Challenging the sales approach can save you big bucks
In many parts of the country, multifamily properties are very hot and command extremely high sale prices. These transactions often make very little sense in terms of the underlying cash flow they can generate. Indeed, there seems to be a speculative fever abroad in the land, probably resulting from investors chasing this property category due, at least in part, to asset diversification needs and other financial asset motivations.
For example, an apartment property owner is not even thinking about selling her property. Then, she receives a telephone call from the assessor advising that her property assessment will increase because of recent sales of comparable properties at relatively stratospheric levels. Can this problem be managed? A recently published case illustrates that the answer to this question is yes. In that case, the approach employed by New York property valuation attorney William D. Siegel was to attack the assessor's sales comparison approach head on. In a tax appeal filed for a 276-unit garden apartment complex in Middletown, N.Y., the property owner challenged the $15 million value estimate offered by the assessor's appraiser, using the appraisal and trial testimony of this expert. The owner's appraiser placed the property's market value at $10 million.
The assessor's expert might have thought he was sitting in the catbird seat with a number of sales at high unit values. However, the property owner's appraiser, William R. Beckmann, located a number of different sales, which resulted in a far lower range of values per apartment unit. Beckmann went even further, though, rejecting the sales approach and resting his value estimate on the income capitalization methodology.
He maintained to the court that a detailed understanding of the income and expenses of the comparable sales used in the assessor's appraisal was absolutely necessary. Otherwise, there was no factual basis for concluding that the sales in the comparable~presented were, in fact, comparable to the owner's property. This litigation suggests that when assessors use the sales approach, owners may be able to challenge increased values by arguing lack of reliability in this approach.
When owners face high valuations based on the sales approach, they should rigorously explore the following questions:
Are the comparable sales relied upon by the assessor relatively recently constructed or older properties? If the sales relied upon by the assessor were relatively newly constructed, they will likely generate higher prices per unit than would a 30-plus-year-old property due to lower repair and replacement expectations.
Just because your local assessor relied on comparable sales to give your property a higher valuation and a bigger tax bill doesn't mean you should pony up without a fight. Take a look at the comps and see how comparable they really are: You may be able to successfully argue that properties built recently, featuring larger unit sizes, or selling with Effective local tax assumable financing were able to fetch much higher sales prices than your property rates are a critical could reasonably command.
What was the average square footage of the various units in these comparables? Average unit square footage is critical because, to a certain degree, larger apartments command higher rents and are easier to lease.
Were the buyers in these sales real estate investment trusts (REITS) or private investors? If many of the buyers in the assessor's sales were REITs, this is important to note because it is well known that investment trusts generally pay significantly more for property than do private investors. They can do this because of their lower cost of funds and financial market pressure to invest.
Was below-market-rate financing in place and assumable? Assumable below-market-rate financing would undoubtedly tend to increase the sales price because, in effect, the buyer's cost of funds is being subsidized by the assumable financing. (The same issue would arise in the event of significant seller financing in the sale.)
Are the capitalization rates apparently revealed by the assessor's sales fairly comparable to the rate which could be commanded by the property? The capitalization rates paid for more attractive, larger, more newly constructed properties tend to eclipse the rates associated with older property sales for many of the reasons discussed in this article. This is true even though cash-on- cash returns will not differ significantly.
Was there significant deferred maintenance? The existence of marked deferred maintenance will almost always affect the purchase price due to the investor's expectations that significant funds will have to be devoted to the property after purchase to bring it up to snuff.
What were the effective real estate tax rates in the communities in which the sale properties were located? Effective local tax rates are a critical element in determining sales prices because properties in low-tax towns tend to sell at higher unit values and at lower cap rates than do properties in more heavily taxed communities. Put differently, investors are frequently willing to pay more to be taxed less. While a number of these issues are beyond the knowledge base of the average property owner, expert appraisal, legal, and other market-oriented consultants' efforts may be helpful in distinguishing an owner's property from those sky-high sale properties relied upon by the assessor.
Of course, if an apartment complex stacks up favorably on most counts to the sales used by the assessor, there will be less running room within which to dialogue with the assessor.