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Property Tax Resources

Dec
31

Thinking Outside the Box

"Smart shopping center owners follow Hoteliers' approach to reducing property taxes."

By Cris K. O'Neall, Esq., as published by National Real Estate Investor, November/December 2009

Why do taxing authorities recognize intangibles for hospitality properties, but not shopping center properties? The answer may be the way mall intangibles have been chara­acterized for tax purposes.

Intangibles include such items as business franchises, licenses and pera­mits, operating manuals and procedures, trained workforce, commercial agreea­ments and intellectual property.

Owners of hospitality properties know that branding their properties with well-recognized franchises or flags, such as Marriott, increases revenues. Because branding usually delivers access to resera­vations and management systems, traina­ing programs and other value-added benefits, it attracts clientele willing to pay premiums for hospitality stays and related amenities.

While hospitality properties benefit from their property tax exemption for franchises and other intangibles, shopa­ping mall properties haven't garnered the same benefits.

A recent unfavorable decision by the Minnesota Tax Court in an appeal filed by Eden Prairie Center in suburban Minneapolis typifies the difficulty shopa­ping center owners face in obtaining exemptions for intangibles. Mall owners who could use a respite from high propa­erty taxes are understandably frustrated.

Identifying intangibles

Hotel owners have succeeded in claiming the intangibles tax exemption by identia­fying specific types of intangibles, such as franchises and employee workforce, and assigning values to those tax-exempt items. This approach is particularly suca­cessful in states like California where statutes and court decisions support deductions for intangibles.

In contrast, shopping center owners typically urge tax assessors to reduce assessments based on residual "business enterprise value" (BEV). These owna­ers ascribe to BEV the higher in-line store rents produced by the presence of high-end anchor tenants or a particularly advantageous tenant mix.

Taxing authorities are reluctant to accept taxpayers' requests for BEV assessa­ment reductions. Court decisions involva­ing shopping center properties usually point to difficulties in proving BEV and the problem of separating intangibles from real estate.

Mall owners should focus on intana­gible assets and rights specific to their properties, as hospitality owners have done, rather than rely on the more neba­ulous BEV. They should identify and determine the value of intangibles such as anchor tenant and/or mall trade names, management agreements, and advertising arrangements. Creativity in identifying and valuing intangibles can bring significant assessment reductions, but success depends on owners' efforts. For example, proving to taxing authorities the benefits of having upscale anchor tenants likely requires an appraiser's analysis and may also depend upon data for competing properties.

Making the case

After intangibles are identified, an appraiser who specializes in intangible valuation should be retained to appraise the identified assets and rights. Then the total value of the tax-exempt intangibles is deducted from the entire property's value to arrive at the value of the taxable real property.

If the value of all intangibles is suba­stantial, this should be presented to the assessor. Ideally, informal negotiations with the taxing authority result in lower assessments. Even with the best efforts, however, it's still possible that the assessor won't reduce a shopping center's value by removing tax-exempt intangibles. In that event, a tax appeal should be filed.

CONeallCris K. O'Neall is a partner with Cahill, Davis & O'Neall LLP, the California member of American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Oct
31

Property Tax Reform Goes Awry

Caps on property value cause unfair taxation.

"In economic downturns, like today, the amount of state and federal money available to local areas declines, while state and federal mandates increase the need for more funding..."

By Darlene Sullivan, Esq., as published by National Real Estate Investor, October 2009

At first blush, it appears that a cap on property tax values, often called appraisal or assessment caps, provides a panacea for limiting increasing property taxes. However, a closer look reveals that artificial caps precipitate other larger, more far-reaching problems, rather than producing a solution for rising property taxes.

The popular answer to the call for property tax relief continues to be a "cap" or limitation on increases on taxable value. Consider the effect of a property tax cap on two identical office buildings.

With no cap on taxable value, a building valued at $1 million sustains valuation growth at the rate the market increases, in this example, 10% annually. A cap on taxable value of 3% limits the rise of taxable value. Thus, the non-capped building's valuation skyrockets from a $1 million to over $1.6 million in five years, while the capped property's valuation grows to only about $1.16 million over the same period.

Illustrating the point

The [enclosed] chart demonstrates the difference in taxes paid by identical buildings, one with a tax cap, the other without.

Sullivanl_PropertyTaxReformGRAPH_NREI_October09

DRAMATIC EFFECT OF ASSESSMENT CAPS
Because non—capped property values increase at a faster rate than capped values, the non-capped property's taxes grow exponentially over time. This chart highlights the difference over time on two buildings initially valued at $1 million.

To appease voters, some states place a cap on residential property only. This results in commercial property paying higher taxes over time and paying a greater percentage of all property taxes than before the cap was established.

Let's suppose that before the cap was instituted, the commercial property sector paid 60% of all property taxes, while the residential sector paid 40%. The residential cap causes a reduction in the total amount of revenue collected from property taxes. To offset the revenue loss, the tax authority raises tax rates.

Since residential properties valuations are capped, commercial property now has a higher tax rate on its ever-increasing valuation. Thus, the commercial and residential sectors trade places, with commercial now paying 65% of all property taxes compared with residential's 35%.

The residential cap, in effect, lets residential property owners pay taxes on less than the full market value of their property, while commercial owners pay based on full market value.

Still more pitfalls

Appraisal caps also lead to other negative effects. Like all artificial limits, a cap creates artificial and unfair competitive advantages. Properties receiving no value caps, such as those newly built, purchased or remodeled, will have an economic disadvantage when compared to competing properties that benefit from the cap.

Suppose a newly purchased office building is assessed by market value when purchased. Also assume that other like-kind office buildings, not newly built, purchased or remodeled, have capped valuations. The owners of these like-kind properties, who enjoy assessment caps, have lower property taxes than the owners of newly purchased buildings and, as a result, can charge lower rents.

In addition, caps don't typically apply to personal property in manufacturing plants, refineries, chemical plants and utilities. The real property cap shifts the tax burden to personal property because local governments will raise tax rates to balance the budget shortfall caused by the real property cap.

That means increased taxes for personal property owners, since their tax assessment is based on full market value and they will be charged a higher tax rate on that value.

A cap also impairs local governments' ability to provide critical services. In economic downturns, like today, the amount of state and federal money available to local areas declines, while state and federal mandates increase the need for more funding.

Thus, local fees and charges for municipal services increase but can't compensate for the lost tax collections resulting from caps, inhibiting infrastructure development. Artificial limits on property valuations produce a myriad of unintended negative consequences. Beware the so-called gift of property tax caps.

DarleneSullivan140Darlene Sullivan is a partner in the Austin-based law firm Popp, Gray & Hutcheson, the Texas member of American Property Tax Counsel. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Aug
01

New Method to Reduce REIT Property Taxes

Stock price offers a reliable indicator for assessed value.

"Prediction of a property's ability to generate income is precisely what the income approach to value in property assessment attempts to accomplish."

By Stephen Paul, Esq., as published in National Real Estate Investor July/August 2009

Assessing the value of REIT assets for property tax purposes has historically been an ordeal for assessors, as well as for owners challenging their work. Published data indicates that property values have dropped over the past two years, but the lack of sales leaves relatively little to prove the declines.

Without an active market of REITs buying and selling property, the sales comparison approach to value loses its usefulness. Even if taxpayers and assessors agree that properties in most REIT sectors are best valued under the income approach, decisions about estimates of future income streams, capitalization rates, and other factors required under the income approach often breed intense discord.

These difficulties are amplified in today's market due to lower predictability of occupancies, lease terms, and percentage rents. Thus, REIT owners need new ways to substantiate for the tax authorities the decline in their property values.

Stock prices are telling

In many REIT sectors, declining stock values actually have the potential to provide suitable proof of decreasing property values. Since the trend in a REIT's stock price represents the market's prediction of the direction in which the capitalized funds from operations of the REIT likely will move, readily available stock market data could be used to show an assessor that assessed values should be reduced.

This methodology is particularly appropriate for REIT properties. The stock price for any ordinary non-REIT company, in effect, states how the market values the company's assets, but any indication of the value oPrediction of a property's ability to generate income is precisely what the income approach to value in property assessment attempts to accomplish.f the real property itself is unclear.

REITs are different. By definition, REIT assets comprise investments in real property. To qualify as a REIT, at least 75% of income must come from real estate sources, and at least 95% of income must be derived from interest, dividends, and the property itself. The trend in the value of a REIT stock thus reveals how the market values the income-producing capability of the REIT's real property.

Paul_NewMethod_NREI09Prediction of a property's ability to generate income is precisely what the income approach to value in property assessment attempts to accomplish. The income approach estimates future benefits from ownership of the property. But this estimate requires extensive market research to evaluate risk factors in order to accurately predict income streams and expenses.

Examples of these risk factors include whether tenants and locations are favorable, whether acquisitions were prudent, the likelihood that locations will go dark, and the extent to which rent collections might be in jeopardy. Evaluating such risks is problematic during a deep recession like that experienced currently.

In setting the stock price, however, the market already has evaluated the risk factors associated with the properties of a particular REIT. The market has performed the research that is so troublesome in a difficult economic climate.

Because the trend in a REIT's stock price represents a statement by the market in direct relation to the real property itself, the trend in value of the stock price can provide valuable support for reduced assessments and input for analysis under the income approach.

Understanding that REITs generally own many properties, often in multiple states or even worldwide, it should be acknowledged that stock price cannot determine with precision assessed values of individual properties. But the correlation between a REIT's stock price and its property value can be employed to demonstrate the necessity for some assessment reduction on individual properties.

Here's how

A simple linear regression analysis provides an ideal tool to prove the correlation between a REIT's stock price and the value of its properties. To illustrate the point, let's use data from an actual REIT property in the Midwest.

Assume the REIT appeals the 2008 assessment of one of its properties. That property is assessed for 2008 at $5.6 million when the REIT's stock is trading at $11.50 per share. Assume further that the assessed values and stock quotes have been as follows over the last six years

Year Stock Quote Assessed
Value
(in millions)
2002

$9.95

$3.75

2003

$11.99

$4.07

2004 $14.51 $4.42
2005 $15.3 $4.96
2006 $18.00 $5.26
2007

$22.16

$5.40

Plotting the stock quotes on the x-axis and assessed values on the y-axis of a graph produces a scatter diagram as shown in the accompanying chart. Using a simple linear regression formula, a trend line can be drawn through the data.

Because the trend line so closely matches the assessments across the six year period, it clearly illustrates that the stock price correlates very closely to the assessed values. Thus, stock price is a reliable predictor of assessed value.

This demonstrated correlation is not exhibited, however, by the 2008 assessment on which the REIT has filed an appeal. During the period illustrated in the chart, the increase in stock price from $9.95 in 2002 to $22.16 in 2007 had been matched by increases in assessed value from about $3.7 to $5.4 million.

But a further increase in assessed value to $5.6 million for 2008 is inconsistent with the stock losing nearly 50% of its value and falling to $11.50 per share.

Therefore, the REIT owner should urge the assessor to reduce the property's 2008 assessment.

In the current market, demonstrating that assessed values should be reduced demands resourcefulness. Absent comparable sales and easily identified factors under the income approach, analysis of the correlation between stock performance and assessed value can help demonstrate a necessary reduction in assessed value.

PaulPhoto90Stephen Paul is a partner in the Indianapolis law firm of Baker & Daniels, the Indiana member of the American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jun
01

Shouldering a Costly Burden

States cut homeowners a property tax break, leaving commercial owners to fill the gap

The conventional wisdom is that lower valuations result in lower taxes. Many commercial owners and tax practitioners expect property values to decline this year due to a depressed economy.

By Linda Terrill, Esq., as published by National Real Estate Investor, June 2009

Will Rogers once said: "The only difference between death and taxes is that death doesn't get worse every time Congress meets." Commercial property owners could say the same thing of state legislatures when it comes to property taxation.

In the beginning, most states provided a "uniform and equal" rate of assessment and taxation for all classes of property. Today, the vast majority of states still have the basic "uniform and equal" framework, but all have tinkered with it to shift the weight of taxation to commercial property.

Once the local tax base and budget are determined, a mill levy is set. Some states apply the mill levy against the 100% value of the property. The math is: 100% value a— mill levy = tax due.

Other states have an intermediary level, generally referred to as the assessed value, which is a percentage of the 100% value. In those cases, the mill levy is applied to the assessed value and the computation is as follows: 100% value a— assessment rate a— mill levy = tax due.

Terrill_CostlyBurden_GRAPH

Altering the equation?

Several states have adopted "classification legislation" that provides for differential assessment rates for commercial real estate versus residential. In most cases, the commercial taxpayer carries the larger load.

This disparity grows wider if the residential owner also qualifies for other preferential treatment that some states may provide to seniors, veterans or low-income property owners. Here are examples of the tax system in practice:

In Colorado, all property is assessed at 29%, except residential, which is assessed at 7.96%. In terms of tax dollars, this disparity means that for every $1 paid by the residential owner, a commercial property owner will pay $3.64.

To further illustrate, assume a mill levy of .075 and a commercial and residential property each valued at $200,000. In Colorado, the property taxes for the homeowner are calculated as follows: $200,000 a— 7.96% = $15,920 a— .075 = $1,194. The commercial owner, however, pays 3.6 times as much: $200,000 a— 29% = $58,000 a— .075 = $4,350.

Arizona legislates commercial assessment rates at 22% and residential rates at 10% (see chart). Thus, for every $1 paid by the residential property owner, a commercial property owner will pay $2.20.

Tennessee commercial property owners fork over $1.60 for every $1 paid by a residential property owner, and in Kansas commercial owners pony up $2.17 for every $1 paid by residential owners. The ratio in Minnesota can be as high as 3 to 1.

The states and city included in the chart represent only a sampling of the disparity in the way the property tax load is shared between commercial and residential owners.

Premature celebration?

The conventional wisdom is that lower valuations result in lower taxes. Many commercial owners and tax practitioners expect property values to decline this year due to a depressed economy. It's only logical that taxpayers who see a reduction in their valuation notices for 2009 expect their taxes to decrease.

Such a conclusion is premature in the states with different assessment rates for commercial and residential property, or with any other significant agricultural and/or residential tax relief programs. That's because if the tax base declines and the needs of government remain the same, a mill levy increase is inevitable and commercial property taxpayers will face paying the majority share.

A savvy commercial property owner would be well advised to take the following steps:

  • Determine the tax appeal date and the rules for filing. If your property requires an appraisal, remember that the number of appeals may rise significantly, so hire an appraiser as early as possible.
  • Determine whether your market area comprises a diverse mixture of property types, or is dominated by businesses that are dependent on a single industry.
  • Compare the local unemployment rate with the national numbers.
  • Decide whether you can manage the appeal on your own.
  • Be prepared for it to take longer than you'd expect to traverse what will probably be a crowded tax appeal docket. To be forewarned is to be forearmed.

TerrillPhoto90Linda Terrill is a partner in the law firm of Neill, Terrill & Embree, the Kansas and Nebraska member of American Property Tax Counsel. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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May
05

Retail Landlords Face Quandary

Even as store sales decline, their property taxes climb

"Doing this math gives owners a powerful tool to help determine if tenants are paying rents above, at, or below sustainable market levels."

By Darlene Sullivan, Esq. as published by National Real Estate Investor, May 2009

Current market conditions have led to tenant bankruptcies, store closings, vacancies, deals placed on hold and declining sales in many retail centers in the U.S. Given these pressures, it should be easy to argue that property values have declined. But how do you prove to the assessor that your property has hit a slump in value when the property's trailing performance does not reflect current fair market value?

A tenant's retail sales are commonly reported to landlords and provide a tool to measure the viability of a tenant and the center in which the store is located. But just showing a drop in tenant sales may not provide enough evidence to convince the tax assessor to lower a center's taxable value.

The taxpayer must be able to demonstrate in actual numbers the relationship between market rents the center can charge and the retail sales performance of the center's tenants. By taking this approach, an owner can empirically show the current rents that should be applied to the assessor's valuation analysis.

Are rents too high?

Occupancy cost is the term used to describe rent plus expenses that retail tenants pay to their landlords for maintenance of the common area, utilities, taxes and other costs. Tenant occupancy cost ratios are calculated by dividing the tenant's total occupancy costs by the tenant's total sales.

Occupancy cost ratios vary for each property type and merchandising category. Large national discounters have occupancy-cost ratios as low as 1.5%. High-margin retailers, such as jewelry stores in regional malls, can have ratios in excess of 20%.

Median occupancy costs at U.S. neighborhood centers are 8% to 9% of sales, while U.S. regional malls typically range between 9% and 16% of sales. A good rule of thumb is the higher the retailer's markup, the higher percentage of occupancy costs they can afford.

Doing this math gives owners a powerful tool to help determine if tenants are paying rents above, at, or below sustainable market levels.

During a downturn, it is imperative that an owner demonstrate the effects of sales on the value of the property. Ultimately, the amount of rent a retailer will pay for a space is related to its ability to generate sales and maintain healthy profit margins.

A drop in sales, an increase in operating costs, or both, may push the cost of occupancy to an unsustainable level. If a retailer has a relatively high occupancy cost ratio compared to market norms, it signifies that the landlord may have to reduce the rent or risk losing the tenant.

To show the assessor the impact of declining sales on property values, retail centers owners should project annual sales per square foot for each tenant and apply the appropriate occupancy- cost ratio to the annual sales figure.

Illustrating through numbers

Assume that a tenant's sales during the height of the market were $500 per sq. ft., and now those annual sales figures have dropped to $350 per sq. ft. An analysis of industry statistics determines that the average market occupancy cost ratio is 8% for this tenant's merchandising category and the type of center.

Applying the 8% occupancy cost ratio to the booming market sales figure of $500 per sq. ft. indicates that this tenant can be profitable at an occupancy cost of $40 per sq. ft. To illustrate to the assessor the correctness of an owner's claim concerning her property value, the same 8% occupancy cost ratio must be used. The 8% is multiplied by today's annual sales of $350 per sq. ft., producing a new sustainable market occupancy cost for this tenant of $28 per sq. ft., as shown in the accompanying chart.

For the retailer to maintain acceptable profitability margins, the total occupancy costs —rent plus expenses— must be reduced by $12 per sq. ft. This decrease in sustainable occupancy cost provides support for the determination of market rent, which should be utilized by the assessor to value the property for tax purposes.

Shopping center owners should always ensure that the rent used by the assessor in calculating the center's tax assessment is an amount that allows tenants to operate profitably in whatever the existing market environment may be.

Sullivan_NREIInvestor

THE SPIRALING EFFECT OF DECLINING RETAIL SALES
As retail sales fall, tenant's occupancy cost as a percentage of sales goes up. If a tenant's sales were to decline from $500 to $350 per sq. ft., the rent would fall from $40 to $28 per sq. ft. to maintain an 8% occupancy cost radio. The property value should also drop.

Source: American Property Tax Counsel

 

 

 

DarleneSullivan140Darlene Sullivan is a partner with the Austin law firm of Popp, Gray & Hutcheson LLP, the Texas member of the American Property Tax Counsel. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Feb
05

Reassessing Market Value

Assessors' use of historical sales data in a recession inflates property values.

"As a result, assessors typically value individual parcels not so much by looking at the specific characteristics of a particular parcel, but rather by the application of a mass appraisal system that relies heavily on historical data."

By Stewart L. Mandell Esq. and Andy Raines Esq., as published by National Real Estate Investor, February 2009

During periods of economic weakness, U.S. commercial and industrial real estate owners become vulnerable to unrealistic and excessive property tax assessments. Assessors' reliance on mass appraisal methodology and their use of data compiled during strong economic periods are the two main reasons for this problem.

Due to the large number of property tax parcels in a jurisdiction and limited resources to assess them, assessors typically employ mass appraisal methodology. In a mass appraisal, assessors gather and study certain economic data for a one- to three-year period preceding the assessment's effective date, including sales transactions, market rents, vacancy levels and/or levels of operating expenses.

Assessors then use that information to develop a valuation methodology, which they apply to individual parcels. For example, an assessor might study sales from the prior two years, which includes a dozen industrial properties located in his jurisdiction. He may determine from his study that the sold properties should have been valued 5% higher than the value at which they were carried on the assessment roll. The assessor would then increase the value of the entire class of industrial property by 5%.

As a result, assessors typically value individual parcels not so much by looking at the specific characteristics of a particular parcel, but rather by the application of a mass appraisal system that relies heavily on historical data. Recognizing and understanding the traditional methodology many assessors utilize is critical to enabling taxpayers to evaluate their risk of receiving excessive assessments.

Methodology under microscope

Odds are that assessors' usual valuation models for the 2009 tax year may be significantly flawed because a huge disconnect exists between economic conditions two to three years ago and today. This disconnect shows up in many ways.

The office vacancy rate in many markets has been low, from 5% to 10%, in the past few years. The current recession, however, is marked by financial sector turmoil and rising unemployment, resulting in increased office vacancies.

Shopping centers, too, are experiencing higher vacancies due to the recession's adverse impact on retail sales, which has been exacerbated by the reduction in new residential subdivision development and high residential foreclosure rates.

Perhaps the biggest data disconnect lies in capitalization rates, which act as a proxy for buyers' recognition of risk. Before the September 2008 economic crisis, buyers expected rental income and property values to continue rising. Now the reality of declining occupancy and rents, plus higher risk, has raised cap rates and lowered property values.

Upside of a downturn

A change in economic climate affects a property's valuation when the assessor uses historical data instead of current data. In 2007, a warehouse in Austin, Texas could command a net rent of $5 per sq. ft. Back then, vacancy held steady at about 9%. An appropriate cap rate would have been about 7.5%.

In late 2008, the recession caused warehouse vacancy rates in Austin to rise to 14%. The market softness pushed up vacancies, and market rent fell to about $4.50 per sq. ft. This trend raised the cap rate by at least 1%.

Based on the use of historical data, a 500,000 sq. ft. warehouse is valued at $26.4 million (see chart). However, the value based on current data comes to $19.8 million, a 25% reduction. Property taxes would amount to about $595,000 annually with an assessment based on historical data. Using current data, the assessment would result in taxes of about $445,000 annually, a $150,000 difference.

Assessors often use historical data to assist in making property tax assessments. That methodology may suffice in periods of economic stability. Unfortunately, in these volatile and challenging times, assessments based on dated information will be inaccurate and overstated.

If assessors keep using the rear view mirror to determine assessments, taxpayers should file appeals to avoid head-on collisions with excessive property taxation. Critical to a successful appeal is the use of current data to indicate an appropriate property tax assessment.

MandellPhoto90Stewart L. Mandell is a partner in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan member of American Property Tax Counsel (APTC). He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
RainesPhoto90Andy Raines is a partner in the law firm of Evans & Petree, the Arkansas and Tennessee member of American Property Tax Counsel (APTC). He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Dec
05

Proper Remedy for Excessive Assessments

Don't value medical office buildings higher than general office space.

"These facilities require certain specialized construction components and finishes to accommodate industry needs."

By Stephen Paul, Esq., as published by National Real Estate Investor, December 2008

Construction of medical office buildings is burgeoning throughout the country due to the aging population and its healthcare needs. Because these facilities generally operate as for-profit medical services, they usually become subject to property tax. Medical office owners often find their buildings assessed for real property tax purposes at excessive values when compared to general office properties.

Assessors normally use the cost approach to determine the value of newly constructed property. For the most part, medical office buildings house multiple tenants, including medical practitioners and associated healthcare facilities such as pharmacies, diagnostic imaging, labs or medical administrative services.

These facilities require certain specialized construction components and finishes to accommodate industry needs. Generally, the construction finishes are higher quality than available in the average office. So, logically, if construction costs more, the return on investment needs to be higher to offset these increased costs.

Two obvious construction cost differences stand out between general office and medical office space. First, medical offices require more partitioning due to the need for numerous small exam rooms, medical staff offices and nursing stations and for extensive file storage.

Secondly, medical office space calls for more plumbing fixtures because every exam room must have facilities to maintain sanitary conditions as doctors move from patient to patient.

Major costs also are incurred when an office building must accommodate X-ray machines, magnetic resonance imagining equipment, or CAT-scan equipment/ rooms that require special shielding, such as cinder blocks and double or triple thicknesses of drywall or lead. Moreover, some medical office buildings include outpatient surgical centers, which demand nonporous finishes, high intensity lighting and greater electrical service. Thus, the cost per square foot of medical office space rises well above that of conventional office space.

Data from Marshall & Swift Valuation Service, the industry bible, supports these facts. The data shows that the base cost to construct medical office space is 26% higher than the cost of building general office space.

Highly persuasive argument

Let's examine a property tax appeal involving a medical office property in Indianapolis in 2007. The assessor valued a newly constructed building at $16.9 million. At the same time, the valuation on an Indianapolis general office building with the same square footage amounted to $11.3 million.

The cost to build the medical building was $15 million; the general office property cost $12.4 million to construct. The assessor valued the medical office building $5.6 million higher than the general office property, or nearly 50% more.

In preparation for the tax appeal, the taxpayer documented each construction component and compared it to general office buildings of similar size. This comparison showed that the real estate should be valued based on the basic components of a general office building.

Because each building has the exact same basic components, no justification exists for a larger tax assessment on the medical office building. In the appeal, the taxpayer also argued that an alternate or second user of the medical office building would likely purchase the property simply for office space.

PaulsgraphAs a result of this painstaking development and presentation of the relevant facts, the Appeal Board ruled in favor of the taxpayer and reduced the property's valuation by $1.3 million to $15.6 million. While this reduction was warranted, the medical office building remains valued higher than the general office building, proving that medical office buildings pay higher property taxes.

Lesson for assessors

Although the cost may be greater to construct medical office space, the added cost doesn't automatically justify higher property tax assessments. Because it is expensive to retrofit medical office space to fit general office needs, those costs should be deducted from construction costs to arrive at what would be market value for a general office building. Clearly, using the cost approach to value properties produces higher property valuations for medical office space than for general office space.

In a property tax appeal, the taxpayer must demonstrate that medical office property requires specialized construction and finishes, and lay out these facts to obtain an appropriate reduction in the property's assessment.

 

 

PaulPhoto90Stephen Paul is a partner in the Indianapolis law firm of Baker & Daniels, the Indiana member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Oct
07

How Assessors Can Veer Off Course

"In a contracting economy, with real estate values falling, the differential between contract rent and market rent can become quite significant."

By John E. Garippa, Esq. as published by National Real Estate Investor, October 2008

In a faltering economy, tax authorities want to cling to contract rents — the amount agreed upon by the landlord and tenants — as the basis for valuing property. Instead, assessors should rely on market rent, the rental income a property would command in the open market. Relying on contract rents to determine a property's value results in increased revenues from property taxes, but causes owners to pay excessive taxes.

Most taxing jurisdictions in the United States are supposed to value property based on market evidence, which is essentially what a willing buyer would pay a willing seller for property with neither party being under duress to act. In a growing economy, most property owners grasp this concept.

However, when the economy weakens and real estate values become depressed, this same concept is not as easy to comprehend. More importantly, even some taxing authorities have difficulty understanding exactly how this concept should work in a recessionary climate.

Why rent isn't rent

Contract rent represents the actual rental income specified in a lease and can be greater or less than market rent, often referred to as economic rent. Market rent has become the basis for valuing property because it allows assessors to uniformly value all property based on the same standard of value.

In a contracting economy, with real estate values falling, the differential between contract rent and market rent can become quite significant. The differences between the two types of rent give rise to the need for diligence by property owners and managers.

This hypothetical example illustrates the point: Assume a 100,000 sq. ft. office building has been well managed for a significant period of time. As a result of superior management, the building is 100% occupied with an average rent of $30 per sq. ft. The leases were negotiated more than two years ago.

Since that time, the office market has deteriorated. Current market rents at similar properties reach no higher than $25 per sq. ft. net with a 10% capitalization rate.

Using contract rents, the value of the property comes to $30 million, but employing market rents, the value is only $20 million (rent multiplied by square footage divided by capitalization rate). Based on a 3% effective tax rate, the assessment at the contract rate comes to $900,000, while the market rate assessment is $600,000, a tax savings of $300,000 (see chart).

garripaGRaphAn owner or property manager examining the rental income from the office property above can rest easy because it's clear that no problem exists. Here's a well-managed property fully leased in a weak economy. However, taxpayers must not be lulled into ignoring the need for a review of any tax assessment received in an economy under duress.

If the taxing authorities are assessing on a market level, they should ignore contract rents and focus on appropriate market rent standards. The example shows that when valued properly the property — which by contract standards is correctly worth $30 million — should be assessed for tax purposes at no greater than $25 million, a significant differential.

Clearly, if the property's assessment comes in above $25 million, it has been over assessed and requires a tax appeal in order to establish its value at the current market level of other properties.

 

 

Make your case

The persuasiveness of a taxpayer's presentation to the assessor depends on differentiating the property's rental history from the marketplace realities. First, every available office rental comparable needs to be analyzed during the relevant time period.

Some of the physical elements of comparison should include security, HVAC, electrical systems, tenant finish, parking and location.

Second, the property owner should develop a scenario that explains why demand has eroded in the market. The owner should focus on factors such as changes in the workforce, the requisite space per worker, and analysis of vacancy rate changes over several years.

This study should cover the time period beginning with the building's lease-up. A study that demonstrates deteriorating market vacancy over a period of several years buttresses the argument that demand will naturally be weaker.

In a declining market, taxpayers must challenge property tax assessment based on contract rents. Unless your assessment is based on market rents, a tax appeal should be the next step.

GarippaJohn E. Garippa is senior partner of the law firm of Garippa, Lotz & Giannuario with offices in Montclair and Philadelphia. Mr. Garippa is also the president of the American Property Tax Counsel, the national affiliation of property tax attorneys, and can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Sep
07

Why Assessors Need to Take a Mulligan

"Assessors prefer the cost approach because the availability of cost data from national valuation services makes the determination of a value rather straightforward.Taxpayers argue that an income approach is better suited to derive the value of a golf course..."

By Andy Raines , Esq., as published by National Real Estate Investor, August 2008

As the old joke goes, the fastest way to become a millionaire as a golf course owner is to start out with $5 million. Unfortunately some property tax assessors don't get the joke. They continue to assess golf courses as if their value is increasing or holding steady.

During the 1990s, the supply of golf courses expanded by 24% while the number of golfers rose by just 7%, according to the National Golf Foundation. What's more, in the first quarter of 2008 there has been a 3.5% drop in rounds played.

Golf course owners now face numerous challenges. Although more courses have closed than opened over the past two years, the oversupply will likely take several years to absorb. Additionally, the soft economy and rising oil prices negatively affect travel to golf courses and course operating costs.

Property assessors have failed to take these factors into account in making their assessments. But golf course owners have begun to fight city hall by filing property tax appeals. If successful, the appeals can result in significant tax savings.

The accompanying chart demonstrates the magnitude of assessment reductions obtained by four different golf courses as a result of their tax appeals. On average, these appeals achieved a 40% reduction.

Why do assessors' valuations of golf courses differ so dramatically from the values contended by taxpayers and, in many instances, adopted by boards of equalization and judges? The assessor and taxpayer each use different valuation approaches that yield different values.

Methodology matters

The generally accepted valuation approaches include the cost, income capitalization, and sales comparison approaches. The appropriate valuation approach depends on various factors:

  • the amount and reliability of the data collected in each approach;the inherent strengths and weaknesses of each approach as it relates to a particular property type;
  • the relevance of each approach to the particular property at issue.

Raines_graph2Assessors typically value golf courses using a cost approach. That approach starts with land value, adds the cost of property improvements, and subtracts physical depreciation. Assessors prefer the cost approach because the availability of cost data from national valuation services makes the determination of a value rather straightforward.

Taxpayers argue that an income approach is better suited to derive the value of a golf course. That approach starts with a determination of revenue and deducts operating expenses to arrive at net operating income. Net operating income is then divided by a capitalization rate, thus yielding the value.

The issue centers on which method of golf course valuation is preferable: the assessor's cost approach, or the taxpayer's income approach?

 

Courts side with owners

The judges in these cases rejected the assessor's cost approach for several reasons. The cost approach rests on the principle of substitution, but replacement sites are difficult to find in the golf course industry. One judge cited an appraisal industry publication, which concluded that the cost approach is generally inapplicable to golf courses.

The cost approach used by the assessor deducted only the physical depreciation, based on age, but did not factor in external obsolescence. External obsolescence results from outside forces such as the oversupply of courses.

Again, a judge cited the appraisal industry publication that noted the difficulty in estimating external obsolescence in a market where prices have fallen 50% or more since the late 1990s. The judges found that investors rarely use a cost approach to determine the purchase price to pay for a golf course.

The judges held that the income approach offers the best valuation method for a golf course because buyers typically buy courses to produce income. The approach measures this capacity and converts it into a projected sales price.

The assessor's cost approach has been found not to be par for the course, so owners should consult their property tax professional to determine if an income approach can reduce their property tax liability.

RainesPhoto90Andy Raines is a partner in the Memphis law firm of Evans & Petree PC, the Tennessee member of the American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jun
07

Industrial Properties Get Their Due

"In most jurisdictions, the taxing authorities include in industrial property tax assessments the value of the real estate and the value of the intangibles, despite the fact that in many states intangibles are not taxable assets..."

By Cris O'Neall, Esq., as published by National Real Estate Investor, June 2008

For over a decade, tax authorities in many jurisdictions have recognized that intangible assets and rights must be removed when assessing certain types of properties for tax purposes. This recognition of non-taxable intangibles has typically been limited to hospitality and retail properties, where intangible assets are easier to pinpoint.

Assessors often believe industrial properties consist of solely taxable real estate and personal property, and don't remove the intangible assets for valuation purposes. That could change, however, in the next few years, due to changes in financial reporting standards made earlier this decade, including the advent of FASB 141 and 142, which address the reporting treatment of intangibles acquired by publicly traded companies.

INDUSTRIAL INTANGIBLES PROVE DIVERSE
New reporting requirements enable industrial property owners to call attention to intangible assets so they can be deducted from property valuations.

table_for_cko_2008_article

Gaining traction

As auditors have learned to apply FASB 141 and 142, the number and types of intangibles reported to regulatory authorities has increased. The above chart provides a few examples of the kinds of data industrial companies have begun to report to the Securities and Exchange Commission following large industrial plant acquisitions.

In each example, a portion of the purchase price paid was allocated to specific intangible assets and rights. For instance, Harvest Energy Trust allocated over $118 million of the price it paid for a refinery in Newfoundland, Canada in 2006 to engineering drawings, marketing contracts and customer lists. In the past, intangibles were usually reported along with property, plant and equipment and not delineated. Thus, assessors could not see the intangible assets much less understand their value. FASB 141 and 142 have changed that. The identification of specific intangible assets by industrial companies in financial reporting of acquisitions represents a big step forward. It gives legitimacy to specific intangibles, both for the company reporting them and for other companies in the same industry. Intangibles are exempted from taxation in a number of states. For example, in California, statutes, regulations and appellate court decisions exempt most industrial plant intangibles.

Property taxpayers who can identify and place a value on intangible assets and rights are entitled to exclude the value of those intangibles in determining their property's assessed value. Similar tax exemptions can be found in other states, such as Texas and Washington.

Doing the math

Once intangibles are identified, the amount of intangible value to be deducted from the property's total value must be determined. This is established by a review of comparable sales or a cash flow analysis. An appraiser should be retained to develop the valuation using the appropriate ad valorem tax standard.

For example, every industrial property has employees and a market expense to recruit and train can be estimated. This figure is an "avoided cost" to a buyer and represents the fair market value of that workforce for ad valorem tax purposes.The same technique can be used to value drawings, manuals and software.

Normally, property owners do not determine the value of intangibles by using the local property tax value standard. By valuing intangibles that way, the taxpayer derives a quantitative value for the tangible real and personal property that should be subject to property tax.

In most jurisdictions, the taxing authorities include in industrial property tax assessments the value of the real estate and the value of the intangibles, despite the fact that in many states intangibles are not taxable assets. Therefore, owners and operators of industrial properties need to follow these key steps:

  • Determine how the taxing authorities appraise your properties for ad valorem tax value. If they include real estate and intangibles in their assessment, take stock of the intangible assets and rights used in connection with your properties.
  • Order appraisals for all the properties' intangibles, basing those appraisals on local ad valorem value standards.
  • Present the facts to the taxing authorities and request that the value of the intangibles be excluded from the taxable value of your properties.

If you and the authorities cannot agree, file a tax appeal.

CONeallCris K. O'Neall is a partner in the Los Angeles law firm of Cahill, Davis & O'Neall LLP, the California member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. O'Neall can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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