The wrong method could leave owners with bigger bills than they should have.

Because industrial properties vary in design and function, not all valuation methods approaches apply to every property. When assessors choose an unsuitable method that inflates taxable value, the taxpayer's best appeal strategy may be to show flaws in the appraiser's approach by explaining the appropriate appraisal methodology.

Industrial properties are typically designed for a specific owner's use in manufacturing, distribution, research and development, or heavy industrial activities. These include standalone flex buildings, multiuse industrial complexes, high-tech facilities, steel mills, timber mills and other subtypes.

The basic valuation premise for property taxation is to determine what the property would sell for in an open-market transaction between a willing seller and willing buyer. Most buyers and sellers in the industrial market would have a thorough understanding of a property's best use before transacting a sale, but an assessor with a limited perspective may treat all industrial real estate as having uniform valuation characteristics.

Taxing authorities often overlook appraisal principles, that if properly applied would reduce the market value of industrial properties. Taxpayers should review their assessments to determine the assessor's valuation approach and evaluate if the appropriate input data was used and the calculations reflect the appropriate adjustments to value.

The appraiser must consider the highest and best use of the property when selecting the appropriate valuation method, considering what is legally and physically permissible and financially feasible for the property as of the valuation date. They will use one of three primary appraisal methods, which are the cost approach, sales-comparison approach, and income-capitalization approach.

Cost Approach

The cost approach is based on theory of substitution, would a prospective purchaser buy this property at a depreciated value or simply build a new facility? Using this approach, an appraiser determines the cost to build a new facility less all forms of depreciation.

A willing buyer would consider not only physical depreciation, but the property's functional operation and any external forces limiting its use. External or economic obsolescence are forces outside the property owner's control, such as government restrictions, consumer demand, or the availability of a raw product or steady labor force.

Functional obsolescence is value loss due to physical or functional deficiencies, such as an outdated building design, inefficient production layout, inadequate infrastructure or outdated equipment.

Most assessor cost models stop at physical depreciation and ignore external and functional obsolescence. They simply add up the component costs of the building, land, and equipment.

This typical cost model fails the "willing seller and willing buyer" test because a potential buyer is not going to evaluate a manufacturing facility by tallying the value of the property's components. A buyer will focus on output capacity, available raw product, available labor, and the market for the product. How many widgets can the facility produce as of the assessment date, and at what cost?

Thus, the often-missed analysis in the cost approach is to really look at theory of substitution. Would a new facility with new equipment and a better layout have higher production capacity? An appraiser should not simply reproduce the same equipment for the cost model if modern equipment offers benefits such as reduced labor, higher speed, or increased output. The appraiser must know the industry and the equipment capabilities of both the older, existing equipment and the new, technically advanced equipment.

Comparing apples to apples in the cost model seldom provides a reliable value. An example would be a plywood and veneer mill built in the 1960s that an assessor values by counting costs invested in the various add-ons and rebuilding of equipment. Simply trending the values would not capture rebuilt equipment or used-equipment purchases, overvaluing the equipment.

The appraiser should determine the cost for the widget capacity of the present facility as of the date of value and compare that to how many widgets a new facility could produce and at what cost. Next, the appraiser should consider all three forms of depreciation to arrive at the proper taxable valuation. Omitting these steps in the cost approach will overvalue the property and overtax the owner.

Sales-Comparison Approach

The sales-comparison approach compares the subject property with property that is similar to the subject. Appraisers often use this approach for single-use real estate with a high degree of market transferability such as warehouses and distribution centers. The appraiser must consider not just the comparable property's floor plate, type of construction and square footage, but also its location, market access and number of loading docks.

The sales comparison model is difficult to use for properties that lack a ready market or that suffer from external or functional obsolescence. Consider the research and development campuses built in the 1980s to house all a company's processes, from research to manufacturing and distribution. Most manufacturing and distribution moved overseas in the 2000s, leaving these campuses half empty.

Adapting these buildings for reuse depends on land-use restrictions, the market for alternative uses, available labor, and the functionality and cost feasibility of conversion. When searching for comparable sales, the appraiser should evaluate what is legally permissible and financially feasible and weigh external forces that impact demand and functional use. After selecting like-kind properties, the appraiser must adjust the sales to reflect the reality of the subject property, or it will be over-valued.

Income- Capitalization Approach

The income-capitalization approach estimates a property's value based on the income it generates, using a capitalization rate from comparable sales or market data. This approach is used for properties with long-term tenants or stable cash flows. The appraiser is to look not at what the value is to the owner, but at what a willing buyer would pay for the property. This requires carefully selected market data and proper adjustment to reflect market value.

Clearly, appraising industrial properties requires a thorough understanding of their unique characteristics and uses, as well as an awareness of economic and functional obsolescence. A knowledgeable appraiser can help the taxpayer ensure their property assessment is consistent with the marketplace to avoid overpaying property taxes. 

Cynthia Fraser is Co-Chair of Foster Garvey's Litigation Practice and the Oregon Representative of American Property Tax Counsel (APTC). The firm is the Oregon member of APTC, the national affiliation of property tax attorneys. Lisa Laubacher is a CMI and Director at Popp Hutcheson PLLC, the Texas member of APTC.

Valuation and procedural changes that were implemented in 2020 may have significant effects on owners' 2021 tax liabilities.

Expertly managing property tax liability is more important than ever in 2021. The COVID-19 pandemic pummeled both real estate and business personal property values in the past year, forcing local jurisdictions to overhaul procedures that had been in place for decades. Many of those procedural changes will likely continue this year as assessments finally register the pandemic's full effect. Understanding the procedural changes made by local jurisdictions, and new valuation considerations for both real and personal properties, will be key. 

New Procedures Volatile 

When the pandemic hit, neither appraisal districts nor property owners knew how long the crisis would last. Most appraisal districts closed their doors to the public and quickly converted all informal and formal meetings to telephone or video conferences. Moving into 2021, much of that uncertainty remains. Most jurisdictions will likely continue to rely upon virtual formats for this year's informal meetings and hearings, which generally begin in April and continue throughout the summer. Property owners should be prepared, however, for procedural changes that may be implemented as conditions change. Communication with assessors will be vital, and taxpayers should make sure to provide all requested documentation in a timely manner. Communicating early and often about the valuation and protest will ensure no deadlines are missed and no procedural changes are overlooked.

Managing Real Estate Taxes 

While the fundamental valuation and appeal process for real property will remain the same in Texas, procedural changes initiated in 2020 will likely continue in many appraisal districts. Assessments will reflect the property's value as of Jan. 1, 2021, and notices will likely be mailed in mid-April as usual. The deadline for property owners to protest their 2021 real property values will be unchanged at May 15 in most cases, or 30 days after receipt of the notice of appraised value. 

Property owners can expect the continued option to protest assessments online, as well as telephone and video conferencing options for hearings. While these procedures were enacted and refined in 2020, the combination of virtual hearings and a potentially increased volume of protests in 2021 may push hearing schedules past their typical end (in June or July) and into the fall.

A Real Impact on Values 

Undoubtedly, 2020 was a unique year for property performance. Some property types sustained disastrous effects from the pandemic and stay-at-home orders while others fared the year well. Because Texas' valuation date for the current tax year is Jan. 1, 2021, many valuation methodologies will rely upon a property's performance over the 12 months preceding that date to inform their value metrics. 

Shopping centers, restaurants, theaters and hotels are among those properties that suffered greatly in 2020. Sadly, many closed their doors for good after struggling to perform this past year. Hotels saw revenue dip as much as 80 percent. Restaurants and theaters experienced government-ordered closures for most of the year, and capacity restrictions for the remainder. 

The resulting drag on potential rents, occupancy and cap rate assumptions has pushed down values. Property owners should see some recognition of value decline in these most-affected property groups, but to what extent remains to be seen.

Business Personal Taxes 

On the business personal property front, we expect deadlines to mirror the statutory language for filing exemptions and rendition reports, which list owned machinery, furniture, equipment, vehicles, merchandise and other business personal property. Due to COVID-19, many large appraisal districts extended the rendition deadline for all taxpayers in 2020, but we expect the typical formal extension request process to be back in place for 2021. All extension requests must be made in writing to the appraisal district before the statutory deadline of April 15. An approved extension allows the taxpayer an additional 15 to 30 days past the statutory deadline. 

Taxpayers with significant business personal property investment need to thoroughly analyze how COVID-19 limited or otherwise compromised the usage of their income-producing assets. Assessors and appraisers rely almost exclusively on the cost approach to value business personal property. In this climate, however, the simple depreciation they normally apply will not capture pandemic-related losses to produce an accurate market valuation.

To account for the loss in value, owners should consider developing an additional obsolescence factor to apply after typical depreciation. The Texas Property Tax Code allows for the inclusion of all forms of depreciation including economic obsolescence, which occurs when factors or trends occurring outside the property reduce its value. 

Each owner will require their own, unique obsolescence factor to measure economic impact. There are many ways to calculate an economic obsolescence factor, depending on the taxpayer's core industry. Analyzing production versus capacity is most often beneficial for manufacturers, for example, while income metrics are better suited for some retailers and medical providers. 

We recommend also doing a lookback for at least three years to properly illustrate the COVID-19 impact. The property tax team must truly understand the business in order to arrive at the proper factor.

What About Tax Rates? 

In addition to assessed value, the second piece of a property owner's tax liability is the tax rate. Taxing entities set their tax rates in the fall, after appraisal districts determine property values. 

Should 2021's overall property valuations decline, property owners should not expect an exactly equal decline in their tax liability. If the total tax levy falls significantly due to the valuation factors affecting property values as of Jan. 1, 2021, it is possible — and maybe even likely — that tax rates will rise. 

No one can predict tax rates with certainty, but owners would be wise to budget conservatively for anticipated tax liabilities. A 40 percent decline in revenue may not translate to a 40 percent decline in the assessed property valuation or tax liability for 2021.

Partnership is Key 

Navigating property taxation in a COVID-19 world can be overwhelming. It can be particularly challenging to stay on top of frequent procedural changes, and to understand the sometimes unique valuation metrics affecting real and business personal property. Partnering with an experienced property tax team can give owners peace of mind in a tumultuous year.