The seniors housing sector can't seem to catch a break. Owners grappling with staffing shortages and other operational hardships lingering from the pandemic are facing new challenges related to debt and spiraling costs. High interest rates and loan maturations loom over the industry, with $19 billion in loans coming due within the next 24 months, according to Cushman & Wakefield's "H1 2024 Market Trends and Investor Survey" on senior living and care.

Factors driving high costs include wage pressures, inflation and — incredibly — rising property taxes. Despite operational challenges and declining occupancy at many facilities during the COVID-19 pandemic, property tax relief for seniors housing was mixed. Many assessors resisted downward adjustments to taxable values, maintaining that recovery was around the corner. Now, seniors housing operators face property tax assessments that equal or exceed pre-pandemic levels.

As in the hospitality sector, most seniors housing owners understand that their operating properties include more value components than real property alone. In evaluating whether a tax assessment is reasonable and fair, however, owners need to realize that how an assessor addresses their real estate, personal property and intangible assets can drastically affect property tax liability.

Intangibles have value

The Appraisal Institute's "The Appraisal of Senior Housing, Nursing Home, and Hospital Properties" states that the valuation of a going concern in the sector includes real property, tangible personal property and intangible personal property. Real property or real estate equates to fee-simple, leased-fee or leasehold interests; tangible personal property is furniture, fixtures and equipment.

Intangible personal property can include assembled workforces, licenses, certifications, accreditations, approvals such as certificates of need, employment contracts, medical records, goodwill and management.

The Appraisal Institute's text also cites a requirement from the Uniform Standards of Professional Appraisal Practice in stipulating that the market value of real estate must be identified and valued separately, apart from the tangible and intangible personal property. Adopted by Congress in 1989, the Uniform Standards serve as ethical and performance standards for appraisal professionals in the United States.

Assessors and real estate appraisers are familiar with the process of separating real property and tangible personal property for purposes of valuation. Valuing intangible personal property, however, is often less clear.

Top-down vs. ground-up valuation

Appraisers often back into an intangible personal property value by first developing a going-concern value and then subtracting values for real property and tangible personal property. In practice, the whole does not always equal the sum of the parts.

Appraisers frequently opt for this "top-down" approach, so described because the appraiser develops a value opinion for the total going concern and then works "from the top down," assigning values to the various components based on market statistics or other data.

By contrast, some appraisers take a "ground-up" approach by valuing all the components independently and then adding those amounts to value the going concern. If done properly, both methods should yield similar value indications for each component.

For especially difficult property tax cases, taxpayers may find it worthwhile to have two appraisers perform independent appraisals using each method and then present both conclusions to the trier of fact.

Either method can help to demonstrate the considerable investment value imbued in many elements of intangible personal property. The assembled workforce may have taken several months to adequately staff and train, for example, while acquiring and maintaining licenses requires investments of time, capital and effort to overcome regulatory and adherence challenges. The loss of licenses or a portion of the workforce at a seniors housing facility can impair its operation and send effects rippling throughout the business, reaching beyond intangible personal property.

Business appraisers, who are accustomed to valuing intangible assets as part of mergers, acquisitions and similar activities, can provide clarity for taxpayers building a case for a tax assessment reduction on their seniors housing property. A business appraiser can be invaluable in these circumstances, allowing for a ground-up approach to valuing the elements of the intangible personal property and even working alongside real estate appraisers to come up with a clearer picture of the going concern.

Accounting counts

Most seniors housing operators fastidiously follow Generally Accepted Accounting Principles (GAAP) and strive to maintain compliance with accounting rules from the Internal Revenue Service (IRS) and Securities and Exchange Commission (SEC). These taxpayers would be wise to include a fourth consideration for their accounting team, which is to understand how their state and local governments define taxable real estate.

Tax definitions may vary slightly from one jurisdiction to another. Thus, it is possible to have one allocation for IRS, SEC or GAAP guidelines while having a different allocation for property tax purposes that corresponds to tax practices in the area. This type of nuance is one of the reasons seniors housing owners or operators can improve their odds of success in a property tax dispute by working with an adviser who understands both local case law and the area assessor's approach to valuing components of seniors housing properties.

In several states and municipalities across the country, assessors will simply increase a property's assessment to the purchase price entered in county records. This can lead to sticker shock when an operator receives their first tax bill after an acquisition.

By working with tax professionals and valuation experts during the due diligence and acquisition process, and by documenting the consideration paid for each component of an acquired asset's value, operators can limit upside exposure for future increases in property taxes and retain the necessary documentation to support these allocations.

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. 

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.

How to use these factors to reduce a senior living property's tax assessment.

The longstanding debate over intangible value in commercial real estate taxation rages unabated, and nowhere is the squabbling fiercer than in valuing seniors living facilities. Because these properties generally transact based on income from a going concern rather than from real estate, taxpayers planning to acquire a seniors facility should consider how to separate intangible value prior to acquisition. Simply waiting for the annual tax bill is a recipe for incurring inflated cost and an inferior investment return.

Skilled nursing facilities, assisted living and other seniors housing subtypes often require state-issued licenses personal to the operator. Critically, seniors housing sales typically involve the transfer of a going concern including a valid operating license, assembled workforce and other business assets required for the operation. In other words, sales involve more than just the real estate, and the intangible personal property component involves more than just goodwill.

Acquisition pitfalls

A seniors housing owner's overall return may hinge on tax consequences. Common considerations include real estate transfer taxes, allocation of basis for income tax purposes, real and personal property tax assessments, and segregation of readily depreciable or amortizable assets from non-depreciable or non-amortizable assets.

A common mistake is to use the transaction price as the consideration in the deed. That consideration is the basis for transfer taxes and should exclude tangible and intangible personal property value. Many assessors will revalue the property based on deed consideration, which is easily identifiable and theoretically reflects both parties' valuation of the land and improvements. Thus, citing overall transaction value on the deed can lead to inappropriate excessive taxation.

Instead, define consideration in an allocation agreement at or before closing, which is when the property's federal income tax basis is determined. This generally identifies four components: land (non-depreciable); buildings or improvements (generally depreciable); tangible personal property (generally depreciable); and goodwill or ongoing business value, represented by intangible personal property or business enterprise value. A cost segregation study is helpful but not required.

Loans secured by senior living facilities often pose valuation challenges. Lenders underwriting on a going concern basis need to address whether the state-issued licenses can be secured. The Small Business Administration requires SBA lenders to obtain a going-concern appraisal for real estate involving an ongoing business. Those appraisals must value the separate components and be completed by an appraiser trained in valuing going concerns.

The federal Office of the Comptroller of the Currency, which regulates commercial banks, requires lenders to use a competent appraiser but does not specify appraiser course requirements.

Property tax issues

State law generally requires tax assessors to value only real estate, based on a hypothetical transaction involving the real estate only. Therein lies the rub, because the property's income reflects a combination of real property and tangible and intangible personal property. There is now general agreement that hotels and most seniors living facilities involve intangible value.

The problem is isolating the intangible value. For example, in a 2020 decision involving Disney's Yacht & Beach Club Resort, the Florida Court of Appeals noted that though the nearly 1,200-room hotel's business and real estate values are linked, the assessor is required to value only the real estate, not the going concern.

Some older literature suggests that real estate value contributes only 73 percent to the value of independent living properties, 53 percent to assisted living values, and only 36 percent to the value of a skilled nursing facility. The remaining, non-taxable value, is from the going concern.

The Appraisal of Real Estate provides that going-concern value "includes the incremental value associated with the business concern, which is distinct from the value of the tangible real property and personal property." The Dictionary of Real Estate Appraisal, 6th Edition, defines intangible property as "nonphysical assets, including but not limited to franchises, trademarks, patents, copyrights, goodwill, equities, securities, and contracts as distinguished from physical assets such as facilities and equipment."

State-issued seniors housing licenses fall squarely in the definition of intangible personal property but can be difficult to value, demanding business valuation skills in addition to real estate appraisal skills.

Appropriate approaches

Appraisers typically try to value real estate using the cost, sales comparison, and income approaches, none of which fit seniors housing well. Moreover, charged with valuing many properties, assessors often employ mass appraisal techniques ill-suited for valuing complex going concerns.

Sales comparison drawbacks include the skewing effects of portfolio sales. Common in seniors housing, portfolio prices can obscure the consideration for individual properties or may include significant price premiums over individual sale prices, for reasons completely separate from real estate value.

Some appraisers will use the nearest multifamily sale as a comparable transaction. Yet most types of seniors housing offer abbreviated individual kitchens, if any, and smaller individual living spaces designed to encourage seniors to use the common facilities. If an appraiser is going to use a traditional multifamily property as a comparable, it must be adjusted to retrofit the property as conventional apartments.

To use an income approach, the appraiser must recognize that a huge portion of the seniors housing rent is not attributable to shelter but to services. As noted, seniors apartments are typically designed to get people out of individual units and into common areas. Common spaces usually generate higher expenses and are built to encourage the use of services such as shared dining rooms.

Similarly, compared with standard apartments, expenses for seniors living facilities involve higher maintenance, utility, management and administrative fees generally associated with the property's intangible value. Further, continuing care retirement communities exercise significant synergies between service levels as residents age. Proper analysis of these income and expense figures requires expertise generally removed from an assessor relying on mass appraisals.

Recognizing that many seniors living facilities include substantial intangible value, a 2017 white paper by the International Association of Assessing Officers (IAAO) suggests the cost approach is the proper method for extracting intangible value. Replacement cost certainly offers an easily understandable way for extracting that value.

While correct in valuing new construction, however, the cost approach has questionable utility for older facilities. Replacement cost will often not reflect value, since one can question whether a seniors facility would be rebuilt in the absence of a license. That raises a problem best analyzed as whether the facility represents the property's highest and best use.

The real valuation answer is anything but simple.

At its heart, the debate over how to value seniors care facilities rests on assessors engaged in a hypothetical exercise which is not reflective of the market. Without agreement on how to value the real property when a transaction involves a going concern, the debate will continue.

​What You Need to Know to Successfully Appeal Your Inordinate Property Taxes

For some time, owners and operators of seniors housing properties have been aware of the staggering demographic statistics, such as the Census Bureau's projection that the baby boomer population will exceed 61 million when the youngest boomers reach 65 in 2029. This is truly the Silver Tsunami. Yet, even seniors housing professionals may be surprised by excessive property tax assessments that break otherwise carefully constructed budgets.

Before discussing what seniors housing owners can do to combat an excessive property tax assessment, it will help to review why some taxpayers will receive such unwelcome notifications. Factors include the large and increasing number and variety of seniors housing projects, coupled with the mass-appraisal methods that assessors typically employ.

With tens of thousands of units constructed each year, the country now has over 3 million seniors housing units ranging from independent living to assisted living, memory care and/or nursing care. Appropriate assessment methods depend on whether a property is an all-encompassing, continuing care retirement community; freestanding with only one component (such as independent living only); or comprising several (but not all) of these subtypes.

Unfortunately, assessors with limited resources usually use a cost-based methodology that is cost-effective for valuing a large number of properties. That may work for residential assessments in areas with similar homes, but given the significant differences between seniors housing properties, this approach can create an enormous tax problem for taxpayers who own seniors housing.

An outrageous assessment

In one recent case, the owner of a newly constructed property was shocked to receive an assessment valuing the property about 30 percent above its actual cost.The resulting taxes would have exceeded the owner's budget by over $250,000, not only ruining cash flow, but also destroying more than $2 million of market value.

Fortunately, there are measures taxpayers can take to counter excessive assessments. A critical initial step is to confirm any appeal deadline. Not only do rules differ across the country, but in many states the appeal deadline depends on when the notice is sent.

Further complicating this point is that more than one formal appeal may need to be filed, and taxpayers often have a narrow window within which to file. Generally, if a taxpayer receives a notice and misses a required appeal deadline, there are no second chances for that tax year.

Other important steps are to determine the applicable value standard and the assessment's basis. Usually (but not always) the standard will be market value, or the probable cash-equivalent price the property would fetch if buyer and seller are knowledgeable and acting freely. To determine that value, the assessor usually will have used an incomplete and improper cost approach that only adjusted for physical depreciation.

For these typical cases where the assessor has estimated market value using a flawed cost approach, drilling down deep into the assessor's cost methodology may produce a gusher of tax savings. In the aforementioned case, the assessor had used the costs for constructing a very expensive skilled nursing facility. Correctly using the assessor's cost estimator service for the subject property, which was mostly comprised of independent living units, reduced the cost by about $10 million.

Additionally, an assessor's cost-based valuation often will only account for depreciation from the property's physical condition. A proper cost approach must also account for any functional or external obsolescence.

Functional obsolescence can be substantial, especially for older properties, because consumer preferences change over time. What consumers may have desired years ago may now constitute a poor offering.

External obsolescence, which is often due to adverse economic conditions, can impact a property regardless of its age. For example, there will be external obsolescence if new properties overwhelm market demand in an area, or if the inevitable next economic downturn lowers market values.

Other scenarios

While atypical, sometimes assessors will use an income approach or sales comparison approach to value seniors housing properties. As with the cost approach, those approaches introduce many ways for assessors to reach erroneous and excessive value conclusions. One potentially large error is valuing the entire business and failing to remove the value attributable to services, intangibles or personal property.

In the previously mentioned case, the taxpayer's appraiser used the income approach and concluded that the seniors housing property had a total business value of approximately $22 million. The appraiser then determined that about $1 million of that value was attributable to services and intangibles and about $800,000 was attributable to tangible personal property as shown in the table below.

In a similar vein, the Ohio Supreme Court recently reversed the Ohio Board of Tax Appeals in the case of a nursing home property where a taxpayer's appraiser had determined that only about sixty-two percent of the total paid for all assets was for the real property. The Board of Tax Appeals had summarily rejected the appraiser's analysis as a matter of principle. The Ohio Supreme Court reversed and ordered the Board to reconsider the appraiser's analysis, and determine what amount, if any, should be allocated to items other than real estate.

These cases underscore that an assessor who uses the income or sales comparison approach and mistakenly values the entire business, rather than the real property alone, can improperly inflate a real property assessment by a material amount.

Another step taxpayers can take to achieve tax justice is to involve experienced tax professionals and appraisers. As the above analysis shows, property tax valuation appeals have many procedural nuances as well as legal and factual issues that must be addressed. In addition, in some jurisdictions there may be a basis to obtain relief based on the assessments of comparable properties.

As the inevitable Silver Tsunami inundates markets, there will be more seniors housing properties and more instances of excessive tax assessments. To the extent that the surge in the elderly population depletes local government finances, whether due to government pension plan shortfalls or otherwise, there should be no surprise if property tax bills increase.

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