and best use?

Highest and best use is the "reasonably probable use of property that results in the highest value," according to the Dictionary of Real Estate Appraisal, 6th Edition. Along with that definition the publication includes four criteria the highest and best use must meet, requiring that the use be legally permissible, physically possible, financially feasible, and maximally productive.

For property tax valuation, assessors, appraisers and property tax attorneys need to consider each factor in a highest-and-best-use analysis. For most properties, determining whether the current use is legally permissible or physically possible is easily ascertained by answering the question, "Can the property do what it is doing?"

Determining whether a use is financially feasible or maximally productive is trickier. Financial feasibility of the current use may be as simple as identifying whether the property generates a positive net operating income, or if it would be cost prohibitive for the user to replace the space with an alternative property.

The analysis gets more complicated when trying to determine whether the use is maximally productive.

Take the example of an aging office building with declining occupancy. Should the owner invest money in building improvements with the goal of attracting more tenants, or is it better to vacate the building and convert it to multifamily use?

In this example, the first option would require a discounted cash flow analysis that considers an extended period of renovations, tenant improvements, vacancy loss during lease-up, and leasing commissions. In other words, the building would be valued as though it were stabilized at some point in the future, the costs associated with achieving stabilization would be deducted, and the future value and investment costs would be present valued to the valuation date.

Alternatively, the property could be valued like a new development with the projected use as multifamily. Whichever use has a greater value in today's dollars is the winner, or maximally productive use, and therefore the highest and best use.

The tipping point

When does a property's current use stop being its highest and best use? It could be when new development is in high demand and buyers will pay more for the land alone than they will for the property with existing structures.

It could be when the property is losing tenants and accumulating significant vacancy. The market sees the building as less appealing, and the remaining tenants start looking for more vibrant properties. Or it could be when the building is simply worn out and the cost to fix or restore it is greater than its value would be after repairs.

Every property will have its own unique set of circumstances to signal the practical end of its current use, but once a usage starts to tip, it seldom comes back. When the tipping point arrives, the highest and best use changes, and can have a profound impact on valuation.

Usage drives taxable valuation

When a property's current use is no longer highest and best, the property tax valuation likely should change too. While property tax assessments are generally based on the highest and best use, the mass appraisal techniques assessors employ to value properties are unlikely to incorporate highest and best use changes. The volume of properties assessors must value is simply too large to include individual highest and best use analyses.

As a result, it is up to taxpayers and their property tax counsel to identify when the highest and best use has changed and bring it to the assessor's attention, either informally or through a property tax appeal. In preparing arguments for such a meeting, remember that valuations based on highest and best use require data reflecting the highest and best use.

For example, if an office building is no longer viable as an office, but rather its highest and best use is conversion for multifamily residences, then the comparable sales should comprise sales of buildings that are also facing a change to multifamily. Using sales of stabilized office buildings as comparable sales would result in improper valuation of the subject property hypothetically stabilized with office tenants, rather than pursuant to its actual highest and best use.

Commercial real estate markets are experiencing significant changes, straining many property operations and owner cash flows. As a result, it is critical to carefully analyze highest and best use when reviewing property tax assessments.

Justices recognize owner rights extend to surplus proceeds from properties sold after tax sales.

Federal courts rarely adjudicate property tax matters, which have traditionally been the province of state courts. In May 2023, however, the U. S. Supreme Court issued a unanimous decision in a case that squared state property tax law up against the Fifth Amendment takings clause, which prohibits taking private property for public use without just compensation.

Taken for taxes

The events leading to Tyler vs. Hennepin County, began in 1999, when Geraldine Tyler purchased a Minneapolis condominium that she occupied until she moved into a seniors housing community in 2010. Ms. Tyler retained ownership of the condominium but failed to pay property taxes on it for several years, resulting in approximately $2,300 in unpaid taxes and $13,000 in interest and penalties.

Acting in accordance with Minnesota tax forfeiture procedures, Hennepin County seized the condominium and sold it for $40,000. This extinguished Ms. Tyler's $15,000 tax debt, and Hennepin County kept the remaining $25,000.

Minnesota's tax forfeiture procedure required the county to give the delinquent taxpayer adequate notice of the tax sale; notably, the procedure lacked a mechanism for a delinquent taxpayer to assert a claim to any sale proceeds remaining after paying off the tax debt.

Ms. Tyler brought a putative class action suit against Hennepin County in Minnesota federal court alleging that Hennepin County's retention of $25,000 in excess proceeds from the sale of her condominium was a taking of property without just compensation, and therefore an unconstitutional violation of the takings clause. The lower courts rejected her claims, and the case made its way to the U.S. Supreme Court.

The Supreme Court first noted that the takings clause does not itself define private property which, if taken by a state, requires compensation. The Court then conducted a thorough analysis of historical practice and traditional property law principles to determine that the surplus value remaining after a forfeiture sale constituted compensable property under the takings clause.

The Court concluded that the right to surplus proceeds is simply an extension of the corresponding interest in the underlying property. Thus, the Court recognized that a taxpayer's compensable interest in property applies to the underlying property itself and to equity in that underlying property in the form of excess proceeds generated from a forfeiture sale of that property.

Accordingly, while Hennepin County had the power to sell Ms. Tyler's home to recover the unpaid property taxes, it could not use the tax debt "as a toehold" to confiscate more property than was due, the Court stated. Doing so effected a "classic taking in which the government directly appropriates private property for its own use," such that Ms. Tyler was entitled to just compensation from Hennepin County.

Mechanisms mandate?

Unfortunately, the Supreme Court's recognizing a property right in surplus proceeds does not mean that states must now automatically return surplus proceeds to delinquent taxpayers. Nor does it directly address how states should administer their tax forfeiture sales to prevent infringing on taxpayers' constitutional rights.

But the Court did give some guidance in Tyler as to what statutory measures might prevent a takings clause violation. The Court cited Nelson vs. City of New York, decided in 1956, in which the city foreclosed on properties for unpaid water bills. Under the applicable ordinance, the aggrieved property owners had an opportunity to request the surplus from any sale by filing a timely answer in the foreclosure proceedings asserting that the properties had a value exceeding the amount due.

The property owners failed to do so, however. The Supreme Court held that, because the owners did not take advantage of this procedure, they forfeited their right to the surplus. Because the ordinance did not absolutely preclude an owner from obtaining the proceeds from a judicial sale but simply defined the process through which an owner could claim the surplus, there was no takings clause violation.

States are already reacting to the Tyler decision. In New Jersey and Virginia, courts have struck down state court tax sale procedures as unconstitutional under Tyler. Nebraska has amended its tax sale statutes to conform with Tyler.

Louisiana is following suit: Under current law, a tax sale grants the purchaser a prospective ownership interest in the form of a tax lien. This lien represents a claim on the property but does not confer immediate ownership rights. The purchaser can acquire full ownership after the redemption period has passed.

After Tyler, the Louisiana Legislature proposed amending the state's constitution to require adding to the state's tax sale procedures a process for delinquent taxpayers to claim any excess proceeds from a tax sale. The measure must be approved by the electorate and is on the December ballot for voter consideration.

Chief Justice John Roberts noted in Tyler that a taxpayer must render unto Caesar what is Caesar's, but no more. While states are conforming their laws to Tyler, taxpayers and aggrieved property owners must still comply with governing statutory procedures to claim their surplus and prevent Caesar from getting more than he is entitled to.

Lawmakers have the opportunity to transform onerous tax mechanisms into programs that boost affordable housing development.

Together with high rent and exorbitant property values, the real property taxes that fund necessary services in New York State make housing affordability a significant concern for low- and middle-income residents. To ensure a sufficient supply of affordable housing, the state must address the ad valorem levy, whereby taxes derive from a property's market value.

This article examines the critical interplay between New York's property tax policies and housing affordability. While some taxing mechanisms hinder the development and availability of affordable housing, adjustments and a few additions to those practices have the potential to promote the affordable sector.

Exemptions, Incentives

New York's real property tax system supports a complex framework of entities that rely significantly upon property tax levies to generate revenue and fund their budgets. Property taxes, assessed at the local level, support essential services such as public schools, police, libraries, highway departments, fire districts, open space preservation, out-of-county college tuition and the New York State Metropolitan Transportation Authority, among others.

To encourage the development of affordable housing and ease the burden that real property taxes can impose on developers and owners in the sector, New York offers several tax exemptions and incentive programs. Availability and benefits for some of the programs vary depending on a project's location.

One such option for developers is the 421-a Tax Incentive Program, also known as the Affordable New York Housing Program. Aimed at developers of new-construction multiunit housing, the program can provide full property tax exemptions during construction, followed by a graduated phase-in to normal taxation once the project is completed. In exchange, applicants must reserve a portion of the units to rent at affordable rates.

Another option, originally enacted by the federal Tax Reform Act of 1986, is the Low-Income Housing Tax Credit Program. This gives state and local agencies the authority to issue tax credits for the acquisition, rehabilitation, or new construction of rental housing targeted to lower-income households. Developers receiving these credits can then sell them to investors, generating equity for the project and reducing their need for debt financing. While this may not be a direct property tax exemption, it can significantly promote the financial feasibility of affordable housing developments.

A third initiative was created by The Housing Trust Fund Corp. as a subsidiary public benefit corporation of the New York State Housing Finance Agency. It provides funding to eligible applicants to construct low-income housing or to rehabilitate vacant, distressed, or underutilized residential or non-residential property to residential use for occupancy by low-income individuals. These funds often come with property tax exemptions or abatements, reducing operating costs for affordable housing providers.

In addition to these broad exemptions, individual homeowners may qualify to ease high property tax costs via incentives such as the School Tax Relief Exemption or exemptions for senior citizens, veterans, people with disabilities, clergy, and certain agricultural properties, among others. A property tax professional can help developers or homeowners determine what programs are available to reduce the tax burden for their property.

Challenges, Criticisms

Despite the evident benefits these programs bring to communities, critics argue that property tax exemptions can create inequities in the tax system. Large developers might benefit disproportionately from programs like 421-a, for example, while smaller property owners bear a more significant tax burden. Additionally, critics argue that tax-abatement-based programs fail to address other challenges that impede the creation of new affordable housing. Affluent neighborhoods, for instance, often resist new affordable housing projects, thwarting development efforts and perpetuating socioeconomic divides.

Administering property tax exemptions and deciphering potential incentives can be complex and burdensome. Developers must navigate convoluted application processes and compliance requirements, which can delay projects and increase costs. Local governments also face challenges in ensuring proper implementation and monitoring of these programs. Real or perceived complexities associated with application processes for permitting, financing and incentives often constitute a barrier in themselves, discouraging developers from undertaking new affordable housing projects.

Ongoing underserved renter demand for affordable housing suggests the current assortment of incentives is failing to achieve the desired outcome, which is to ensure an adequate supply of affordable housing. Rising construction costs, limited availability of suitable land, and community opposition exacerbate this imbalance, resulting in a persistent gap between the number of affordable units needed and those available.

A Call to Action

New York lawmakers have the opportunity to boost affordable housing efforts by enhancing the effectiveness of property tax policies that promote the sector. Simplifying the application and compliance processes for tax incentives would be a significant first step that would encourage more developers to participate.

Following on the theme of simplification, the state should consider creating a centralized information hub with dedicated support for all development incentives. This would give developers a single resource to help them navigate the bureaucratic landscape and complete new affordable projects successfully.

Answering the call for more affordable housing will require more than tax abatements, however. Leaders must find ways to increase funding for affordable housing programs. Additionally, offering low-interest loans, grants, and technical assistance to non-profit developers would enhance their capacity to deliver affordable units.

New York State's real property tax system plays a crucial role in shaping the affordable housing landscape. While current tax exemptions and incentive programs provide some essential support, challenges remain in achieving equity, efficiency, and adequate supply. By refining these policies and addressing systemic issues, New York should be able to make significant strides toward ensuring that affordable housing is accessible to all its residents.

Taxpayers transforming office buildings into living space can argue for a lower property tax assessment.

The conversion of obsolete office buildings to new uses is a growing trend in many markets, especially in dense urban centers. Unfortunately, properties under reconstruction can continue to incur hefty property tax bills, even when the asset lacks a rent stream to help offset the owner's costs.

The right arguments can help these taxpayers reduce their property tax liability during a building conversion, however, and set the stage for an accurate, fair assessment of the asset's adjusted market value under its new use. The taxpayer's challenge is to understand how reconstruction affects market value and to show assessors how those forces affect taxable value.

Obsolescence and opportunity

Demand for office space was already faltering when the COVID-19 pandemic accelerated occupancy declines. Since then, remote work and space sharing among office workers has further reduced the amount of offices companies need, with many tenants returning space to property owners as leases mature.

Normally, appraisers value multitenant office buildings under an income approach, attributing rental income per square foot as a starting point for valuation. When the space loses market viability, the per-square-foot rent variable declines and lowers the net valuation for tax purposes.

Expanding this result over an entire central business district can erode the tax base significantly as older buildings lose value. Many older properties struggle to compete with newer spaces, in addition to suffering from declining post-pandemic user demand. In essence, the older office towers were hampered by economic obsolescence.

Downtown office vacancy rates now exceed 25 percent in many major cities, dealing a significant blow to market value and, subsequently, tax value. Obviously, owners and city government share a common goal of maximizing property usage, which increases revenue to the owner and tax value to the government.

One solution gaining traction in markets with strong residential demand is converting obsolete office buildings to residential apartments or condominiums. This is a multistep process that can take considerable time, possibly spanning one or more tax years.

Investments in time

The first task in a conversion is to empty the building, an often protracted process that simultaneously reduces the property's income and market value. Waiting for each lease to expire while revenue streams decline can be an expensive exercise. Taxpayers should ensure that the assessor has factored in this negative movement in the building's value under the income approach. When few tenants remain, the owner may choose to buy out the remaining leases.

Reconstruction begins with demolishing building components that will not fit the future use. For example, suspended ceilings commonly used in office buildings are unsuitable for living spaces and would need to be removed.

While this phase can start before the building is completely empty, it cannot be finished until the building is unoccupied. During this period, the income generated is virtually zero and has a continued negative effect on the building's market value and taxable value.

The project design will be partly determined by the local apartment market. Creating a product that will compete successfully for tenants has a direct impact on cost, finish work and amenity choices. During this stage, the owner is incurring costs without generating income from the property.

Because the building is as an empty space during conversion, income-based valuation methods no longer apply. Appropriate value would be that of an old, empty building that is economically obsolescent. Further, the value would be lower than when the building still had office tenants.

New beginnings

The building owner can begin to attract potential residents during the conversion. While tenants may sign leases, they will not be paying rent until the building has received a certificate of occupancy from local government.

This marketing period is an extension of the construction phase that could bring the start of a residential rent stream closer by having tenants lined up. This gives the owner a vision of future value and may also allow a return to the income approach to valuation by more clearly defining the property's function.

Once the property is available for residential use, a different revenue stream will begin and grow as tenants lease the units. Clearly, taxpayers should make sure assessors apply the income approach as the building moves toward full occupancy. Residential units typically generate lower rent per square foot than office properties, but healthy occupancy will more than make up for the slight reduction from the asking rental rate on an obsolete office building in a declining market.

Usage conversion is a long and meandering trail that a property owner must travel before a new use can begin to generate revenue and a return on investment. By protesting tax assessments that fail to reflect the asset's diminished value during this process, taxpayers can at least defend against an unfair tax burden.

The steps outlined here for transitioning from office to residential space have many moving parts and presuppose the owner has identified residential demand to support the new use. Many urban cores have experienced an uptick in urban living, however, and with the right circumstances, many old buildings can be converted for increased use. Consequently, while the process is time consuming, the net result may prove invaluable to the owner and taxing authority.

Ancillary services have become a crucial revenue generator in student housing and can help owners improve occupancy, justify higher rents and increase tenant satisfaction. In an industry that often correlates income with market value, however, it is critical to distinguish ancillary service revenue from real estate value and property tax liability.

Failure to properly distinguish between real estate and intangible business assets can lead to unfair valuations and excessive property tax bills. Simply put, real estate is land and improvements to that land, such as buildings. Intangible assets, as the term suggests, cannot be held or touched. Examples include business service operations and partnership contracts with third parties.

To help taxpayers recognize the intangible components of their private, off-campus student housing operations, we will review some of the most popular services that owners are using to boost revenue today. Then we will explore strategies for managing valuation and tax implications of these non-real-estate income streams.

Selling premium amenities and convenience

Owners and operators working to improve the financial performance of their off-campus properties know that increased rents and occupancy are not the only ways to drive revenue. By adapting to student renters' changing wants and needs, providers are turning ancillary services into significant revenue producers.

Here are a few of the key services at many properties today:

High-speed internet. Working with a provider to offer broadband internet connectivity as a premium feature can generate hundreds of dollars per unit annually for a student housing operator.

Fitness centers. Property managers know that offering tenants access to an on-site or nearby fitness center can justify increased rental rates. Some properties partner with a local fitness center to ensure access for their residents or to provide on-site programming such as yoga classes.

On-site laundry services. This revenue generator is a no-brainer, which is why landlords for decades have offered access to coin-operated washers and dryers. On-site laundry facilities at a 100-unit apartment building can easily generate $10,000 annually. With student housing's higher density, operators have the potential for more substantial revenue. Owners without laundry facilities may be able to partner with a nearby laundry or dry cleaner to offer these services.

Movers. When a new tenant signs a lease agreement, some student housing managers provide the new resident with an email link or advertising material from a local moving company offering moving kits, boxes, packaging tape or services. The referral agreement behind this relationship is yet another potential income producer for the landlord.

Advertising. Student housing managers often sell advertising to local businesses. Restaurants, retailers and service providers may buy ad space in tenant emails or plaster vinyl ads on the outside of the property's elevator doors. Partnerships with area restaurants or other businesses may also bring in referral fees or commissions.

Housekeeping: Many student housing owners have taken a page from assisted living operators' book by offering cleaning service options to their residents.

Separate ancillary revenue from real estate value

It is crucial for off-campus housing providers to differentiate ancillary services revenue from the real estate value of the property and to ensure the local tax assessor recognizes this distinction when valuing their property for taxation. This is important because ancillary service revenues represent money derived from intangible business assets rather than from the real estate.

The owner of a student housing property with ancillary revenue streams should track this income specifically and separately in record keeping. Resist the temptation to throw specific ancillary income into a catchall "other income" line item on the property's income and expense spreadsheet.

When student housing properties trade hands based, in part, on revenue attributable to ancillary services, their improved economic performance generates higher sale prices than do properties under less creative management. Over and above the total sale prices reported to the public, were an assessor or appraiser to include revenue from ancillary services in property valuations, it would lead to inflated assessments.

Accurate assessments should reflect only the real estate value excluding business income. And properties with extensive ancillary services might appear more valuable compared to those without, even if the actual real estate is comparable.

Owners and managers of private, off-campus student housing can help to ensure fair property valuations and tax liability by conducting annual reviews.

Regular and careful reviews of assessments can identify and help correct any discrepancies, saving the property owner money in reduced tax bills. If a property is over-assessed, consider challenging that assessment. Each jurisdiction presents unique rules, laws and challenges requiring careful and informed decision making, Taxpayers often find it helpful to consult an experienced, local property tax professional before deciding whether to begin a valuation challenge.

Outdated valuations create risk of assessment increases under Shelby County's 2025 reappraisal.

In late 1811 and early 1812, West Tennessee's New Madrid Fault produced several earthquakes greater than magnitude 7.0, swallowing the town of Little Prairie, Missouri, in liquefaction and temporarily reversing the flow of the Mississippi River to crest its banks and create Reelfoot Lake.

Almost 200 years later, pseudo-scientist Iben Browning infamously sparked an earthquake frenzy by predicting another major New Madrid quake would occur on Dec. 3, 1990. School children of the 1990's likely still remember earthquake drills in the classroom and "earthquake kits" (trash cans filled with food, water and medical supplies) assembled and stored in basements and garages for years after.

Fortunately, Browning's prognostication was a dud and nothing happened. Still, those living above the New Madrid Fault today know in the back of their minds that "The Big One" could hit at any time.

For taxpayers, that time may be 2025, when Shelby County Assessor Melvin Burgess will reappraise properties countywide to 100 percent of fair market value for the first time since 2021. It may not shake buildings to the ground or flood low-lying areas, but the 2025 reappraisal could do grievous damage to unprepared taxpayers.

Market heat builds pressure

During the Shelby County reappraisal in 2021, the market was recovering from the 2020 slow-down in lending and sales transactions due to COVID-19. The assessor seemed to take the pandemic into account, refraining from aggressively capturing all of the market's growth from 2017 to 2019.

Low interest rates helped transaction volume accelerate in 2021 and the first half of 2022, however, quickly putting distance between the assessor's mercifully low appraisals and actual market value. The real estate market cooled after interest rate hikes in late 2022, but the value differential was already significant. A sales ratio study by the Tennessee Division of Property Assessments indicated the overall level of assessor's value in Shelby County was 75.87 percent of actual market value by Jan. 1, 2023. That ratio could be even lower for individual properties.

Shelby County's 2025 reappraisal program will aim to eliminate such undervaluations. The bigger the current undervaluation, the bigger the taxpayer's potential increase next year.

This is a major flaw in long reappraisal cycles: Undervaluations expand over the course of the cycle like geothermal pressure until the difference suddenly, and sometimes catastrophically, vaporizes in a single year with a massive increase in assessed value.

These delayed assessment adjustments and resulting tax increases make budgeting more difficult than would more frequent but less dramatic reappraisals. The Tennessee Legislature has been considering shorter reappraisal cycles, but none of the proposals have passed both houses yet.

Bad timing for a big setback

Property tax increases are never convenient, but 2025 could be especially poor timing. If interest rates stay relatively high and operating expenses keep rising, tax increases may arrive when there is no room to accommodate them in over-stressed taxpayer budgets.

Even in 2024, a non-reappraisal year, the mayor of Memphis has proposed a monstrous tax rate increase for properties inside the city. It is doubtful the city will raise rates as much as the mayor wants, but a 2024 increase in city taxes before the assessor's 2025 reappraisal could create back-to-back blows that are hard to absorb.

Preparing for "The Big One"

Hiding under a desk or filling a trash can with supplies will not stop a major assessment increase in 2025, but there are other ways to prepare.

1. Understand the timeline. The assessor will formally certify 2025 values by April 20, 2025, but value-change notices are expected around mid-March or early April. Appeals must be filed to the Shelby County Board of Equalization, with a likely deadline of June 30. The city of Memphis sends tax bills around July that are due by the end of August. Shelby County taxes are due by the end of the following February.

2. Anticipate the increase. Don't be caught off guard by a higher tax bill. It is important to estimate the assessor's reappraisal value and develop a realistic 2025 property tax budget. If the assessor's new value is unreasonably high, it can be challenged through a timely appeal to the Shelby County Board of Equalization. Some amount of increase is likely to be fair and supportable, however, so adjusting tax escrows in advance would be prudent.

Property tax professionals can help

Preparing for the 2025 reappraisal needn't be a daunting process. A property tax professional can provide a tax estimate in preparation for the 2025 reappraisal, and if the assessor's new value is too high, file an appeal.

Taxpayers preparing for The Big One to rattle their real estate would be well served to consult a property tax professional in advance. An experienced advisor can help identify the fault lines of undervaluation and brace-up vulnerable budgets before the reappraisal strikes.

To tax assessors, an investor's single-family, build-to-rent neighborhood is a cluster of separately valued properties.

Multifamily investors are accustomed to paying property taxes based on an assessor's opinion of their asset's income-based market value. But for the growing number of developers and investors assembling communities of single-family homes and townhomes for rent, tax assessment is more complex and potentially troublesome.

The difficulty for these taxpayers is that most assessors shun the income approach to valuing single-family rental properties. In the following paragraphs, we examine the roots of this common assessor stance, and explore strategies that may help taxpayers argue for a more predictable, apartment-like treatment for their single-family rental communities.

Similar, but different

Multifamily construction has delivered a tremendous volume of apartment properties over the past decade. Once stabilized, these assets have been relatively simple to value by relying on market rents, occupancy, expenses, and cap rates.

On the heels of this apartment construction, the nation is seeing a proliferation of investor-backed, single-family construction and acquisitions of large blocks of homes and townhouses for use as rental properties. This may take the form of constructing a multitude of homes or townhomes in a single development. Alternatively, it may involve the acquisition of many existing homes or townhomes in a localized area.

A concentration of adjacent or proximate single-family residences operated as rentals can enable owners to achieve economies of scale for management, maintenance, groundskeeping, repair and similar costs, similar to the operation of a large apartment complex or group of complexes. In most jurisdictions, however, the similarity between apartments and communities of rental homes and townhomes doesn't extend to valuation for property taxation.

As a rule, houses and townhomes are individually platted and therefore have separate tax parcel numbers. For existing properties acquired from third parties, this is expected. When it occurs with new construction, however, it typically results from the developer's decision to create true townhouses and single-family houses, as opposed to a traditional rental complex. The reasoning for this decision may be complex, but at the gate it appears to be a protective measure to allow for subsequent sales of the units.

For taxing purposes, each separate parcel – house or unit – is valued separately and independently, just as if individually owned and occupied for personal use by a homeowner. The taxing authorities value these properties using a market-comparable-sale approach, just as if the units were individually owned for personal use.

This is causing a good deal of consternation among investors who seek to have the units valued utilizing the income approach, and for those who would like to value assembled units collectively. The owner of a row of inline townhomes, for example, may prefer to have the properties valued as one economic unit, in the nature of an apartment complex.

Case law insights

The North Carolina Property Tax Commission in two recent cases affirmed that assessors must use the comparable sales approach to individually assess independent, platted rental homes. In those cases, (Mingo Creek Investments III LLC and American Homes 4 Rent Properties One LLC), commissioners set forth numerous reasons for their decisions.

Those cited factors included a legal requirement that each separately platted parcel be separately taxed. Additionally, the common owner was able to sell off a single unit at any time, and lacked an apartment owner's common control over amenities and other units. Not all units in a particular development are necessarily owned by the same entity, and in the cited cases there was a history of buying or selling of the individual units or neighboring units.

Assessors often make the policy argument that where single-family rental units exist in common with units that are individually owned for personal use, applying a different valuation method to those held for rent would create inequitable results. It would also raise uniformity concerns, because similar properties would be taxed differently. The same inequity issue that applies to a rental residential unit also applies to homes used as vacation rentals. To value rental single-family residences using an income approach and the neighboring, owner-occupied, single-family residence by the comparable sale approach would create inequities and a lack of uniformity.

Taxpayer tactics

So, where is the investor to go from here?

The elements addressed in each of the two Property Tax Commission decisions issued thus far, together with the policy considerations, limit the taxpayer's options. An investor or developer could common-plat the residential rental units in the development stage, creating a single plat that could be more readily valued with an income approach.

If the owner or developer is unwilling to common-plat the assemblage of rental homes or townhomes but seeks to have them valued for tax purposes under the income approach, it appears they would at least have to consider imposing common control restrictions on the parcels to create, as nearly as possible, the functional equivalent of an apartment complex.

For example, a development or ownership regime could impose not only common ownership but also common control over all the units, including a prohibition on the sale of individual units, or perhaps restrictions that the sale of a specific unit would not release that unit from the common control mechanism. Such a mechanism would be akin to a 100 percent developer-controlled homeowners association.

From a practical perspective, the developer could prohibit investors from selling individual properties until the developer chooses to start divesting itself of the project piecemeal. At that time, the developer could amend the restrictions, since it would still have total control because no units had been sold, and therefore no third parties had vested rights. At that time, it is likely the taxing authority would change the valuation method to a comparable sales approach.

Further, the developer would most likely need to ensure that the units under such common ownership and control would be physically distinct from neighboring properties. For example, all the units could be in a designated subdivision or portion of a development, as opposed to being alongside units held for personal use by their owners. By so doing, the developer could hopefully remove the uniformity argument.

From a market perspective, the units held for rent under common ownership and control would never be for sale on the open market as single units, at least so long as the restrictions remained in place.

As to appraisal, the appraiser could either apply the income approach to each unit, or appraise the combined residences as one economic unit and then apportion value among the units, so that each tax parcel receives a separate value. This is not to say this approach would be accepted by a tax court, but it would address many of the concerns espoused to date against use of the income approach for separately platted residential units held for rent.

These valuation regimes described above may prove too restrictive for some investors, in which case they would appear stuck with the current process. In all events, before becoming wedded to any plan, taxpayers should at least run the numbers both ways – using income and comparable sale approaches – to be certain the value difference is worth the effort of contesting their assessment. 

Jaye Calhoun and Divya Jeswant of Kean Miller LLP on an assessment strategy that may help you trim your property tax bill.

Few states impose property tax on intangible assets such as a trade name, franchise, goodwill and the like. Indeed, some office buildings, industrial properties and big-box stores don't derive significant value from intangibles in the first place.

Intangibles are a significant income generator for many hotels, casinos, restaurants and other properties, however. For these assets, assessors are required to identify and exclude the value attributable to those nontaxable intangibles. The proper method to do so has been the subject of much debate.

Fortunately for taxpayers, recent case law is helping to clarify best practices for isolating and removing value attributable to intangibles from commercial assessments. By following the examples of taxpayers who have successfully applied alternative approaches, property owners across the country may be able to exclude a larger portion of overall property value as intangible and, in turn, lower the property taxes on their business real estate.

Scaling Rushmore

Although some assessors persist in applying the cost approach, most valuation professionals consider the income approach most appropriate for valuing income-producing properties. That is because a property's past, present and future or projected income inevitably impact its valuation.

Many assessors have traditionally applied the "Rushmore Approach" to exclude the value of intangibles from an income-based valuation. This essentially deducts management and franchise fees from a property's net income, treating those amounts as a proxy for the value of intangibles.

Many taxpayers reject the notion that the Rushmore Approach can account for the full value of intangibles. Some of these property owners and their appraisers have countered with the "Business Enterprise Approach," which seeks to remove the often significantly higher revenue generated by intangible assets. This approach is sometimes called the "Income-Parsing Approach" because it requires going-concern income attributable to intangibles to be parsed and stripped from taxable property income.

A spate of decisions over the last few years, particularly concerning hotel valuation, has created a growing momentum favoring the Business Enterprise Approach. Taxpayers should be aware of the potential for significant tax savings with this approach.

Business enterprise successes

The most significant recent cases in which taxpayers successfully argued for using the Business Enterprise Approach are in two states known for high property taxes: Florida and California.

The first is Singh vs. Walt Disney Parks and Resorts U.S. Inc., a 2020 case dealing with the valuation of the Disney Yacht & Beach Club Resort adjacent to Epcot. A Florida appellate court categorically ruled that the Rushmore Approach fails to remove all intangible business value from an assessment. The court was simply unconvinced by the assessor's arguments that deductions for franchise and management fees can remove the entire intangible business value.

Another encouraging decision occurred in 2023, SHR St. Francis LLC vs. City and County of San Francisco. A California appeals court considered various income streams of the Westin St. Francis hotel, including its management agreement, income from cancellations, no-shows and attritions, in-room movies, and guest laundry services.

The court held that it was insufficient to simply deduct the management fees because income from a nontaxable, intangible asset like a management agreement should include both a "return of" and a "return on" that asset. In other words, the owner would expect to generate a profit, or income-based value over and above the cost of the management agreement. The court found that the assessor failed to present evidence that the management agreement's value did not exceed management fees.

In dealing with the remaining items, the court drew a dividing line between "intangible attributes of real property" that merely allow the taxable property to generate income (cancellations/no shows/attritions) and are therefore includible vs. "intangible assets and rights of the business operation" utilizing the real property. These latter assets and rights, including in-room movies and guest laundry services, relate to the intangible business operation and are, therefore ,excludible from income-based, taxable property value.

Another widely reported decision from 2023 is Olympic and Georgia Partners LLC vs. County of Los Angeles. The appellate court in this case pointed out a key flaw in the Rushmore Approach. That it is unlikely the deduction of franchise and management fees could fully account for the value of intangibles because no owner would normally agree to fees "so high as to account completely for all intangible benefits to a hotel owner."

Half Moon Bay legacy

Several recent decisions cite SHC Half Moon Bay LLC vs. County of San Mateo, a 2014 California case involving the Ritz Carlton Half Moon Bay Hotel's workforce, leasehold interest in the employee parking lot, and agreement with a golf course operator. The appellate court explicitly acknowledged that the deduction of management and franchise fees from the hotel's projected revenue stream did not properly identify and exclude intangible assets.

Taxpayers throughout the country have successfully made these same arguments. In 1300 Nicollet LLC vs. County of Hennepin, a Minnesota court in 2023 took stock of case law across the country and observed that although the two methods have been competing for 20 years, there is an emerging preference for the Business Enterprise Approach and increasing skepticism of the Rushmore Approach.

Some states such as New Jersey continue to rigidly administer the Rushmore Approach, while other states consistently uphold the Business Enterprise Approach, at least in recent years. Yet other states view both methods as potentially reasonable for an assessor to apply; some of those cases may have more to do with the standard of proof during appellate review. There are also states such as Louisiana in which the issue is yet to be dealt with judicially, arguably giving taxpayers an opportunity to get ahead of the curve.

Clearly, taxpayers and their commercial appraisers should determine whether the assessor has properly excluded maximal value for intangibles in valuing their income-producing properties for property tax purposes. In particular, appropriately applying the Business Enterprise Approach can generate significant property tax savings on commercial real estate and may be worth pursuing.

Below is a property owner's guide to reducing the taxable value of contaminated real estate.

Valuing contaminated properties presents numerous challenges due to the complexity and uncertainty that contamination entails. The presence of hazardous substances or pollutants can affect both a property's value and potential uses. As an assessment must reflect market value, contamination can significantly impact taxable valuation.

Determining the extent of that impact requires careful consideration of legal, technical, and economic factors as the valuation of contaminated properties is governed by a combination of statutory law, regulatory guidance, and case law. Yet these are the fields a taxpayer with contaminated real estate must tread to evaluate assessments for fairness and, if necessary, to appeal an unfair assessment.

Tax assessment review proceedings are crucial mechanisms for all property owners to ensure fair and accurate assessments. These proceedings provide avenues to challenge property assessments they believe are incorrect or unfair. Understanding the process, timelines, and legal considerations involved is essential for property owners, assessors, and legal professionals alike.

Most real estate taxes in the United States are ad valorum or "according to value." Thus, the owner of a high-value property would expect to pay more real estate taxes than the owner of a lower-value parcel. While the exact procedures to file a tax appeal can vary by state, all give property owners the right to challenge property assessments through various means, including administrative review, grievance procedures, and judicial review.

Four Preparatory Keys

To prepare for a tax appeal, the following important considerations should be addressed:

1. Assess contamination levels: Determining the extent and severity of contamination on a property requires expertise in environmental engineering, so expert assistance is a must. Documentary evidence can significantly strengthen a property owner's case during the appeal process. Procure this with expert testimony from environmental consultants, appraisers, and other qualified professionals to establish the impact of contamination on the property's value. Assessors may need to rely on those reports to understand and truly appreciate the contamination's nature and scope.

2. Estimate remediation costs: The price tag to remove or contain pollutants can vary widely depending on the type, quantity and spread of the materials involved, as well as the chosen remediation method. While there are state statutes concerning remediation and liability, those matters are also codified at federal levels within the Comprehensive Environmental Response, Compensation & Liability Act (CERCLA) of 1980, commonly referred to as the Superfund Law. If a site is designated a "superfund site," it will typically have a remediation plan with anticipated cleanup costs, which assessment professionals can rely upon in determining market value.

3. Gauge market perception: Market perception can play a significant part in valuation since contamination can have a negative impact on the property's appeal to potential users or buyers. Known as "environmental stigma," this can severely depress market values. Prospective buyers are typically hesitant to purchase contaminated properties, often leading to decreased demand and lower market prices.

4. Don't sweat legal liability: Property owners may face legal liabilities for environmental contamination, which can also affect the property's value. This, however, should have no effect on valuation in a tax appeal proceeding, because the statutory mandate to value property in a tax appeal according to its market value cannot be subordinated to environmental property concerns. Most significantly, any liabilities for contamination or remediation must be addressed in a separate proceeding outside the tax appeal.

More to Consider

The three accepted approaches to valuation in the context of a tax appeal are income capitalization, sales comparison, and replacement cost less depreciation. Unfortunately, none of these truly account for the presence of contamination and its negative influence on value. The effects of environmental contamination, and even stigma from nearby contamination, must be part of the valuation equation.

Local case law also plays a significant role in shaping the legal landscape surrounding contamination in tax assessment review proceedings. Many courts have recognized the impact of contamination on property values and have upheld adjustments to tax assessments to account for this factor. Additionally, these same courts have established principles regarding the burden of proof and evidentiary standards in contamination-related tax appeals.

For example, the seminal case in New York is Commerce Holding vs. Board of Assessors of the Town of Babylon. In this 1996 case, a property owner filed a tax appeal contending the assessed values should be reduced to account for contamination by a former on-site tenant. While New York's highest court held that "any fair and non-discriminating method that will achieve [fair market value] is acceptable," they concluded that contaminated property in a tax assessment review proceeding shall be valued as if clean, then reduced by the total remaining costs to cure the contamination.

Clearly, valuing contaminated properties in tax assessment review proceedings requires a nuanced understanding of environmental regulations, property valuation principles, and market dynamics. Assessors and property owners must navigate complex legal and technical challenges to arrive at a fair and accurate valuation that reflects the unique circumstances of each contaminated property. By employing appropriate valuation strategies and seeking expert guidance, stakeholders can ensure that contaminated properties are assessed fairly and in accordance with applicable law. 

Market deterioration and municipal ineptitude are driving taxpayers to the courts for relief.

The New York City real estate market, once the pinnacle of economic health, has undoubtedly declined in recent years. Exploring the factors that brought the market to this point paints a clearer picture of what current conditions mean for property taxpayers and suggests strategies that may offer relief.

Five Causes of Decline 

The COVID-19 pandemic left an indelible mark. The coronavirus took a significant toll on New York City, which became an epicenter of U.S. infections. Many residents fled to suburban areas for more space and less harsh mandates from local authorities. According to a Cornell analysis of U.S. Census Bureau data, "New York City's population plunged by nearly 4 percent – more than 336,000 people – during the pandemic's first year as residents migrated to less dense areas in nearby counties and neighboring states."

The New York City Comptroller's Office estimated that the City lost an additional 130,837 residents from March 2020 through June 2021. This caused unprecedented vacancies in residential and commercial properties, and approximately 100 hotels in the City closed. Those that survived endured high vacancy rates and struggled to pay property taxes.

Economic uncertainty plagues the real estate market. The economic fallout of elevated vacancies and decreasing income has rendered investors and developers hesitant to invest in New York City real estate.

Remote and hybrid work slashed office demand. The decline in office usage that accelerated during the pandemic is ongoing and appears permanent. Most workplaces have loosened to a hybrid work environment, and many employers allow a full-time work-from-home option as well.

This means office buildings that once bustled with employees are now vacant or significantly emptier than they were in 2019. Midtown Manhattan lunch spots and after-work happy hour sbars and restaurants have also taken a hit. The National Bureau of Economic Research estimated in 2022 that New York office buildings had lost as much as $50 billion of value in the wake of reduced demand.

Crime is soaring. New York City police reported making 4,589 arrests for major crimes in June, a 9.3 percent increase from the same period a year earlier. In the first six months of 2023, officers made 25,995 such arrests – the most for any half-year period since 2000.

Property tax revenues are under threat. The previous trends have been slow to erode the municipal view of the tax base. The City's Department of Finance reported a tentative assessment roll of $1.479 trillion for fiscal 2024, a 6.1 percent increase from the previous tax year. For the same period, the department reported a 4.4 percent increase in citywide, taxable, billable assessed value, the portion of market value to which tax rates are applied, to $286.8 billion.

"New York City continues to show mixed signs of growth and economic recovery, with the FY 24 tentative property assessment roll reflecting improvements in subsectors of the residential market while key commercial sectors still lag behind pre-pandemic levels despite modest growth over the past year," Department of Finance Commissioner Preston Niblack said in a press release announcing the tentative tax roll.The decline in office occupancy continues to impact retail stores and hotels in the City contributing to the sector's slow recovery. At the same time, single family homes, which constitute a majority of residential properties, have exhibited a robust recovery and continued growth."

A study by NYU's Stern School of Business and Columbia University's Graduate School of Business calculated that a decrease in lease revenue, renewals and occupancy would cut the value of office buildings in the City by 44 percent over the next six years. Based on those findings, a worst-case analysis by New York City Comptroller Brad Lander found that a 40 percent decline in office property market values over the same six years would result in $1.1 billion less tax revenue for fiscal 2027, the last year of the City's current financial plan. Real estate taxes on office properties currently generate 10 percent of overall City revenue. The City expects office vacancies to peak at a record 22.7 percent this year, posing a potential threat to tax collections.

The result of the forgoing changes is that income is down, expenses are up, demand is evaporating, and market values have plunged by more than 50 percent for most commercial properties except perhaps multifamily (although sales of condominiums have stalled due to high mortgage costs).

How To Get Relief

The hotel industry anticipates a four-year recovery period. Hotel owners preparing arguments for reduced assessments should collect information for their team documenting closure dates, occupancy rates, and any specific pandemic-related expenses incurred during the reopening process.

It is inappropriate for assessors to evaluate hotels for property tax purposes solely based on non-real-estate income. A recent court ruling has affirmed the illegality of utilizing non-real-estate income generated by hotel businesses, leading to an overassessment of real estate taxes that must be refunded to owners. Business-related income, such as that from movie rentals, should not be considered in property tax assessments.

In addition, it is essential to identify and exclude income from personal property, furnishings, and the value of intangibles, franchises, trained workforce, and going concerns when determining real estate income.

The prevalence of empty stores and closures of local standby establishments in every corner of New York City underscores the severe economic impact on retail properties. Retail and office owners should be prepared to demonstrate declines in gross income and rents reported in their financial filings with the City. They are also required to provide a list of tenants who have vacated or are not paying rent. The Tax Commission now mandates an explanation for declines in rents exceeding 10 percent.

There is considerable potential for assessment reductions, but it is crucial for taxpayers to compile evidence of market value declines, and to collaborate with experienced advisors to secure warranted tax reductions.

There is no longer any absorption of vacant office space since demand is declining. That means that 80 percent occupancy or lower is the norm. Only an adjustment in property taxes to the actual earnings of the property will save the real estate, and over-leveraged properties may be lost.

Tax Process in a Tailspin

Extensive personnel turnover has hampered the review process that relies on action by City agencies, with inexperienced staff and numerous unfilled positions at both the Department of Finance (assessors) and the Tax Commission. Thus, expected remediation of excessive assessments often go unresolved. This leaves no alternative but to go to court.

Resorting to the courts is also difficult because in-person appearances are still relegated to video conferences, with few trials taking place.

The taxpayer's best approach is to push forward with all speed to demand a trial.  Only pressure to demand speedy trials will provide the needed result.

Office property owners should contest excessive assessments now, before a potential crisis drives up taxes.

The Great Recession, from December 2007 to June 2009, was the longest recession since World War II. It was also the deepest, with real gross domestic product (GDP) plummeting 4.3 percent from a peak in 2007 to its trough in 2009.

Entering that recession, unemployment was at an unalarming 5.0 percent, which is on par with historical averages, and interest rates hovered around 6 percent. The roots of the recession lurked at the intersection of risky subprime mortgages and the repeal of the Glass-Steagall Act, which allowed for the mega-mergers of banks and brokerages to escalate.

And here we are in January 2024, looking down a steep market slope. On the bright side, we are in a more advantageous position than at the beginning of the Great Recession. GDP was a respectable $25.46 trillion in 2022, up 19 percent from $21.38 trillion in 2019. Unemployment is at 3.7 percent, and values in the single-family housing market are increasing again, in part due to a lack of supply.

The investors standing on unstable ground this time around are those heavily leveraged in major metropolitan markets, such as New York, Chicago, and San Francisco, or other municipalities that rely on office values. (Think suburban office markets.) The sharp increase in interest rates under the Federal Reserve's tightening monetary policy, and the extreme drop in demand for commercial office space that accelerated during the pandemic, will have significant ramifications on all property types.

Dire developments

What ramifications? Assume a hypothetical "Metro City" that, like most major markets, has a tax base with 75 percent of its independent parcels classified as residential, and 25 percent as commercial real estate. However, the assessment values are strongly weighted on the commercial properties, with 30 percent of the entire assessment value born by office properties.

The municipality has a total tax levy of $16.7 billion and overall assessed property value of $83.1 billion. The office portion of the property makeup is 30 percent, or $24.9 billion in assessed value. The office share of the total tax levy is $5.0 billion.

Now assume that the city's overall office market value collapses by 50 percent. This leaves Metro City with a $2.5 billion deficit – not a small number. To recapture that $2.5 billion, the city must increase its tax rate by 15 percent. That means tax liability increases by 15 percent for every taxpayer, even if their property's assessed value is unchanged.

So, how can developers and owners protect themselves from excessive tax liability, given the current market conditions? One solution is to appeal property tax assessments aggressively. Regardless of the jurisdiction, regardless of property type, property owners must evaluate their opportunity for an assessment appeal.

Office-specific issues

Market transactions show vast valuation differences between Class A office properties, which are typically newer buildings with great amenities, versus "the others," or those office properties 10 or more years old and offering fewer amenities. Properties that fall in the latter category have many opportunities for assessment reductions. Here are key points to consider.

Ensure the appraiser or assessor is using the property's current, effective rental rates. In many instances, an owner will show a tenant's gross rent on the rent roll without disclosing specific lease terms contributing to effective rent. For example, the lease may have been negotiated at $27 per square foot, but the rent roll does not account for free rent, amortization, free parking or other amenities the tenant receives.

Additionally, although office leases historically pass through taxes and other costs to tenants, many negotiated leases now cap expenses for the tenant, potentially shifting a portion of expenses to the landlord. That is a key issue the taxpayer should address in the income analysis of an appeal, because it provides evidence for a reduction in effective rental rates, as well as an imputed increase a buyer would demand in the capitalization rate to reflect the additional risk.

Appraisers need to understand this issue for rental comparables as well as for the subject property. Typically, they will confirm public information posted by various data services, but if they lack the finer details of a transaction, the rates they derive could exceed the true market.

Address vacancy and shadow vacancy. Prior to the pandemic, office vacancy in most markets hovered between 5 percent and 14 percent, depending on the location and building class. As of the third quarter of 2023, vacancy is over 18 percent, according to CBRE.

In October 2023, CBRE reported that suburban Chicago's office vacancy rose 50 basis points to 25.9 percent in the third quarter. Manhattan's overall office vacancy rate including sublease offerings is 22.1 percent, according to Cushman & Wakefield.

Shadow vacancy, or space where the tenant is still paying rent but no one physically occupies the space, is the canary in the coalmine for an office building's future. If a building is 12 percent vacant, the assessor probably won't be sympathetic. But if the owner highlights that leases in the space expire in the next year or two, and/or they are large blocks of space, the assessor (or at least the owner's appraiser) should acknowledge that risk and apply a higher cap rate for the subject property.

Adjust for interest rates. Any investment-grade property is now worth less than it was two years ago, simply because of the rise in interest rates.

Because interest rates have increased significantly, the property owner can argue that the assessor should use the "band of investment" method, which calculates capitalization rates for the components of an investment to produce an overall cap rate by weighted average. This methodology takes into account not only the increase in market interest rates, but also equity demands of lenders. Interest rates have increased over 3 percentage points across the last 2 years, which in many cases equates to a 100 percent increase in interest rates.

Additionally, the equity requirements on commercial mortgages have increased from 30 percent to 50 percent. Increasing the base capitalization rate to reflect these changes in an income analysis will offer significant relief in the assessment.

Jurisdictions that rely heavily on office values to support overall assessment value in the tax base will be experiencing increasing tax rates. This increase in rate is factored into the loaded capitalization rate, which obviously means a lower market value for assessment purposes. Analysts and appraisers should review the increased rates annually.

The near term will be challenging for entities that invested in office properties prior to 2023, but the strategies outlined above can offer some protection in this stormy market.

Incurable obsolescence — the stealth killer of commercial real estate value — is all too often overlooked in property tax appeals.

Any obsolescence can affect a property's value. Normal obsolescence involves curable problems, such as outdated fixtures and finishes that reduce a building's desirability. In valuation, the anticipated cost to cure the obsolescence (in this case, with a refreshed interior) is deducted from the property's taxable value.

As the name suggests, incurable obsolescence cannot be cured within the boundaries of the property. The obsolescence stems from outside circumstances, whether next door or in the larger markets, and no change to the property itself can overcome the deficiency.

Perhaps the government is going to change the traffic pattern, or a hog farm is going in next door. The market value may rise if a good thing is coming to the area. It will surely decline if a bad thing is coming, and the market value declines in relation to the predictability of such an event.

Property owners who learn the common forms and causes of incurable obsolescence will be better equipped to recognize its symptoms in their own real estate. In arguing for a reduced tax assessment value, evidence of obsolescence weighing on a property's operations will often tip the scales in convincing an assessor, review board or court to grant a reduction.

Passing or permanent?

Owners should be aware of functional obsolescence and be prepared to discuss it when appealing assessments. If it is a problem that can't be cured within the boundaries of the property, it is incurable obsolescence and reduces the property's market value.

The condition may have existed from the inception of the property's development and use, but more typically it results over time from factors relating to design, usability, markets, traffic patterns, government takings or regulation. For example, economic need or a government requirement may leave a property without adequate parking to support commercial buildings on the site, rendering those structures incurably obsolete.

Incurable obsolescence can be partial and a handicap to the property's viability without entirely preventing its continued use. For example, an office building designed for single-tenant use will not accommodate multiple users. There is a very limited market for single-tenant, high-rise buildings. The cost of retrofitting such a building into separate leasable offices is infeasible.

The loss in value due to incurable obsolescence may be anticipatory. If the market's users and investors see imminent incurable obsolescence, it may already affect market value. The negative impact of incurable obsolescence occurs when the problem cannot be cured on site at any cost.

In evaluating a property for instances of incurable obsolescence, however, it is important to remember that the source of obsolescence may be offsite.

Owners concerned with the production and marketing of a product or service from their property may not be aware of external elements of incurable obsolescence affecting their property's value. Or they may simply regard the circumstance as a non-priority item — at least until they get their property tax bill.

Instances of the incurable

Incurable obsolescence takes many forms, but taxpayers are most likely to encounter it in one of a few common scenarios. Those include:

Property access changes. Typically imposed by a highway or street authority, moving or removing access points can reduce a commercial property's appeal to users and lower its market value.

Altered traffic patterns. Changes to surrounding roads or highways can reduce commercial value. Limiting the property's visibility and accessibility, for example, may reduce customer traffic and brand exposure for operators on the property.

Size modifications. The property may fail to meet the required property size in relation to improvements. Possible causes include changed government requirements or the physical loss of a portion of the property due to government taking. A simple change in setback lines may have a dramatic negative impact on a property's value.

Takings. Use of eminent domain may reduce the remainder of the property to a legal non-conforming use which may not be altered to accommodate a commercially viable use. Alternatively, commercial uses on a state highway may be untouched by highway takings, but diverting traffic to a new highway kills viable commercial use of properties on the abandoned roadway.

More examples

Other sources of incurable obsolescence span a wide range, from changing industry practices and preferences to evolving government regulations, markets and natural phenomena. Zoning or regulatory changes may restrict usage, for example. The property may no longer meet current tenant needs regarding loading dock height, or access by delivery and customer vehicles. Nearby development or street construction may inundate the property with surface water. Properties have incurred incurable obsolescence for their intended uses from light pollution, and from disruptive air traffic following a change in flight patterns.

Property owners discussing excessive taxable valuation with the assessor should recognize that the assessor has employed the cost approach to value. While cost may be a value indicator, it lacks relevance in situations involving incurable obsolescence. Help the assessor to look beyond cost by showing how obsolescence reduces the property's value in the marketplace.

In preparation for meeting with the assessor, an owner seeking a reduced assessment should look for negative conditions beyond the control or ability of the owner to correct within the boundary of the property. Be prepared to discuss with the assessor how the conditions affect the property value. Bring plat maps, photos, restrictive regulations and ordinances, and any documents that entail restrictions on the use of the property — legal, physical or otherwise — and an explanation of how these matters negatively affect the property's value.

While there is no cure for incurable obsolescence, there are treatments for unfair tax assessments. When incurable obsolescence results in lost improvement value, the owner is entitled to an appropriate downward adjustment of the assessed value. 

Taxpayers should look beyond fair market value in deciding whether — and how — to protest assessments.

Taxpayers usually appeal property tax assessments by proving a market value different from the assessor's finding, but they should not overlook constitutional guarantees of uniform and equal taxation.

As an ad valorem tax, real property taxes are charged on the value of the underlying real estate, usually measured as fair market value. In many states, taxpayers can demonstrate their property's market value with a recent, arm's-length sale price or by independent appraisal evidence.

Two potential concerns emerge for taxpayers in an assessment appeal centered on market value: the declining reliability of data in volatile and rapidly changing markets, and the trailing nature of market data used by assessors. Those data issues can skew the mass appraisal techniques tax assessors often use, including comparisons to sales of similar properties, when assessing real property.

Volatility and rapid change

Commercial property data can lose relevancy with surprising speed in a volatile market. For example, office properties continue to bear the consequences of increased remote work and occupants' shrinking footprints since the pandemic. Many office properties with mortgages maturing in 2023 have lost half or more of their previously underwritten asset values. Badge swipes tracked by Kastle Systems show an average office attendance of about 50 percent throughout 2023.

In early 2023, Cushman & Wakefield attributed slowing construction to uncertainty in the office market along with challenges related to higher interest rates, supply chain issues, and labor shortages. Office properties may be in danger of becoming "zombie" buildings with utilization of 50 percent or less, while market watchers warn of doom loops or a domino effect of property failures, especially in dense central business districts. Most market participants are waiting for the other shoe to drop and for the market to reveal its bottom.

Assessors are not immune to the valuation problems this market uncertainty creates. Assessors currently valuing properties are likely considering comparable sales that occurred as far back as 2019 or early 2020. Even more recent sales are likely to be based on leases executed years earlier, or on financing obtained prior to the pandemic.

Further undermining data reliability is the decline in sales activity after March 2020, when pandemic-related uncertainty and economic pressures like rising interest rates began to discourage participants from unnecessary transactions. As pre-pandemic leases expire and loans underwritten on those leases mature, transactional data will likely show drastic valuation declines within a short amount of time. The lag in sales data as these properties are brought to market will affect the accuracy of property tax assessments.

What can a taxpayer do when market activity is too chaotic and volatile to accurately price value? Taxpayers should not forget constitutional safeguards of equal protection and uniform taxation.

The U.S. and most state constitutions protect taxpayers against non-uniform and discriminatory tax policies. For example, the Ohio Constitution requires that "land and improvements thereon" are "taxed by uniform rule according to value." Ohio statutes also require that assessors appraise property according to "uniform rule" in both the "mode of assessment" and as a "percentage of value." The constitutions of Pennsylvania and Texas also contain uniformity clauses. The 14th Amendment of the U.S. Constitution prohibits the government from depriving any person of their property without due process or denying any person equal protection of the law.

These constitutional protections are important enough that federal and state courts have held that when the goals of uniform taxation and correctly assessing market value cannot both be met, the constitutional priorities of equity and uniformity prevail.

Uniform, equal taxation

There are a few ways to help ensure consistent and equitable property taxation, starting with regular reassessment cycles. Some Pennsylvania counties have not reassessed countywide since the 1960s. The lack of regular appraisals to determine market value results in fewer properties being taxed on their true market value, especially if recently sold properties are assessed at their sale price while others have not been reappraised in decades.

A related problem is variation in the taxed percentage of market value between similar properties, which leads to non-uniform assessment ratios. There have been a series of successful contests recently in Lackawanna County, Pennsylvania, by taxpayers demonstrating that other property owners with similar properties were not paying taxes based on similar market values. Therefore, properties with the same market values were not being assessed at the same ratio, leading to non-uniform assessments. "The problem in Lackawanna County was not caused by this assessor's office, but gets perpetuated when new construction is placed on the assessment rolls at 100% of construction costs based solely on permit information, while similar properties have not been property reassessed since the base year of 1967," explains James Tressler of Tressler Law LLC, the attorney who brought a number of these successful challenges.

Another way to ensure assessment uniformity is by valuing the unencumbered, fee-simple interest in the real property, regardless of whether a particular property is leased, owner-occupied, or vacant. Ohio amended its controlling legislation to clarify that assessors must value the market value of the fee simple interest for all properties. Valuing the same market-based fee simple interest for all properties safeguards real estate tax assessments from being influenced by the business value of a successful (or unsuccessful) enterprise conducted on the property.

Governments can check discriminatory treatment by allowing taxpayers to contest the unequal ratios of market value across similar properties, or by allowing taxpayers to challenge assessments based on the median assessments of a reasonable number of comparable properties. Texas law contains this type of protection for taxpayers, and similar legislative remedies are being discussed in Ohio.

These additional checks and balances to secure equal and uniform property tax systems assure taxes are not borne discriminatorily by a few. The Pennsylvania Supreme Court wisely reminds us of these protections in a 2017 decision involving Valley Forge Towers Apartments, stating: "As every tax is a burden, it is important that the public has confidence that property taxes are administered in a just and impartial manner, with each taxpayer contributing his or her fair share of the cost of government."

Differentiate personal property from real estate values for fair tax treatment.

North Carolina taxes both real estate and personal property, but differing valuation schedules and processes for the two types can lead to confusion and inflated tax bills for industrial property owners. Understanding how assessors value industrial properties can help those taxpayers detect issues and contest unfair assessments.

Dual processes

North Carolina requires assessors to revalue real property at least every eight years. The value as of Jan. 1 of the valuation year then remains constant until the next valuation, unless specified changes in the property occur to trigger a change in the assessment. Many counties revalue every four years, and a few, even more frequently.

Assessors use a market analysis to determine real property's taxable or fair market value. This involves applying one or more of the three valuation approaches: cost, comparable sales, or income.

The state requires annual valuation of personal property based on installed cost, which is subject to the applicable trending and depreciation schedules. For the most part, taxing authorities rely on the taxpayer's annual business personal property listing to determine what items of personal property are present, the installed cost, and the trending and depreciation schedule applied. The counties follow schedules for auditing the property tax listings, and most disputes that arise stem from these audits.

With industrial real estate, the two tax schemes can create conflicts based on property components that could be considered either real estate or personal property, depending on circumstances. For example, reinforced foundations or specialized wiring for unique machinery could be considered a real estate improvement, thereby adding value to the real estate, or they could be considered personal property subject to depreciation and trending.

Although the tax rate applied is the same for both real estate and personal property, categorization can significantly affect taxable value. Real property improvements enhance market value on a more permanent basis, while personal property value is generally presumed to decline because of annual trending and depreciation.

And of course, no one wants to be taxed twice on the same property: once by having a component or improvement included in the real estate value, and again by having it taxed as personal property.

Defining characteristics

How can a taxpayer determine what is real and what is personal in their industrial property? Generally, personal property items are movable and not permanently affixed to real estate. An issue of intent arises, however, if the item can be removed but not without causing serious damage to the real estate.

A rule of thumb in the North Carolina Department of Revenue's Personal Property Appraisal and Assessment Manual instructs assessors to classify all property and investment necessary for the operation of machinery and equipment as personal. Examples are wiring, venting, flooring, special climate control, conveyors, boilers and furnaces, dock levelers, and equipment foundations. Stated another way, property used as part of a process, or that is in place to support equipment, is generally personal property.

On the other hand, Department of Revenue staff regard items in the plant for lighting, air handling and plumbing for human comfort to be part of the real estate. The department's appraisal and assessment manual includes an extensive chart, and each county's published schedule of values may also provide a helpful listing.

It is often difficult to know whether the county has included what could be classified as personal property in its calculation of real property value. Regardless, if the taxpayer has not listed such items on the annual personal property submissions, it will be difficult to argue after the fact that they should have been excluded from the real estate value.

Taxpayer strategies

Taxpayers can argue for a reduced assessment by identifying personal property items improperly classified as real property in the assessor's calculations and seeking to have them treated as personal property subject to trending and depreciation. Knowing where to look for personal items will help the property owner in this task.

A critical item to be generally classified as personal property is any leasehold improvement. Leasehold improvements often look like real estate but are owned and controlled by the tenant for the lease term. These are items the tenant paid for and received under terms of the lease or other contract, and were installed for the tenant's use. Leasehold items almost always facilitate the tenant's business.

In deciding whether these items are real or personal property, the taxing authority will apply a test akin to a traditional fixture analysis, determining the manner of affixation, whether the item can be removed without serious damage, and whether it is intended to remain permanent. In the end, the assessor will apply a "totality of the circumstances" test, including the lease terms.

The tenant - as the owner of the leasehold improvements - is required to list those items as personal property. The landlord should monitor the tenant's personal property submissions to ensure that all tenant improvements are being listed. This will help to avoid leasehold items being considered as part of the current real estate valuation.

Unlike a traditional fixture analysis, and dependent on the lease terms, the improvements may be taxed to the tenant during the term of the lease. When the improvements are left to the landlord at the end of the lease term, the taxing authority will need to consider assigning any remaining value to the real estate.

The owner of an industrial property needs to be cognizant of how the assessor is valuing both the real estate and personal property, and how those components are taxed. This requires knowing what improvements are included in the valuation of the real property as of the valuation date, and tracking the annual personal property tax listings, especially those submitted by a tenant. Finally, taxpayers must be timely in correcting any erroneous assumptions or listings.

The often-overlooked band-of-investment argument helps taxpayers demand maximum capitalization rates to combat inflated property tax assessments.

When commercial property owners review assessments of their properties' taxable value for fairness, they typically look to the markets for context. This year, however, superficial market observations do little to clarify questions about property valuation. At the risk of understating the obvious, 2023 has been a confusing time in commercial real estate.

Most investors, brokers, appraisers, and even tax courts seem to agree that the office sector is under severe strain and unlikely to recover soon, even if they debate the extent or duration of damage to the property type. With other sectors, however, the wide range of perspectives today can be confusing and even contradictory.

Mainstream news reports of strong occupancy and tenant demand for retail space only tell part of the story. Many retail property owners continue to struggle with historically high tenant improvement costs and contend with tenants seeking concessions far more frequently than they did before the pandemic.

The multifamily and industrial sectors have remained robust relative to other property types, but inflationary construction costs and borrowing costs driven up by interest rate hikes have thinned margins and clouded projections in many deals.

Against that backdrop, economic forecasts garner a mixed reception. Predictions of an impending recession have felt like sage prophecy, foolish overreaction, or an echo chamber of crying wolf, depending on one's perspective or position in the markets.

Ideal time to review assessments

Clearly, the economics of operating investment properties are far less predictable than they were five years ago. Even within stronger property types, performance and pricing have become more volatile.

That kind of uncertainty means increased risk, which any appraiser will tell you should indicate elevated capitalization rates. Combine that risk with climbing interest rates, and the negative impact on overall commercial property value is undeniable. That makes this an ideal time to review property tax exposure and to contest assessors' overstated valuations.

Data trackers and analysts estimate that value losses among commercial property types range from 30 percent to more than 50 percent. Retail and office properties have suffered the greatest declines from their original appraised values, at 57 percent and 48.7 percent, respectively, according to CRED iQa commercial real estate analytics and valuation platform. In a study of $10 billion in assets across property types, CRED iQ noted an average 41.2 percent valuation decline from original appraised values.

And what's more, KC Conway, the principal of The Original Red Shoe Economist and 2018-2023 chief economist for the CCIM Institute, predicts "lots more (commercial real estate) value loss and bank failures to come."

A residential example helps to put these losses into context. The average 30-year fixed residential mortgage interest rate for the week ending Dec. 30, 2021, was 3.11 percent, compared to 6.42 percent for the week ending Dec. 29, 2022, according to Freddie Mac's Primary Mortgage Market Survey. At 3.11 percent, a homebuyer purchasing a $200,000 house with 20 percent down would have had a monthly mortgage payment of $684.

One year later, a homebuyer putting 20 percent down and using a mortgage with 6.42 percent interest would have to purchase a home for $109,138 to achieve the same monthly payment of $684. This is a roughly 45 percent decrease in purchasing power over the span of one year.

The same principle applies to commercial real estate, where climbing interest rates and a related spike in capitalization rates have rapidly hammered down property values.

Cap rate consequences

It is important for taxpayers to understand that assessors often draw the capitalization rates used in property valuation from cap rate surveys, which may not indicate true cap rates because surveys are backward-looking. And cap rates have risen quickly along with buyers targeted internal rate of return (IRR).

With an increase in interest rates, a potential deal that may have met a target IRR in early 2022 would no longer meet that same threshold at the end of 2022. Correspondingly, the buyer looking at a deal in early 2022 vs. the end of 2022 would likely have to lower their purchase price to meet their target IRR. Assuming net operating income remains constant, the cap rate for the deal in late 2022 would be higher than the cap rate reported for the early 2022 deal. This is a chief reason why cap rates tend to follow interest rates.

Taxpayers may be able to achieve a reduced assessment by arguing for a higher capitalization rate that more accurately reflects a buyer's expected rate of return. To support the highest possible cap rate, taxpayers should take a hard look at the mortgage-equity method, often called the "band-of-investment" technique.

Based on the premise that most real estate buyers use a combination of debt and equity, the mortgage-equity method calculates the weighted average of the borrower's cap rate and the lender's cap rate. Equity cap rates tend to be higher than those on debt, and with lenders offering lower loan-to-value mortgages, equity caps play a greater proportional role in today's acquisition pricing.

Until recently, the method had become disfavored by some tax courts and county boards of equalization. Common criticisms are that the methodology is too susceptible to manipulation, or that the equity component is too subjective and/or too difficult to support. Arguably, many critics just don't understand it. But in the current climate, the band-of-investment is increasingly accepted and perhaps more relevant than ever.

Band-of-investment strategies

Taxpayers can use the methodology in a few ways. For properties purchased or refinanced recently but before the Fed's interest rate hikes really accelerated, taxpayers may argue for straightforward adjustments to recent appraisals to reflect market changes. More complex situations may require a specialist's appraisal to support the value change.

Importantly, even properties which have maintained strong performance are subject to value loss from market changes, which may justify making the additional effort to prepare a mortgage-equity argument.

Before attempting such strategies, taxpayers should evaluate the jurisdictional laws and definitions that control property taxes, including the effective date of the challenged assessment. With 2024 looming and bringing with it a new lien date for measuring assessments in many jurisdictions, now is an ideal time to review portfolios for excessive property tax assessments.