2023 Municipal Revaluations

It is always important to carefully review your tax bill and/or notices of assessments, but even more so in the year in which your city or town conducts a revaluation.

Each assessment should be carefully reviewed, even if your assessment has not increased substantially, as an appeal immediately after a revaluation maximizes a property owner's potential tax savings.

Connecticut law requires that each municipality conduct a general revaluation of the real estate within its borders at least once every five years.The purpose of a revaluation is for a municipality to determine the market value of real estate to be used to calculate property taxes.

Once a property's value is set in a general revaluation, it remains constant over the entire five-year cycle, absent appeal, demolition, improvements or expansion. Of course, the annual taxes usually increase, as a municipality's mill rate increases incrementally from year to year. Municipalities across the state are on differing revaluation cycles. The following is a list of Connecticut municipalities conducting revaluations this year:

If your municipality is conducting a general revaluation for the October 1, 2023 Grand List you will receive a notice of tax assessment change soon, if you have not already.

Once the notices are issued there may be a chance to meet informally with the assessor to discuss the new assessment, which should represent 70 percent of the fair market value of your real estate. However, if a property owner wishes to challenge the assessment formally, a written appeal must be filed with the local Board of Assessment Appeals by the February 20, 2024 statutory deadline.

It is in your best interest to be proactive in monitoring the revaluation process and your new assessment so that you can take all necessary steps to ensure that the assessment is equitable.

News on the Newly Enacted Tax-Payer Appraisal Deadline

While we have deadlines and key dates fresh on the mind, 2023 was the inaugural year for a new deadline that was implemented into Connecticut's overvaluation statute, C.G.S. 12-117a, by the Connecticut General Assembly. Per the newly amended statute, if a taxpayer brings an overvaluation appeal on real property that has an assessed value over $1 million, the taxpayer is now required to file an appraisal of the property with the superior court by no later than 120 days after commencing the appeal.

It remains to be seen what relief, if any, a taxing authority may seek from the court if a taxpayer fails to meet this deadline, but expect some case law to develop on this subject if the statute is not amended in future legislative sessions. One recent superior court decision involving a tax appeal captioned as Shortline Properties, Inc. v. City of Stamford, FST-CV23-6060950-S discussed the implications of this deadline to a certain extent, but it did not squarely address the question of what judicial relief is available to municipal defendants.

The court did make clear, however, that appraisals filed for purposes of this statutory requirement must be from the grand list date from which the taxpayer commenced the appeal. In this case, the taxpayer's appraisal appeared to be from two years prior to the grand list date in question, and the court concluded that this did not meet the appraisal requirement. That said, the case remains pending and although the court rejected the appraisal, it allowed the plaintiff to proceed with prosecuting the appeal.

Tax considerations often drive site selection and form an importance piece of the reshoring puzzle.

COVID-19 laid bare many problems inherent in offshore supply chains and spurred widespread interest in reshoring manufacturing to the United States. As companies and communities explore site selection and expansion opportunities, they should remember that manufacturing profitability often hinges on tax strategy.

Staging a comeback

For the first time in decades, industry and the public sector are working to make American manufacturing competitive in a rapidly changing global marketplace. The recent enactments of the Inflation Reduction Act, the Bipartisan Infrastructure Law and the CHIPS and Science Act have directed billions of dollars into enhancing domestic manufacturing capacity.

The semiconductor industry presents a high-profile case study. The United States holds 12 percent of the world's semiconductor manufacturing capacity, eroded from 37 percent in 1990. The CHIPS Act's $52 billion in federal funding is intended to strengthen domestic semiconductor manufacturing, design and research and reinforce the nation's chip supply chains, fortifying the economy and national security along the way.

Simultaneously, the United States is becoming a leading producer of electric vehicles and vehicle battery plants. Since 2021, announced U.S. investments in semiconductors and electronics exceed $166 billion, and announced U.S. investments in electric vehicles and battery manufacturing exceed $150 billion.

Deciding where manufacturing occurs depends partly on proximity to suppliers, available labor, distribution hubs and customers, and operating costs. Property tax is typically a significant component of operating costs. That's why tax abatements on real property and equipment are a commonly offered incentive.

Most states offer incentives to attract industry, and one of the hotbeds for increased American manufacturing has been the southeastern United States, specifically South Carolina, Georgia and North Carolina. All are leaders in foreign direct investment.

Abatements generally provide a manufacturer with predictable property taxes, helping to overcome the uncertainty of future tax liability that can put companies at a disadvantage. An example is South Carolina's "fee in lieu of tax" agreement (FILOT) which offers manufacturers predictable and consistent taxation. Generally, FILOT agreements fix tax rates and the value of real estate and improvements for the length of the agreement, while allowing manufacturers to depreciate the value of machinery and equipment.

FILOT agreements can have up to a 50-year term. However, by fixing a manufacturer's real property value at actual cost without depreciation, the owner's taxes over time may be higher than they would be without the agreement. That's because they do not account for depreciation, valuation changes or required improvements to accommodate changes in the marketplace for the manufacturer's product.By locking in the real property value, the manufacturer receives the benefits of predictability and protection from higher taxes on appreciating real property.In exchange, however, the manufacturer loses the benefit of any depreciation and takes the risk of a locked-in property value if the property's market value diminishes.

Other states offer different incentives including more traditional property-tax abatements, where a manufacturer receives a grant as a partial rebate or discount on the new property taxes the project creates. Since tax rates and taxable value assessments change over time, these systems can provide less certainty for manufacturers than FILOT-type agreements, but potentially offer more long-term flexibility to respond to changing tax rates, depending on how the agreements are negotiated.

As a manufacturer's industry evolves and demand for its products changes, flexibility to appeal tax assessments can be a key to maintaining profitability and competitiveness.

Committed but flexible

Certainly, a manufacturer is better off in an appreciating real estate market by fixing the value of the real estate and improvements. Organizations negotiating for incentives should protect their ability to protest unfair assessments of taxable value, however, because valuing a manufacturing plant in the traditional ad valorem system is challenging and subject to controversy.

For example, most state ad valorem property tax systems define "value" as a variant of "market value," assuming an exchange between a willing buyer and a willing seller. However, will the buyer of a manufacturing facility benefit from the features of a specialized building constructed for a different manufacturer's specific needs? The answer is usually "no."

Manufacturing facilities are special-purpose properties, which The Dictionary of Real Estate Appraisal defines as a "property with a unique physical design, special construction materials, or a layout that particularly adapts its utility to the use for which it was built." And changes in the manufacturing process can render many buildings economically obsolete.

If the facility's use is no longer viable, it should be appraised as an alternative use. This necessarily occurred as American industry declined. Often there were no manufacturers who could effectively use single-purpose buildings vacated by other manufacturers, necessitating drastic value reductions.

An assessor's three traditional valuation methods all have limitations. A sales comparison approach is difficult when the production facility has essentially been designed to produce specific products. Put differently, finding sales of comparable facilities can be extremely challenging.

An income approach requires a market rent calculation, but manufacturers historically own their facilities, making an income approach difficult. A cost approach using actual cost ignores that the same building might not be appropriate to respond to changes in the marketplace for the product being produced. The cost approach without depreciation also limits the manufacturer's flexibility in responding to changes in the marketplace for its product.

Remember, too, that a manufacturer must be nimble, as changes in the market or technology can render an entire plant (or industry) obsolete virtually overnight. Adapting processes may require equipment upgrades or replacement, structural modifications or other changes that affect property value.

The speed at which manufacturers need to be able to adapt to a changing marketplace, the strong desire for certainty in costs and the difficulties in valuing manufacturing facilities for tax purposes all argue in favor of valuing real property and improvements on the basis of cost less depreciation.

Successful reshoring will require focused efforts by the public and private sector, together with sensitivity to industry's need to be nimble and the implications of historical incentives to ensure that reshored industry remains competitive. Flexibility offers the key to long term success, and property taxes form an important piece of the puzzle.

Here are some property tax strategies owners can use in the rebounding apartment sector.

Multifamily construction and renovations are enjoying a resurgence after taking a pause during the pandemic. And with residential, apartment-style rental units back in vogue with renters and investors, developers are even converting underutilized office buildings and shopping malls into multifamily housing.

As developers step up construction spending to tempt renters with an assortment of amenities, tax assessors are having a field day, tabulating costs on renovations and new projects that they are using to justify ever-larger assessments of taxable value across the sector. Multifamily owners must look out for themselves to guard against unfair, blanket assessment increases founded on these gross generalizations about the industry.

New offerings, New Renters

The target demographics for today's projects include young professionals not yet equipped to buy their own homes; middle-aged, single-family homeowners looking for a more carefree housing option; and aging individuals looking to downsize and become part of a seniors community.

Apartment models have evolved to better suit today's renters. Gone are the cookie-cutter, brick-and-mortar, garden style structures with minimal common areas. New apartment communities are more often high-end projects boasting pools, gyms, lush landscaping, retail shops and other non-traditional apartment features.

The added expense to deliver amenity-rich apartments is only one of many rising costs for multifamily developers and owners. Supply chain breakdowns, material shortages, rising interest rates on commercial mortgages, governmental bureaucracy, and increased inflation have forced owners of apartments and other commercial buildings to search for avenues to reduce their costs. While costs associated with owning and maintaining apartment buildings are trending higher, real property taxes remain one of the largest expenses, warranting an annual review and challenge.

Fortunately, in ad valorem jurisdictions where a property's tax assessment is tied to its market value, the law allows taxpayers to appeal assessments and seek relief from onerous real estate taxes. The process involves the filing of an annual administrative grievance followed by a judicial action against the tax-assessing entity.

The Protest Process

In tax appeal proceedings, the aggrieved party or petitioner bears the initial burden of proof. Assessments are presumptively valid, so it is up to the taxpayer to provide substantial evidence that calls into question the assessment's correctness. Taxpayers often meet this minimum standard by submitting a qualified appraisal.

In a court setting, once the presumption of validity is rebutted, the judge must determine by a preponderance of the evidence whether the property was overvalued. However, most tax assessment cases reach a resolution through negotiation and settlement without the need for a formal expert report or judicial oversight. A tax advisor skilled in real property tax assessment challenges is more often than not all the taxpayer requires.

The three traditional approaches to real property valuation in a tax appeal are the income capitalization, comparable sales, and cost approaches. Absent a recent arm's-length sale of the subject property, appraisal professionals, practitioners, and the courts generally regard income capitalization as the preferred method to value income-producing properties.

In utilizing the income approach, a taxpayer's team is seeking to value the property based on its net-income-generating potential. In other words, what would a buyer pay on the valuation date for the future income stream?

Point-by-Point Analysis

There are several steps to properly arrive at a value conclusion through the income approach. Understanding and following the steps will not only inform the property owner's valuation, but also provides a checklist to review and question calculations in the assessor's conclusion.

To calculate potential gross income, it is important to analyze the subject property's actual rental data and test it against market rents to reflect the property's economics. Similarly, the assessor or appraiser must gather, review and analyze occupancy and collection data. The appraiser will need to deduct for vacancy and collection loss because many buildings are seldom at 100 percent occupancy, and some tenants may be behind in their rent payments.

The same process is applied to real estate-related expenses such as insurance, utilities, and replacement reserves. These should be deducted to arrive at a net operating income before the deduction of real estate taxes.

In analyzing data for a tax assessment challenge involving income-producing property, real estate taxes are not accounted for at this stage because this is the expense in question. In addition, since the property tax expense is a percentage of market value, it is accounted for in the capitalization rate along with an appropriate rate of return reflecting the risk of investment.

Appeal prospects

How can the taxpayer gauge a tax appeal's likelihood of success? Among other things, consider the size of the rental units, location, competition, and parking to form a reliable value opinion. Give special attention to the tax system in the state and local jurisdiction where the property is located to ensure the taxpayer meets all statutory filing requirements and deadlines. If a challenge is not timely and properly commenced, the aggrieved party will lose its right to real property tax relief for that tax year.

Given the complexity of commercial property valuations and the nuances involved in disputing the correctness of valuation calculations, savvy apartment building owners may benefit by discussing their property's economics with a specialist in real property tax assessment review challenges. 

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

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

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

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

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

1. An intangible asset should be identifiable.

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

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

4. An intangible asset should be legally transferrable.

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

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

Multifamily comparisons

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

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

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

Difficulties with financing data

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

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

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

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

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

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

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

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

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

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

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

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

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

1. Understand and observe all filing deadlines.

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

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

2. Critically analyze the assessment basis.

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

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

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

3. Analyze the assessor's comparable sales.

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

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

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

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

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

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

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

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

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

Projecting Income:Look Forward, Not Back

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

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

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

Projecting Expenses: The Compounding Costs of COVID

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

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

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

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

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

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

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

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

Question the Assessor's Valuation

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

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

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

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

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

Getting started

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

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

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

Know dates and procedures

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

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

Learn the lingo

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

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

Call the assessor

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

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

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

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

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

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

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

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

Escalate as needed

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

Property Tax Terms

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

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

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

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

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

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

Owners can use the hurting office market to their benefit.

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

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

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

Why care about the office market?

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

Wrong.

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

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

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

Inflation and interest rates

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

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

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

Where are the sales?

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

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

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

Is it time to appeal?

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

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

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

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

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

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

High hopes

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

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

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

Real property tax rates

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

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

Timing of reclassification

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

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

Property acquisition

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

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

Abatements

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

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

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

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

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

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

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

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

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

High-flying fees

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

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

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

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

Fee-simple principles

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

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

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

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

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

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

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

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

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

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

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

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

A guide to effectively challenge and reduce bloated tax valuations.

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

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

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

Know Your State's Value Standard

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

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

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

Maybe. Maybe not.

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

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

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

Sales Won't Sell It

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

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

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

What About The Cost Approach?

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

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

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

Market Rent Is King

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

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

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

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

Go for Broker

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

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

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

Let's Be Reasonable

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

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

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

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

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

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

Debilitating obsolescence

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

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

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

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

Tied hands

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

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

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

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

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

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

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

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

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

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

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

Property tax implications

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

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

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

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

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

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

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

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

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

New Construction Assessed at Material Cost

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

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

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

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

Substantially Complete?

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

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

Adding Insult to Injury

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

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

The Good News

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

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

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

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

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

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

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

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

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

Office valuations suffer

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

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

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

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

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

Challenge unfair assessments

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

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

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

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

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

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

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

Debilitating obsolescence

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

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

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

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

Tied hands

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

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

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

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

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

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

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

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

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

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

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

Property tax implications

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

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

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

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

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

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

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

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

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

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

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

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

A constitutional concept

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

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

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

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

Ready remedies

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

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

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

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

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

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

A pervasive need

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

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

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

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

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

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

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

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

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

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

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

What is market value?

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

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

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

The Tax Jurisdiction's Evidence

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

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

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

Taxpayer's counterpoint

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

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

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

Lessons learned from the Tribunal's decision

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

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

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

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

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

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

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

Value Judgments

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

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

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

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

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

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

Two Approaches

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

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

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

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

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

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

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

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

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

Follow these steps to stop excessive property tax assessments.

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

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

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

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

How to reduce property tax liability

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

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

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

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

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

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

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

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

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

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

Apply to other valuation approaches

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

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

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

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

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

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

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

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

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

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

Restoring a precedent

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

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

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

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

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

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

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

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

Who's who?

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

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

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

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

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

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

Owners who understand the nuances of tax incentives, abatements and exemptions can gain an upper hand in reducing their property taxes.

The Low-Income Housing Tax Credit (LIHTC) has long been a key device in the affordable housing tool chest. Although it has been the primary source of financing for the construction and preservation of affordable housing, the tax credit has not allowed the vast expansion of affordable housing development
that many communities need to keep up with rapidly growing demand.

With rents and materials costs rising amid rapid U.S. inflation, cities and rural areas alike need more resources to help keep many Americans in quality affordable housing.

According to the National Low Income Housing Coalition, only two states (West Virginia and Arkansas) have housing costs that put a two-bedroom rental within the reach of a fulltime worker earning less than $15 per hour.

The recent spike in residential real estate prices and now increasing interest rates are forcing more potential home buyers to rent. This has left fewer units available, which drives up rents and further reduces the supply of affordable housing throughout the country. As of April 2022, more than half of U.S. consumers were living paycheck to paycheck, reports financial services company LendingClub.  

According to the U.S. Department of Housing and Urban Development, the Federal Reserve Bank of St. Louis and the U.S. Census Bureau, the national median rent increased more than 145 percent from 1985 to 2020, while median income increased by only 35 percent.

Clearly, more needs to be done to assist developers in the construction of affordable housing. Fortunately, many cities and states are implementing new legislation and programs that will directly assist developers who expand the affordable housing market.

State, Local Initiatives
Texas — In Austin, Affordability Unlocked is a development bonus program that waives or modifies some development restrictions in exchange for providing affordable housing.

In return for setting aside half of a development's total units as affordable, developers can receive increased height and density limits, parking and compatibility waivers and reductions in minimum lot sizes for the project.

The program is designed to increase the number of affordable housing units developed in Austin and to fully leverage public resources by allowing housing providers to build more units in developments that include significant amounts of affordable housing.

Washington, D.C. — Tax abatements for affordable housing are available that provide a reduction equivalent to 75 percent of the difference between the property tax owed before and after development. To be eligible, at least 5 percent of the units in the development must be reserved for low-income households, and an additional 10 percent of units must be reserved for households earning up to 60 percent of area median income (AMI).

The tax abatement is good for 10 years. The affordability requirements apply for at least 20 years, with a $10,000 penalty per year for each unit that does not meet income set-aside requirements during the final 10 years.

Illinois — In 2021, Illinois enacted legislation to develop and coordinate public and private resources targeted to meet the affordable housing needs of low-income and very low-income residents. The act applies to all counties within the state and allows each county to administer the applications for the property tax incentive.

In Cook County, for example, property owners with seven or more multifamily units may apply for the Affordable Housing Incentive, if they can prove a set of conditions that would qualify the property for one of three tiers of relief.

For example, an applicant with a pre-existing building that has spent more than $8 per square foot on rehabilitation of major building systems and has at least 15 percent of the units available at or below 60 percent of AMI qualifies for the "15 Percent Tier" incentive.

Major building systems include heating and cooling, electricity, windows, elevators and more. This incentive will reduce the property tax assessment by 25 percent for 10 years and can be renewed for two consecutive terms.

New York — Although state lawmakers allowed New York's longstanding 421a abatement to expire in June 2022, some property owners can still qualify for relief under the New 421a Program. The New 421a is available to projects that began construction between Jan. 1, 2016, and June 15, 2022, and will be completed on or before June 15, 2026.

Projects that commenced construction on or before Dec. 31, 2015, also may opt into the new program if they are not currently receiving 421a benefits. Applications must be filed within one year after completion, and construction benefits would be retroactive.

Benefits of the New York program include a construction period tax exemption of up to three years, plus post-construction exemptions of 10 years (two years full, plus an eight-year phase-out period); 15 years (11 years full, plus a four-year phaseout); 20 years (12 years full, plus an eight-year phaseout); or 25 years (21 years full, plus a four-year phaseout).

In post-construction periods, qualifying properties are exempt from the increase in real estate taxes resulting from the work. The length of benefits depends on location, commencement of construction and affordability within the project.

All market-rate rental units become subject to rent stabilization for the duration of the benefits, with initial rents approved by the Department of Housing Preservation and Development. Affordable rental units are rent stabilized for 35 years.

Massachusetts — Multifamily property owners can claim a tax exemption for any portion of the property used for affordable housing purposes. The exemption is calculated by multiplying the amount of tax ordinarily due by the percentage of floor area set aside for affordable housing purposes.

The exemption is granted on a year-to-year basis for units serving households earning up to 80 percent of AMI, and the local board of assessors reviews tenants' income information to confirm eligibility. Because the exemption is granted on a year-to-year basis, there is no long-term affordability requirement.

Oregon — The Multiple-Unit Limited Tax Exemption Program requires that at least 20 percent of rental units be affordable to households earning 60 percent of AMI,or 80 percent of median family income in high-cost areas, for the 10-year term of the exemption.

Hundreds of programs throughout the country offer tax credits, abatements or other incentives. In markets that are happy to assist willing partners in providing affordable rental housing for their communities, developers can gain an upper hand by learning to fully understand and navigate the application process.

A New Jersey township learns that tax courts don't always buy into theoretical constructs.

Our tax courts live in a hypothetical world where they review property tax assessments in a theoretical manner to mimic the actual marketplace. Often municipal officials use this paradigm to distort concepts and achieve high values that cannot be realized in the market. The case of CIBA Specialty Chemical Corp. vs. Township of Toms River highlighted this dichotomy.

The subject property is an industrially zoned, 1,211-acre former chemical plant in Toms River, New Jersey. The plant produced industrial dyes and resins for over 40 years. Unfortunately, the manufacturing process also created significant industrial waste that was treated and disposed of on site, significantly contaminating the soil and groundwater.

The environmental contamination was so severe and pervasive that the entire property was designated a Superfund Site and was placed on the U.S. Environmental Protection Agency's (USEPA) National Priorities List in 1983.

Commercial operations at the site ceased in 1996, but environmental remediation work has been both active and ongoing. The controversial nature and extent of the contamination has embroiled the property and township in public controversy, federal criminal prosecution, and a number of civil lawsuits initiated by both public entities and private citizens.

Further complicating matters, the subject property is in a protected coastal zone adjacent to a tributary known as Toms River. This added layer of government oversight by the New Jersey Department of Environmental Protection serves to safeguard sensitive coastal areas and endangered species from overdevelopment. When put into practice at the subject property, these regulations either completely prohibit or severely restrict redevelopment activity on most of the property.

Any proposed redevelopment at the property would require the prospective developer to navigate this labyrinth of federal and state regulations, obtain consent and cooperation from a number of federal and state agencies, and garner support from the local municipality and public interest groups to avoid politicization of the zoning and planning processes at all levels.

Undaunted by these regulatory restrictions, the town asserted that not only could the property be developed, but that numerous residential housing units could be constructed on the site despite the current zoning or the pervasive contamination. And, of course, the town sought to tax the property on its potential residential value.

It was undisputed that the USEPA was the primary regulatory authority from whom a market participant would have had to obtain approval before attempting to redevelop any portion of the site. The town's own expert conceded this fact. The USEPA has total control over the property while remediation is taking place and will reject any proposal it believes may interfere with selected remedial action, or that would lack public support.

Despite overwhelming evidence that USEPA regulations would prohibit any development, that the zoning didn't allow residential construction, and that the public opposed the site's redevelopment, the town was undeterred. Its leaders argued that high-density housing could have been developed on the property with a rezoning, justifying its revaluation as residential rather than industrial real estate.

The frequent use of hypothetical scenarios encourages assessors to fly far from the reality of the marketplace to justify otherwise unsupportable assessments and increased tax burdens. Finding comfort in this hypothetical world, the town appealed to the perceived taxing-authority bias of the New Jersey Tax Court.

To create their hypothetical world in court, the town redefined key words in the USEPA regulations to establish results that were completely inappropriate for a rational reading of the rules. They stretched logic and applied to the subject property actions that USEPA had taken at other Superfund Sites. In doing so, they assumed that all contaminated sites can be treated the same, and that the case workers at this site will make decisions based on events at other remote Superfund sites, rather than basing decisions on the facts related to the subject property.

The town contrived its self-serving arguments to satisfy an outrageous assessment. It is all too often that the hypothetical nature of the court's standards and the theatrical nature of appraisal theory invite the clear distortion of marketplace reality.

The only saving grace in the system is that the courts assigned to decide these cases are trusted to end the nonsense and craft a decision based on fact and actual dealings. That does not always happen, but here, it did. In a detailed and thorough decision, the court summarized the overwhelming data that proved the taxpayer's case.

The court concluded that the entirety of 1,211 acres was development-prohibited, due to its status as an active Superfund Site and USEPA's ongoing institutional controls. The USEPA's oversite documents, which are legally enforceable and filed with the county clerk, restrict any development at the property unless the USEPA approves, or the site is partially or fully delisted as a Superfund site.

Reality finally hit home for the municipality when it was compelled to refund the taxpayer over $18 million.

These types of rulings in taxpayers' favor are rare. Nonetheless, taxpayers must continue to press courts to recognize market reality. It is not the courts' job to protect the municipal tax base.

Nuances of ownership and operations can reduce or eliminate ad valorem liability for property owners.

How municipalities and counties tax medical real estate can vary by modes of ownership, location and how a property affects the local economy. Much, however, depends on each taxing entity's goals and its degree of interest in attracting hospitals, creating medical hubs, enlarging commercial areas or encouraging excellent health care locally.

A typical approach to achieving some or all of these goals is for local government to control the property. This can be through outright ownership, where the facilities are leased out. Governments can also create an economic zone and issue bonds to finance the area's development. Each of these methods poses property tax issues.

In a direct ownership scenario, the government owner is exempt from taxation. The operating and management company that leases the property has tax liability for its going concern, however. That going concern has untaxed intangible value, but also will have onsite assets such as medical equipment that can be taxed under standard code approaches at fair market value. They can also be taxed under a modified fair market value, which is a common incentive designed to entice investment by medical businesses.

If the local government chooses a development-bond approach, it will create a development district entity to issue bonds, with proceeds from bond sales paying for construction of the hospital or other facility. A private entity would lease the facilities under the cost of the bonds, with lease payments going toward retiring the bonds. Lease provisions would set out agreed-upon valuations for property tax purposes. These valuations can be flat or adjusted over time. Once the bonds are paid off, the terms of the lease can be extended or modified.

After using one of these favorable property tax techniques to establish a footprint for a healthcare district, development or zone, the governmental body may widen its impact by offering lower taxes within the area. These adjustments would favor medical facilities that support hospitals or medical practices nearby.

For example, a community could use tax breaks to encourage construction of medical office buildings. If the economic district includes other buildings that would be useful to the healthcare industry, it can offer similar tax incentives to encourage development and use of those facilities. Likewise, such incentives can be used for standalone facilities within the economic district.

For governments that do not envision a medical district but want to foster broader access to healthcare providers, tax policy can create special tax methods without uniformity restrictions. This would encourage small medical investments throughout the community. Examples would include free-standing treatment facilities such as "doc in a box" walk-in clinics, urgent care facilities and small medical office buildings.

Strategies for tax exemption

In Georgia, hospitals can be owned in a couple of ways to avoid taxation. First, the government can own the hospital and lease it to a non-profit manager or operator. So long as the lessee remains a non-profit, the real property is tax exempt. If the leasehold transfers to a for-profit entity, the tax exemption disappears and the management or operational entity becomes responsible for the property tax.

Second, the local government can create an economic development zone using bonds. Within any leaseholds created by the bond issuer, property tax responsibility can be addressed by contract. This can range from zero liability to points on a sliding scale, and will usually correlate to the gradual elimination of the bonds.

Another scenario involves an exempt property that is then acquired by a for-profit operator. In Michigan and Georgia, such a transfer will void the tax exemption, subjecting the facility to full taxation at fair market value. A question remains about a retransfer of the operations to a non-profit, which may or may not restore the tax exemption. In Minnesota and Kansas, the ownership is through the government but the facility must be operated as a non-profit.

In some jurisdictions hospitals can be a taxing authority. In Texas and Iowa, rural hospital districts can levy a component of the property tax millage rate. The hospital district then uses that portion of the millage rate to pay part of its operating expense. This allows rural hospitals to maintain their operations by spreading costs throughout the community, rather than to the users of the system. In recent years states have tended to reduce property taxes overall, which has squeezed revenue for rural health systems in states that allow hospitals to participate in taxation.

Personal property, which is movable property such as medical equipment, can be treated in different ways. If the operation is a non-profit, the personal taxes are exempt. Liability is more complicated if the owner of the personal property is a for-profit entity operating within an exempt property; in such instances the personal tax rates apply.

On the other hand, a non-profit may operate within a taxable medical office building, in which case the personal property is still exempt. In fact, a building may have multiple tenants, some of which are non-profits and some of which are for-profit. In such a scenario, each business would have to be examined to determine whether personal tax exemptions apply.

Consider each of these proven strategies to minimize ad valorem tax bills.

Record-breaking commercial real estate trading activity during 2021 is having a marked impact on property values in 2022. Transactions in 2021 were up 88% from 2020 and were 35% above 2019 levels, according to Ernst & Young. The large number of sales in 2021 extended to all categories of real estate, and many commercial property types experienced significant price increases.

Market values are the basis for property tax assessments in most taxing jurisdictions. As post-pandemic market values fluctuate due to higher prices, property owners need to adopt strategies to keep their assessed property values down. As we emerge from COVID-19 here are seven key considerations to minimize property tax assessments even as prices increase.

1. Report Property Operating Metrics. A commercial property's market value is based on its financial performance. A weak property will have poor performance indicators, such as excessive vacancy or below-market rental rates. Poor performance is usually the basis for a reduced assessment and a lower property tax bill. Where possible, property owners should report these types of performance indicators to taxing authorities each year before assessed values are set and tax bills go out.

2. Allocated Prices in Real Estate Portfolios Are Not Market Values. A buyer purchasing a real estate portfolio will typically allocate the total price paid over all the acquired real properties as well as other, non-real-estate assets. Investors create these portfolio purchase allocations for income tax, accounting, financing or other purposes, and they may commission an "allocation" appraisal for bookkeeping or underwriting purposes. Allocations of total portfolio price or value to individual properties in a portfolio are rarely a good indication of a property's market value, however. Likewise, allocation appraisals are unhelpful or even detrimental in determining taxable market values because they may not account for the unique aspects of an individual property.

3. Transaction Type May Affect Value. Market values can also be impacted by the nature of the transaction and its participants. For example, REITs set purchase prices for real estate portfolios based, in part, on income tax considerations. Similarly, when a transaction involves the acquisition of an entity that holds various types of assets, the price paid will include payment for assets other than real estate alone. Non-real-estate motivations for purchasing properties and non-realty components of a transaction must be removed in order to determine the market value of the real estate alone. Otherwise, the values for the real estate will be above market.

4. Only Real Estate Is Subject to Property Taxation. As previously mentioned, property portfolios will sometimes convey with other assets. These can include personal property, such as fixtures and equipment, or intangible assets and rights like contracts, licenses and goodwill. Market values for these non-real-estate items are evaluated differently from real property and some, such as intangible assets and rights, are not subject to property taxation at all. In addition, any "synergy" or "accretive" value from a portfolio sale is intangible and should be excluded when assessing a specific property's value for property tax purposes.

5. Properties May Not Stabilize at Pre-Pandemic Levels. Properties that were hardest hit by changes related to COVID-19 may take years to return to pre-pandemic performance levels, and some may never fully recover. Awareness of a particular industry's recovery will be key to understanding whether market values and property tax assessments for that property type will return to pre-2020 levels. Uncertainties about time to stabilization reduce real estate values. The knowledge that some properties may never achieve pre-pandemic performance levels puts long-term investment value into question, which decreases the current value of those properties and lowers their taxable value.

6. Leasehold Interest Values May Not Match the Market. Investors buy and sell commercial properties based on the net income they produce. However, if the leases generating that income are above or below market, the value derived from rents will not be at market. In addition, lease rates from synthetic or operating leases used to finance the purchase of a portfolio of properties will not produce market value for individual properties unless those lease rates happen to be set at market levels.

7. If All Else Fails, File a Property Tax Appeal. Taxpayers who work proactively with their local tax assessor are often able to achieve reduced assessed values and lower property tax bills. Property owners should address each of the previous six points with the local assessor. Nevertheless, there will be times when attempts to reduce assessed values are unsuccessful. In those cases, property owners should be prepared to file an appeal by the deadline and pursue it, preferably with the assistance of a knowledgeable property tax advisor.