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Sep
14

Are All Bricks Created Equal?

Proper functional obsolescence may not be factored into the estimates provided by the cost estimating services.

By Kirk Garza, MAI, CCIM, CMI, Joseph Jarrell, and Jordyn Smith

Appraisal districts across Texas often use the cost approach to determine market value for property tax purposes, and when valuing certain commercial properties via the cost approach, county appraisers frequently use cost-estimating services. These services enable appraisers to estimate the cost of the subject property's improvements as if they were new, as well as determine the depreciation to apply to the subject.

Cost estimators can be a great resource and valuation tool, but the appraiser is likely to reach an incorrect value conclusion using estimates from one of these services without also incorporating proper analysis of functional obsolescence.

Functional obsolescence is one of the three types of depreciation that measures a building's function and utility against current market standards. Given this, placing all weight on a service's depreciation estimates could lead to incorrect assessments that ignore functional obsolescence within the property's total depreciation.

The Trouble With Tables

Cost-estimating services typically provide depreciation tables that contain depreciation data for multiple commercial property types. County appraisers often cite these tables as their main source of depreciation support when using the cost approach.

It is important to know that these tables typically assume that all components of the improvements for the various property types depreciate equally across time. So for example, a brick used in a multifamily or office development will depreciate at the same rate as a brick used in a fast-food restaurant or movie theater.

Often-overlooked warnings from these services point out that certain real estate product types are subject to functional obsolescence that occurs rapidly and can significantly reduce the economic lifespan conclusion for the applicable property type. Given this information, a determination of total depreciation for the subject property must include an appropriate functional obsolescence analysis.

Evaluating functional obsolescence involves an analysis of the utility of the improvements, and how that degree of usefulness affects total depreciation. As an example, consider the fast food industry, which has evolved drastically over the past few decades.

As fast-food real estate models from the 80's and 90's continue to become obsolete, new models have appeared to attract and retain the millennial and Generation Z customer base. Because of this, it is common practice for fast-food companies to refresh their store models every five to 10 years, with a complete rebuild taking place every 20 to 25 years.

This refresh-and-rebuilding cycle is necessary to fit ever-changing consumer tastes and demands for this real estate product type. While the store refresh may include new flooring, additional exterior decoration and color schemes, a complete rebuild is necessary when the utility of the building no longer fits the current design standards demanded by the market. An economic life of 20 to 25 years may be appropriate to capture the potential functional obsolescence associated with this industry.

Picture A Theater

Movie theaters are another competitive product type that may be subject to functional obsolescence outside standard physical depreciation. Theaters built in the 1990s and 2000s may struggle to compete with the eat-drink-and-play models that continue to increase in popularity. Across Texas, select stand-alone theaters that lack dining, bar, and event options continue to see revenues decline.

Theaters without these features often lack the capacity to add a commercial kitchen, bar service, or bowling alley into their existing structure, which limits the utility of the property based on market tastes and preferences. These older theaters may also contain large projection rooms that were previously used to house large equipment and film reels. Given the arrival of digital cinema, most projection rooms now require less space to house and project content into the auditorium.

Auditorium spaces are also evolving, based on the capacity to house premium luxury sections or reclining seats with independent power modules. These popular seating features have resulted in auditoriums having less seating capacity, given the additional space required for each seat. Clearly, it is important to analyze and recognize any applicable functional obsolescence that could affect this property type.

Real estate product types continue to evolve along with consumer standards and tastes; it will be important to consider the impact these requirements have on a building's utility over time.

Cost-estimating services are a great tool that is used frequently for valuation, but it is important to know what is – and what is not – reflected in their information. Once assessors realize this distinction, they can apply proper analysis of total depreciation in their cost-approach determination of a property's market value.


Kirk Garza holds the MAI designation of the Appraisal Institute and has earned the CCIM designation through the CCIM Institute and the CMI designation from the Institute of Professionals in Taxation (IPT). Kirk is a Director and licensed Texas Property Tax Consultant with the Texas law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel, the national affiliation of property tax attorneys. Joseph Jarrell and Jordyn Smith are graduate students at Texas A&M University's Master of Real Estate program. They may be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
Jul
27

Not All Bricks are Created Equal: How Functional Obsolescence Affects Property Taxes

Appraisal districts across Texas often use the cost approach to determine market value for property tax purposes. When valuing certain commercial properties via the cost approach, county appraisers frequently use cost-estimating services. These services enable appraisers to estimate the cost of the subject property's improvements as if they were new, as well as determine the depreciation to apply to the subject.

Cost estimators can be a great resource and valuation tool, but the appraiser is likely to reach an incorrect value conclusion using estimates from one of these services without also incorporating proper analysis of functional obsolescence.

Functional obsolescence is one of the three types of depreciation that measures a building's function and utility against current market standards. Given this, placing all weight on a service's depreciation estimates could lead to incorrect assessments that ignore functional obsolescence within the property's total depreciation.

The trouble with tables

Cost-estimating services typically provide depreciation tables that contain data for multiple commercial property types. County appraisers often cite these tables as their main source of depreciation support when using the cost approach.

It is important to know that these tables typically assume that all components of the improvements for the various property types depreciate equally across time. So for example, a brick used in a multifamily or office development will depreciate at the same rate as a brick used in a fast-food restaurant or movie theater.

Often-overlooked warnings from these services point out that certain real estate product types are subject to functional obsolescence that occurs rapidly and can significantly reduce the economic lifespan conclusion for the applicable property type. Given this information, a determination of total depreciation for the subject property must include an appropriate functional obsolescence analysis.

Evaluating functional obsolescence involves an analysis of the utility of the improvements, and how that degree of usefulness affects total depreciation. As an example, consider the fast food industry, which has evolved drastically over the past few decades.

As fast-food real estate models from the '80s and '90s continue to become obsolete, new models have appeared to attract and retain the millennial and Generation Z customer base. Because of this, it is common practice for fast-food companies to refresh their store models every five to 10 years, with a complete rebuild taking place every 20 to 25 years.

This refresh-and-rebuilding cycle is necessary to fit ever-changing consumer tastes and demands for this real estate product type. While the store refresh may include new flooring, additional exterior decoration and color schemes, a complete rebuild is necessary when the utility of the building no longer fits the current design standards demanded by the market. An economic life of 20 to 25 years may be appropriate to capture the potential functional obsolescence associated with this industry.

Theaters undergo sea change

Movie theaters are another competitive product type that may be subject to functional obsolescence outside standard physical depreciation. Theaters built in the 1990s and 2000s may struggle to compete with the eat-drink-and-play models that continue to increase in popularity. Across Texas, select stand-alone theaters that lack dining, bar, and event options continue to see revenues decline.

Theaters without these features often lack the capacity to add a commercial kitchen, bar service, or bowling alley into their existing structure, which limits the utility of the property based on market tastes and preferences. These older theaters may also contain large projection rooms that were previously used to house large equipment and film reels. Given the arrival of digital cinema, most projection rooms now require less space to house and project content into the auditorium.

Auditorium spaces are also evolving, based on the capacity to house premium luxury sections or reclining seats with independent power modules. These popular seating features have resulted in auditoriums having less seating capacity, given the additional space required for each seat. Clearly, it is important to analyze and recognize any applicable functional obsolescence that could affect this property type.

Real estate product types continue to evolve along with consumer standards and tastes; it will be important to consider the impact these requirements have on a building's utility over time.

Cost-estimating services are a great tool that is used frequently for valuation, but it is important to know what is – and what is not – reflected in their information. Once assessors realize this distinction, they can apply proper analysis of total depreciation in their cost-approach determination of a property's market value.



Kirk Garza holds the MAI designation of the Appraisal Institute and has earned the CCIM designation through the CCIM Institute and the CMI designation from the Institute of Professionals in Taxation (IPT). Kirk is a Director and licensed Texas Property Tax Consultant with the Texas law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel, the national affiliation of property tax attorneys. Joseph Jarrell and Jordyn Smith are graduate students at Texas A&M University's Master of Real Estate program. They may be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
May
17

Property Taxes And The Growing Millennial Impact On The Retail Sector

As researchers continue to debate how market conditions affect the value of commercial real estate, one thing is certain: Appraisal districts across Texas are recalculating taxable property values. To ensure fair tax assessments, it is crucial for retail property owners to monitor demographic and technological changes that can disrupt retailers’ sales and a shopping center’s overall income potential.

Here are a few points for taxpayers to broach when helping assessors determine correct taxable property value.

Consumers spent more on dining out than at the grocery store last year, a historical first, according to Marcus and Millichap’s 2016 U.S. Retail Investment Forecast. With millennials dining out more than other age groups, this trend will likely continue. Some landlords are shifting the balance of stores, restaurants and bars at their properties to lure millennia) shoppers.

Conversely, changing consumer demand is weighing on outdated shopping centers that require significant renovation to remain relevant. Even with the right updates, a center could suffer from external obsolescence, or conditions outside the property that reduce its value.

Millennial Impact

The growing influence of millennials has also increased demand for convenience commerce.

Businesses such as Instacart now enable consumers in some markets to order groceries and goods directly from major grocery chains using smartphones, to be delivered to their home in as little as one hour.

E-commerce companies are adapting services that were once accessible only in a retail space and delivering those conveniences to the consumer. Entrepreneurs have already begun to experiment with mobile services ranging from dog grooming, manicures, hair styling and even massage therapy.

As the availability of services grows in step with millennials’ disposable income, owners of shopping centers offering similar services may see a decrease in foot traffic within their developments.

Shopping centers with tenants that cannot adapt to this service delivery model may be exposed to significant vacancy risk.

Adapting to the Market

Many national retailers adapting to e-commerce growth have announced store closures in 2016. Many of these retailers are investing significant capital into their omni-channel platform, suggesting that additional store closures are still to come.

With the continued growth of e-commerce, some industry observers believe that retailers will reduce the size of their showrooms or sales floors to allow more square footage for warehouse fulfillment space.

More warehouse space would allow retailers to process merchandise for pickup or delivery without interfering with the shopping space for customer foot traffic.

In this scenario, market rental rates that represent part showroom and part warehouse space would be appropriate for assessors to use when applying the income approach to value.

Adapting to Change

Taxpayers must always ensure that assessors use correct rates and values as comparables, otherwise the assessor could reach an improper value.

Additionally, as retailers across the nation continue to experiment with smaller store footprints, assessors must consider the potential for that trend to reduce the market value of large boxes and inline spaces, with a corresponding impact on property values.

Shifting demographics, the evolution of convenience commerce and retailers’ adaptation to e-commerce can profoundly increase or decrease a retail property’s value.

These trends demand that assessors carefully analyze a property’s individual characteristics as well as the market area in which the subject is located.

Apparel tenants may be the most at risk of losing sales, but landlords must also consider the viability of other tenants that could occupy the retail space at market rents.

The assessor should consider this uncertainty when selecting capitalization rates. Also discuss with the assessor year-over-year changes in income and expenses, and in tenant health, within the subject property.

By protesting property taxes, landlords can pass any tax savings onto their tenants, who typically reimburse the landlord for taxes, depending on the terms of the lease. In addition, a successful tax protest may enable the landlord to quote lower operating expenses, which can help attract and retain retailers. Correct analysis can identify any obsolescence that may exist, enabling the assessor to adjust taxable value accordingly.

And with a more accurate picture of the property’s marketability, the assessor will be in a better position to judge proper market rents, vacancy and collection loss, and capitalization rates. Only with all these essential pieces can the assessor correctly determine a retail property’s taxable value. 

kirk garza activeKirk Garza is part of the Member Appraisal Institute and a licensed Texas Property Tax Consultant with the Texas law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of the American Property Tax Counsel, the national affiliation of property tax attorneys. Reach him at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

Nov
30

Shrinking Retail Footprint Complicates Taxes

With other major retailers making similar announcements in 2015, this market shift will likely affect property owners and their property values for years to come.

As brick-and-mortar store operators respond to competition from online retailers, shopping center owners face a mounting risk of unfair taxation when assessors fail to account for retailers’ changing preferences for space.

In markets across the nation, select big box and junior big box retail tenants are changing their existing store concepts and shrinking the building footprints of retail shopping center and standalone locations.

Businesses that were once considered strong anchor or junior anchor tenants are even restructuring their business models, renegotiating leases for smaller spaces and closing stores that no longer meet viable internal metrics.

JC Penney, Barnes & Noble and Sears have all announced nationwide store closings in 2015, and the merger of Office Depot and Office Max has fueled additional store closings this year.

With other major retailers making similar announcements in 2015, this market shift will likely affect property owners and their property values for years to come.

Changes Threaten Values

Retailers’ new criteria for inline and freestanding stores will almost certainly present a property tax challenge for big box and junior big box space, as store closures and footprint reductions affect demand, market vacancy and lease rates in the sector.

Often, assessors will focus too much on the tenant and what the lease states, instead of remembering that the ultimate goal is to properly value the building and land as of the date of value.

When working with assessors, it is important to consider that calculations involving existing tenants constitute a leased fee analysis, which is inappropriate for calculating value for property taxes.

On a fee simple basis, which looks at the property and its market position, this type of space may have an entirely different market value.

With that in mind, it is important to know what the space would lease for if available for lease in an open market as of the date of value.

Another important factor to consider is what the property would sell for in an open market transaction on a fee simple basis. In reviewing the assessor’s calculations, consider whether any referenced sales of other properties reflect leased fee or fee simple pricing.

Blending leased fee and fee simple sales without a proper analysis can yield conflicting data points, compromising the integrity of subsequent conclusions.

These oversights often result in in-correct market value assumptions and metrics, and lead to artificially inflated property tax values.

Interest Shrinks for Big Boxes

Some tenants have reduced their store footprints by more than 20 percent over the past few years.  In part, this adjustment maximizes inventory turnover and sales per square foot.

When looking for new space, certain retailers have also set strict size limits with leasing brokers, and some stores that were once considered anchors are moving into inline retail space.

This type of size restriction can significantly impair a retail property’s overall market rent potential if an owner already has a vacant big box or junior box space. These factors are important metrics to consider when surveying rent to arrive at an appropriate market rental rate conclusion.

One way property owners are dealing with unmarketable big boxes is by subdividing the space into smaller suites that better accommodate the growing demand for small retail footprints.

This conversion can be costly, and if relevant, it is important to discuss the conversion costs with the assessor as of the date of value for the property.

It is also important to consider a proper lease up analysis if the property has substantial vacancy. With store closings triggering an increase in the available retail supply and online shopping continuing to gain market share, a lease up analysis that captures these factors is essential.

An additional issue to consider with the conversion into smaller suites is the depth of the original box and the potential for what some brokers term “bowling alley” space.

Often when the subdivision of big box or junior big box space is complete, new tenants will refuse to lease the excess depth the suite may provide.

In this instance owners are sometimes left with non-leasable space in the rear portion of the original building.

When this happens, it is important to consider excluding this space from the net rentable area of the analysis since the configuration often makes this space impossible to lease.

If subdivision is not an option, be realistic about the future lease up prospects for this type of space and use an appropriate, stabilized vacancy rate in addition to a proper lease up analysis.

Even after observing the points mentioned here, be sure to consider the particular characteristics of the local market before reaching any value conclusions.

As business models for big box and junior box retailers evolve, so must the assessor’s approach to valuation. Only after considering all of these factors can the assessor determine a proper market value to the fee simple estate.

 

kirk garza activeKirk Garza is part of the Member Appraisal Institute and a licensed Texas Property Tax Consultant with the Texas law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of the American Property Tax Counsel, the national affiliation of property tax attorneys. Reach him at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

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