Property Tax Resources

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The Silver Lining of Increased Vacancy

"By demonstrating the scale of the reduction in income to the property and quantifying the precise loss in value through the process of income capitalization, a taxpayer can often reduce its tax burden..."

By Stephen Paul , Esq., as published by Real Estate Forum, September 2012

The clearest way to convey the bright side of declining commercial real estate values is through a residential example. At the height of the real estate boom in 2007, my wife and I received an unsolicited offer for a condominium we owned in Florida. The buyer was persistent and eventually paid us three times what we had paid only four years earlier. But because we still wanted a vacation place in Florida, we purchased a new condo as the market was topping out.

As soon as we moved into our new condo, the market crashed. Similar units in our development were soon selling for half the amount we had paid for ours. When my wife saw our first tax assessment, she was dismayed that our condo's value had dropped so far below our purchase price. But because we intended to hold onto the property for many years, and because our property taxes had decreased, the decline in assessed value actually improved our position.

For commercial real estate, the post-2008 increase in vacancy rates and the collapse of the capital markets have led to a substantial value loss. Value-weighted US commercial property values in June this year were down 30.7% from the peak of January 2010, according to the CoStar Commercial Repeat Sales Index. This cloud has a silver lining for property owners, however. The decline in the market creates an opportunity to reduce taxable value, increase the bottom line and begin to turn the property's value upward. To everything there is a season.

Real estate values, much like the real estate market itself, are largely cyclical. Tax assessors usually calculate commercial property value by capitalizing the property income. As rents decline, property value declines, both for business valuation and tax purposes. A lower assessment also reduces the tax bill.

Logically, any reduction in a major expense will raise net income. Other than debt service, the largest expense for most real estate is property tax. Consequently, as the tax load decreases, the property owner's bottom line increases.

Few local governments assess properties annually. Most properties are reassessed every three or four years, and the tax authority simply adjusts values annually to reflect general market changes. A property may carry an assessment from the market's peak or from a time when the property had less vacancy, thereby overstating the current value.

Assessors will not always reduce a property's assessed value simply because hard economic times have fallen on a region. The problem is further compounded because assessors rarely have access to a property's rent roll. When assessors choose to reduce values generally, the reduction may not be tied to a specific property's actual reduction in tenancy.

In most jurisdictions, however, when a building suffers from an inordinate loss through vacancy, the taxpayer can file a real estate tax appeal requesting an adjustment of the building's assessed value. By demonstrating the scale of the reduction in income to the property and quantifying the precise loss in value through the process of income capitalization, a taxpayer can often successfully and substantially reduce its tax burden. A successful tax appeal and the resulting reduction in tax burden can in turn help offset the loss of income caused by the building's excessive vacancy. Additionally, the lower assessment may remain in effect even as the market improves, resulting in savings for future years.

The tax reduction will boost the property's net operating income. In turn, this will raise the property's market value once the building's increased net operating income is capitalized into anindication of value. This cyclical cause and effect is a built-in economic buffer for owners whose properties suffer from above-normal vacancy rates.

Outside of the tax arena, if a property's expenses decrease and its net income increases, the owner may seek a professional appraisal of the property. An appraisal that accounts for the reduced tax burden may be used to secure more favorable financing, particularly for properties with underwater mortgages. Further, for owners looking to sell their properties, the decrease in the real estate tax load may counterbalance higher-than-average vacancy. A potential buyer will see a better return on investment with a lower tax burden and may be willing to pay more for the property than the occupancy alone would suggest.

By recognizing that there is a silver lining to excessive vacancy and by acting to secure a more favorable assessment, owners can better manage their taxes and keep their property's value elevated in lean times.

paul Stephen Paul is a partner in the law firm of Faegre Baker Daniels, the Indiana member of American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. This email address is being protected from spambots. You need JavaScript enabled to view it., associate, contributed to this article.


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