As the commercial real estate industry continues its slow but steady recovery, investment in large, speculative real estate developments and new construction is returning, and surpassing pre-recession levels in many markets.  By their nature, large developments often take longer to construct than smaller projects, and this lengthy construction time can generate higher carrying costs for a developer at a time when the property is not generating income.

One of the largest expenses for commercial real estate is property tax.  The property tax burden can be even more onerous when the development does not yet have tenants, who ordinarily would reimburse the developer for taxes, or whose rent would otherwise provide the funds to pay taxes on the property.

As the number of large-scale construction projects ramps up, many properties will be under construction on a given assessment date, on the date on which an assessor values the property for that year’s property taxes.  This raises questions as to how and whether the property should be assessed, and the answers to those questions may provide opportunities for taxpaying developers to reduce their carrying costs.

Most states value property using a fair market value standard, and assess a property based on its value to the market.  Other states apply a market-value-in-use standard, which seeks to value the property’s current use.  In both systems, a property that is partially build on the assessment date would arguably have limited or no value because it is unable to generate income for its owner.  Further, as seen in many markets during the recent recession, few buyers are willing to purchase a partially constructed building.

In either circumstance, the property’s in-progress status would significantly hinder its value.  Even the value of the land would be impaired, because a buyer wanting that land would have to demolish the existing construction to begin anew.

Nevertheless, many states authorize local tax assessors to value developments for tax purposes while still under construction.  The means employed by assessors vary, and some states lack explicit guidance on how assessors should perform such a valuation.

Despite the many issues involved in valuing a property that is only partially built, some assessors create another layer of difficulty by assessing only some partially constructed projects on any given assessment date.  A recent review of the assessments in one midsized US market revealed that only one of the many projects in the construction pipeline was assessed as “construction in progress.”  Every other partially built property maintained its prior value until the project was completed and placed in service.

Aside from the apparent inequity of this situation, it raises potential legal ramifications as well.  Nearly every state’s constitution requires that property taxes be assessed and administered uniformly and equally.  Under these provisions, which are at the heart of the modern data-based property tax system, if two properties are identical, then the process by which they are assessed should be identical and the resulting values should be identical.  The techniques used to value one property in a jurisdiction should apply to all similar properties.

As the recovery continues for commercial real estate, assessors are eager to restore the tax rolls to pre-recession values or higher.  But that restoration of tax rolls should not come at the expense of developers who have major projects under way.

Whether in-progress buildings should even be assessed is questionable, but if they are, then every property should be subject to the same standard.  Increasing the value of only select projects violates state constitutions.  Fortunately, those same constitutions give developers an avenue to challenge their unfair tax liabilities.

Reprinted with permission from the “ISSUE DATE” edition of the “PUBLICATION”© 2016 ALM Media Properties, LLC. All rights reserved.

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Stephen Paul is a partner and Benjamin Blair is an associate in the Indianapolis office of the law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of American Property Tax Counsel. They can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. or This email address is being protected from spambots. You need JavaScript enabled to view it..  The views expressed here are the authors' own.

Indiana has become the latest battleground in the debate over how assessors should value retail real estate and other commercial properties for property tax purposes. The debate’s conclusion will likely affect owners of retail, office and even industrial properties in Indiana, and may affect taxpayers grappling with similar issues in other states.

At the heart of the debate is the question of what assessors should value under Indiana’s market value-in-use standard. Though that term can seem somewhat puzzling, the Indiana Supreme Court has stated that any valuation standard must be based on objective data while also protecting Indiana taxpayers who choose to use their properties at something less than full market potential.

How is market value in-use different from market value? In many if not most situations, they are identical. Where a property is being used for its highest and best use, the property’s market value-in-use will be the same as its market value.

Because a property can be used for something less than its highest and best use, however, its market value-in-use may be lower than its market value. This is the case in the example of agricultural land surrounded by commercial development.

A property cannot be used for something greater than its highest and best use, however; by definition, nothing is higher or better than the highest and best use. Accordingly, a property’s market value-in-use cannot exceed its market value.

Importantly, market value-in-use does not mean the value to the individual user. This distinction may seem like mere semantics, but how the state defines market value-in-use affects many commercial taxpayers. A series of Indiana cases show why.

Since at least 2010, when the Indiana Tax Court issued a pair of decisions addressing the meaning of market value-in-use, Indiana has recognized that market value-in-use as determined by objectively verifiable market data, is the value of a property for its use, not the value of its use to the particular user.

Indiana courts also recognize that in markets where both buyers and sellers frequently exchange and use properties for the same general purpose, a sale often indicates value. The Indiana Board of Tax Review has affirmed and applied these rulings in subsequent cases, including a pair of decisions issued in December 2014 involving big-box retail stores.

These decisions followed longstanding precedent from the Indiana’s Tax Court and kept Indiana in line with the overwhelming majority of other states that have considered the question. Had the board instead agreed with the assessors’ interpretation of market value-in-use as being the value of the use, it would potentially have created a number of anomalous outcomes, including similar properties being assessed differently based on the property owners’ characteristics and not on the properties’ characteristics.

Following the board’s decisions, local governments petitioned the Indiana legislature to change the valuation standard for commercial properties. After a heated debate, legislators left the market value-in-use standard unchanged but amended the property tax statute to modify the evidence available to prove a property’s value, based on the facts of the case.

It is too early to know the full ramifications of the new statute. Assessors’ repeated attacks on the market value-in-use standard, however, will produce one certain result, Taxpayers that own property in Indiana or are considering doing business there will face increasing uncertainty. For that reason, taxpayers must monitor their assessments to ensure fairness as the debate continues.

Stephen Paul is a partner and Benjamin Blair is an associate in the Indianapolis office of the law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of American Property Tax Counsel. They can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. or This email address is being protected from spambots. You need JavaScript enabled to view it..  The views expressed here are the authors' own.

Anchors weigh heavily in tax decisions

As the post-recession recovery for retail properties continues, local assessors are eager to increase shopping center tax assessments to their pre-recession highs or beyond. But regional and super-regional shopping centers are among the most complex types of real estate that assessors regularly value, and that complexity yields errors.

By failing to remove the value of an often-overlooked intangible asset, assessors are improperly attributing excess income to the real property, resulting in excessive tax assessments. This error stems from assessors incorrectly answering one of the most fundamental questions in property assessment: What property is being valued?

Too many assessors look at the income generated by a shopping center and conclude that the income is entirely attributable to the real estate. But the value of a shopping center's going concern is not equal to the market value of its real property. Unless the assessor makes an effort to extract the non-real-estate components, the value indications under the income and sales comparison approaches to value will capture not just the value of the real property, but also non-taxable personal and intangible property.

AGREEMENTS ARE INTANGIBLE

One major non-realty component of a shopping center's value is its operating agreements with anchor tenants.

Shopping centers depend on their anchor tenants for more than rent, Anchors typically make major advertising expenditures to draw customers to the property. As a result, customers ordinarily visit the mall with the initial purpose of shopping at the anchor retailer, and only then venturing out into the rest of the mall, which is typically the domain of more specialized retailers.

Shopping centers with better-quality anchors are able to draw more customers and charge higher rents to inline tenants. The presence of high-quality anchors also conveys stability, which attracts potential inline tenants. Conversely, when a mall loses one or more of its anchor tenants, inline tenants almost always follow the anchor, and the landlord must offer larger concessions to attract replacement tenants.

Beyond helping to attract and retain inline tenants, high-quality anchor tenants contribute indirectly to higher income generation for the shopping center. Because shopping centers often collect percentage rent, or rental income based in part on an inline tenant's retail sales, the long-term presence of an anchor that draws customers is vital to a mall's long-term financial success.

Shopping center developers typically ·offer significant inducements to attract and retain anchor tenants, and to convince those tenants to sign favorable long-term operating agreements. These inducements may take the form of cash, a preferred site, site improvements, or reduced expense recoveries, and may occur both upon the initial development of the shopping center and during redevelopment ·

Whatever the form and timing, shopping centers have to subsidize the anchor's costs. The shopping center gets a return on this investment over the lifetime of the tenancy in the form of higher in-line rents.

Because the higher rental income from in-line tenants is, in part, a byproduct of the anchor operating agreements rather than a reflection of the real estate value alone, it is inappropriate to attribute the entire income stream to the real property. But when assessors use the total income of the shopping center's business in their calculations, they implicitly value the total assets of the business, rather than the real property alone.

PROPER ASSESSMENT TECHNIQUE

To properly value just the shopping center’s real property, the income attributable to the favorable anchor operating agreements must be subtracted from the ' shopping center's total income prior to capitalization.

The calculation of the income attributable to anchor inducements is a two-step process. First, the appraiser must determine the value of the anchor inducements, accounting for both a return of the initial investment and a return on that investment that would be expected by developers in the market. There is no one-size-fits-all method of determining the amount needed to induce a particular anchor tenant. Every shopping center owner has its own method of determining how much it should pay in inducements to potential anchors given the location, size, age, design, and tenant distribution of the shopping center.

Whatever method is used to determine the value of the favorable contracts, it is important that appraisers select values that reflect inducements actually provided by market participants. For that reason, it is important that taxpayers contesting assessments select appraisers who have experience with shopping centers and who understand the dynamics of that industry.

ANCHOR INDUCEMENTS

Once the assessor calculates the total return of and on the inducements, the second step in this process is to determine the income attributable to those inducements. To do this, the appraiser must amortize the total return over the term of a typical anchor agreement – generally 10 to 15 years – at a yield rate high enough to account for the fact that intangibles are the highest-risk components of a business enterprise.

The appraiser will then subtract the resulting figure from the going concern's net operating income, along with return of and on personal property and other non-real-estate expenses, such as start-up costs. The result will be the net income from the real property alone, which is the correct base for the income approach for property tax purposes.

For most retail properties, the largest expense after debt service is the property tax bill. Any reduction in the tax burden can drastically impact a property's profitability, and a reduction in property taxes passed through to tenants can itself be a method of attracting and retaining better-quality tenants. So as the retail market continues its slow recovery, proper treatment of anchor agreements may be a way to keep from drowning in excessive property taxes.

Stephen Paul is a partner and Benjamin Blair is an associate in the Indianapolis office of the law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of America Property Tax Counsel.  They can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. or This email address is being protected from spambots. You need JavaScript enabled to view it.. The views expressed here are the authors' own.

"How will market conditions in 2014 be different from what we saw in 2013?"

Stephen H. Paul, Esq., President of APTC, answered as follows:

"As Congress has been prone to "kick the can" down the road on tough budget issues, I believe many financial institutions holding large amounts of real estate mortgage paper have been kicking the can down the road over the past few years on many of their loans that have been underwater for some time, extending balloon payback dates into the future in hopes of having their troubled properties recover from their lagging performance. At some point, these financial institutions will have to fish or cut bait as to those properties that haven't recovered during their period of leniency. To the extent these institutions swallow hard and take their hits, we could see a large number of properties come onto the market at attractive prices for investors during 2014 — a reprise of 2010-2012.

"As to those properties that have recovered during this forgiveness period, to the extent they come back to the market, if the they're higher quality retail and office assets, we could see some slight appreciation in prices during 2014, certainly in primary, and most probably in good secondary markets as well."

Real Estate Forum, December 2013

Stephen H. Paul is a Partner in the Indianapolis law firm of Faegre Baker Daniels LLP, 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..

"By demonstrating the scale of the reduction in income to the property and quantifying the precise loss in value through the process of income capitalization, a taxpayer can often reduce its tax burden..."

By Stephen Paul , Esq., as published by Real Estate Forum, September 2012

The clearest way to convey the bright side of declining commercial real estate values is through a residential example. At the height of the real estate boom in 2007, my wife and I received an unsolicited offer for a condominium we owned in Florida. The buyer was persistent and eventually paid us three times what we had paid only four years earlier. But because we still wanted a vacation place in Florida, we purchased a new condo as the market was topping out.

As soon as we moved into our new condo, the market crashed. Similar units in our development were soon selling for half the amount we had paid for ours. When my wife saw our first tax assessment, she was dismayed that our condo's value had dropped so far below our purchase price. But because we intended to hold onto the property for many years, and because our property taxes had decreased, the decline in assessed value actually improved our position.

For commercial real estate, the post-2008 increase in vacancy rates and the collapse of the capital markets have led to a substantial value loss. Value-weighted US commercial property values in June this year were down 30.7% from the peak of January 2010, according to the CoStar Commercial Repeat Sales Index. This cloud has a silver lining for property owners, however. The decline in the market creates an opportunity to reduce taxable value, increase the bottom line and begin to turn the property's value upward. To everything there is a season.

Real estate values, much like the real estate market itself, are largely cyclical. Tax assessors usually calculate commercial property value by capitalizing the property income. As rents decline, property value declines, both for business valuation and tax purposes. A lower assessment also reduces the tax bill.

Logically, any reduction in a major expense will raise net income. Other than debt service, the largest expense for most real estate is property tax. Consequently, as the tax load decreases, the property owner's bottom line increases.

Few local governments assess properties annually. Most properties are reassessed every three or four years, and the tax authority simply adjusts values annually to reflect general market changes. A property may carry an assessment from the market's peak or from a time when the property had less vacancy, thereby overstating the current value.

Assessors will not always reduce a property's assessed value simply because hard economic times have fallen on a region. The problem is further compounded because assessors rarely have access to a property's rent roll. When assessors choose to reduce values generally, the reduction may not be tied to a specific property's actual reduction in tenancy.

In most jurisdictions, however, when a building suffers from an inordinate loss through vacancy, the taxpayer can file a real estate tax appeal requesting an adjustment of the building's assessed value. By demonstrating the scale of the reduction in income to the property and quantifying the precise loss in value through the process of income capitalization, a taxpayer can often successfully and substantially reduce its tax burden. A successful tax appeal and the resulting reduction in tax burden can in turn help offset the loss of income caused by the building's excessive vacancy. Additionally, the lower assessment may remain in effect even as the market improves, resulting in savings for future years.

The tax reduction will boost the property's net operating income. In turn, this will raise the property's market value once the building's increased net operating income is capitalized into anindication of value. This cyclical cause and effect is a built-in economic buffer for owners whose properties suffer from above-normal vacancy rates.

Outside of the tax arena, if a property's expenses decrease and its net income increases, the owner may seek a professional appraisal of the property. An appraisal that accounts for the reduced tax burden may be used to secure more favorable financing, particularly for properties with underwater mortgages. Further, for owners looking to sell their properties, the decrease in the real estate tax load may counterbalance higher-than-average vacancy. A potential buyer will see a better return on investment with a lower tax burden and may be willing to pay more for the property than the occupancy alone would suggest.

By recognizing that there is a silver lining to excessive vacancy and by acting to secure a more favorable assessment, owners can better manage their taxes and keep their property's value elevated in lean times.

Stephen Paul is a partner in the law firm of Faegre Baker Daniels, the Indiana 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. This email address is being protected from spambots. You need JavaScript enabled to view it., associate, contributed to this article.

By Stephen H. Paul, Esq. and Benjamin A. Blair, Esq. as published by IPT - Tax Report, July 2012

On June 4, 2012, the Supreme Court of the United States issued a significant decision in Armour v. City of Indianapolis, No. 11-161, finding that a city's forgiveness of sewer assessments for some property owners without offering refunds to others did not violate the Equal Protection Clause. Applying a rational basis standard of review, the Court held that administrative concerns can be sufficient to justify tax-related distinctions without running afoul of the Constitution.

Introduction
On June 4, 2012, the Supreme Court of the United States decided Armour v. City of Indianapolis, No. 11-161, which affirmed the Indiana Supreme Court's ruling that when a city switches from one method of infrastructure financing to another, the city's decision to forgive certain financial obligations arising under the prior financing method may be justified by administrative concerns even when the forgiveness creates disparate consequences. Although ostensibly a sewer-financing case, the Supreme Court's decision directly affects the scope of state and municipal taxing authority and the impact of the Equal Protection Clause on tax-related distinctions.

Facts
For more than a century, cities in Indiana have been permitted to apportion the costs of infrastructure projects among all affected property owners by a statute called Barrett Law. When a city built a Barrett Law project, the city would divide the total cost of the project equally amongst the affected lots. The city would issue a lot-by-lot assessment and would collect payment of the assessment in the same manner as other taxes. Barrett Law allowed lot owners to pay the assessment either in a single lump sum or as installment payments over a period of 10, 20, or 30 years with accruing interest. Until fully paid, an assessment constituted a lien against the property, and the city could foreclose on the property in the event of a default.

For several decades, the City of Indianapolis (the "City") used the Barrett Law system to fund sewer projects. One of the Barrett Law projects was the Brisbane/Manning Project, which began in 2001. It connected about 180 homes to the City's sewer infrastructure, and in July 2004, the homeowners were sent formal notice of their payment obligations. Each property was assessed $9,278 for the project, with options for 10-, 20-, and 30-year payment plans at 3.5% interest. Thirty-eight homeowners paid the assessment in full.

In 2005, the City adopted a new system of sewer-financing, the Septic Tank Elimination Program ("STEP"), in which each homeowner was charged a flat fee and the remainder of the cost was financed by bonds paid by all taxpayers. STEP had the advantage of lowering sewer-connection costs for individual lot owners. However, more than 40 Barrett Law sewer projects had been constructed before STEP was adopted, and more than half of those projects still had installment paying lot owners, including the Brisbane/Manning Project, which had been in place for only a year. In enacting STEP, the City decided to forgive all outstanding assessments under the Barrett Law system because the system presented financial hardships on lower income homeowners who most needed sanitary sewer service. However, no refunds would be issued for assessments already paid. Thus, while 38 of the homeowners in the Brisbane/Manning project had paid $9,278, others paid as little as $309.27 for the same sewer connection.

The homeowners who had paid in a lump sum brought a lawsuit seeking a refund from the City, claiming that the City's refusal to provide refunds at the same time that the City forgave outstanding assessments of other homeowners violated the Federal Constitution's Equal Protection Clause, which provides that "no state shall ... deny to any person within its jurisdiction the equal protection of the laws." The trial court granted summary judgment in favor of the homeowners, and the Indiana Court of Appeals affirmed that judgment. The Indiana Supreme Court reversed the lower court, finding that the City's distinction was "rationally related to its legitimate interest in reducing its administrative costs, providing relief for property owners experiencing financial hardship, establishing a clear transition from Barrett Law to STEP, and preserving its limited resources." Slip op. at 5. The homeowners appealed to the U.S. Supreme Court to consider the equal protection question.

Holding
In a 6-3 decision, the Supreme Court held that the City's tax-related distinction was supported by a rational basis and thus did not violate the Equal Protection Clause.

Analysis
The Court began by finding that the proper question was whether the City's distinction between homeowners had a rational basis. Although the Equal Protection Clause strongly protects individual rights in certain circumstances, a classification that does not involve fundamental rights and which does not proceed along suspect lines "cannot run afoul of the Equal Protection Clause if there is a rational relationship between the disparity of treatment and some legitimate purpose." Slip op. at 6. Rational basis review requires deference to reasonable underlying legislative judgments, and legislatures have "especially broad latitude" in creating classifications and distinctions in tax statutes. Id.

The City's classification involved neither a fundamental right nor a suspect classification. "Its subject matter is local, economic, social, and commercial." Id. The City did not discriminate against out-of-state commerce or new residents, actions which would have increased the degree of scrutiny the Court would give to the City's action. The distinction between fully-paid homeowners and those who had their debt forgiven was simply "a tax classification." Id. Hence, the Court found that the case fell directly within the scope of its precedents holding such a law constitutionally valid

if there is a plausible policy reason for the classification, the legislative facts on which the classification is apparently based rationally may have been considered true by the governmental decision maker, and the relationship of the classification to its goal is not so attenuated as to render the distinction arbitrary or irrational.

Slip op. at 7 (quoting Nordlinger v. Hahn, 505 U.S. 1, 11 (1992)).

The Court found that the City's decision to stop collecting outstanding Barrett Law debts was based on rational administrative concerns. Administrative considerations can justify a tax-related distinction. The City's administrative burdens would have included the need to maintain parallel and expensive administrative systems to monitor both the new and the old financing systems, with the possible need to track down defaulting debtors and bring legal action. The fixed administrative costs would have continued to increase on a per-debtor basis as debts were paid off. Further, the City would have to calculate and administer refunds, which would require appropriating funds from other city programs. In other words, the entire purpose of transitioning from Barrett Law to STEP would have been defeated. While the homeowners put forth systems they deemed superior to the one implemented by the City, the Court noted that "the Constitution does not require the City to draw the perfect line nor even to draw a line superior to some other line it might have drawn... only that the line actually drawn be a rational line." Slip op. at 11.

Although the Indiana court held that relieving financial hardship was also a rational governmental concern, the Court noted that it did not need to consider that argument, explicitly holding that "the administrative considerations we have mentioned are sufficient to show a rational basis for the City's distinction." Slip op. at 10. The homeowners correctly stated that administrative considerations could not justify a system where a city arbitrarily allocated taxes among a few citizens while forgiving others simply because it is easier to collect taxes from a few people than from many. "But that is not because administrative considerations can never justify tax differences." Slip op. at 11. "The question is whether reducing those expenses, in the particular circumstances, provides a rational basis justifying the tax difference in question." Slip op. at 12. The Court held that the homeowners had not met their burden of showing that there was no rational basis justifying the distinction.

In a spirited dissent, Chief Justice Roberts noted that the Court had never before held that administrative burdens alone justify grossly disparate tax treatment of those who should be treated alike. "The reason we have rejected this argument is obvious: The Equal Protection Clause does not provide that no State shall 'deny to any person within its jurisdiction the equal protection of the laws, unless it's too much of a bother.'" Dissent at 4. Similarly, the City's argument that the unequal burden was justified because it would have been "fiscally challenging" to issue refunds "gives euphemism a bad name." Dissent at 5. The dissent disagreed that the City could evade returning money to its rightful owner by the "simple expedient of spending it." Dissent at 6.

The City had been presented with three choices: 1) continue to collect installment payments from all homeowners; 2) forgive the debts of installment-plan homeowners and give equivalent refunds to lump-sum homeowners; or 3) forgive future payments and offer no refunds of past payments. "The first two choices had the benefit of complying with state law, treating all of Indianapolis' citizens equally, and comporting with the Constitution." Dissent at 2. The City chose the third option, and the dissent saw the equal protection violation as plain.

The Ongoing Vitality of Allegheny
The Court's decision in Armour will have a significant impact beyond the limits of Indianapolis' sewer system, particularly in the realm of equal protection challenges to state tax regimes.

The most substantial disagreement between the majority and the dissent, and the area where some commentators have expressed concern, is the continuing vitality of Allegheny Pittsburgh Coal Co. v. Commission of Webster County, 488 U.S. 336 (1989). That case involved a county assessor who valued real property on the basis of its recent purchase price, except where the property had not been recently transferred, in which case the assessment for each property remained essentially flat. The system resulted in gross disparities in the assessed value of generally comparable properties. The Constitution allows a State to divide property into different classes, but the division must not be arbitrary and the distinctions in practice must follow state law. The Supreme Court held that the assessments violated the Equal Protection Clause because the Clause requires that similarly situated property owners achieve rough equality in tax treatment.

The majority in Armour distinguished the earlier decision by emphasizing that Allegheny was "the rare case where the facts precluded any alternative reading of state law and thus any alternative rational basis." Slip op. at 13. There, the assessor "clearly and dramatically violated" a clear state law requirement of equal valuation. In contrast, the City in Armour followed state law by apportioning the cost of its Barrett Law projects equally. State law said nothing about how to design a forgiveness program or how to draw rational distinctions in doing so. Thus, to adopt the view of the homeowners "would risk transforming ordinary violations of ordinary state tax law into violations of the Federal Constitution." Slip op. at 13-14.

The dissent found the equal protection violations to be identical between Armour and Allegheny. Whereas the majority spent little time on the Allegheny decision, the dissent saw the cases as direct analogs, even down to the levels of disparity. Whereas the majority found that the City complied with state law, the dissent viewed the state law as requiring the assessment to be equally apportioned amongst the homeowners. The result of the City's decision was that some homeowners were charged 30 times what the City charged their neighbors for the same service.

The fundamentally different treatments given by the majority and the dissent treatments to Allegheny show that Allegheny is still an important case in equal protection claims relating to taxation. The sides disagreed about how central Allegheny is to the argument for rational basis and the manner in which compliance with state law demonstrates a rational basis.

The majority seems to have taken steps to avoid dealing with Allegheny, despite the obvious parallels between the cases. The Court only discussed Allegheny after finding that the City had a rational basis for the distinction. Whereas Allegheny stands for the notion that failure to comply with state law demonstrates a lack of rational basis, the majority found a rational basis and then read the state law in a way that supported its finding.

The dissent viewed compliance with state law as central to the argument for rational basis. If a City's tax regime fails to comply with state law, it fails rational basis review. Thus while the majority took a broad view of compliance, saying that the assessment itself complied with state law, the dissent took a narrow view of compliance, saying that the end result of the tax regime must comply with state law.

Allegheny, though a "rare case", has long provided taxpayers with some guidance on how to proceed in an equal protection challenge to an unequal tax regime. The decision in Armour shows how rare Allegheny truly is, and how difficult the path for future taxpayers will be. The most significant lesson for taxpayers seeking to overturn a tax regime on equal protection grounds is that the bar is set extremely high. Taxpayers who attack legislative line-drawing have the burden of showing that it was not rational for the City to draw the line to avoid an administrative burden. Slip op. at 12. Taxpayers must show that the administrative burden on the municipality is "too insubstantial to justify the classification." Id. The homeowners in Armour were unable to do so. The discriminatory effect in future cases will need to be egregious in order for taxpayers to successfully show an equal protection violation in light of Armour.

The Impact of Armour on Amnesty Programs
The Court's decision in Armour is also significant because it may be broadly interpreted to give state and municipal governments a wide berth in crafting amnesty programs and other tax policies.

The Court drew a parallel between Indianapolis' assessment forgiveness and other common amnesty programs involving mortgage payments, taxes, and parking tickets. Slip op. at 9-10. The City's distinction between past payments and future obligations is a line consistently drawn by courts between actions previously taken and those yet to come. The Court implied that to overturn the City's sewer-financing distinction would require overturning tax amnesty programs that are regularly used by governments.

The dissent, however, emphasized that the Court's analogy to typical amnesty programs was misplaced. "Amnesty programs are designed to entice those who are unlikely ever to pay their debts to come forward and pay at least a portion of what they owe." Dissent at 5. Because administrative convenience alone does not justify those programs, their constitutionality would not be in question.

The Court's decision continues the line of cases allowing under the Equal Protection Clause distinctions between taxpayers in forgiveness situations. As more states offer tax amnesty programs to increase tax revenues and encourage future compliance, they can feel secure that their programs should receive broad support from the courts, so long as they serve a rational purpose.

Conclusion
The question in Armour was summarized by Justice Breyer, the eventual author of the decision, near the close of oral argument as whether the City's choices were rational. To the majority of the Court – including, notably, Justice Thomas who broke with the conservative wing of the Court – found that administrative considerations alone can justify a tax-related distinction between taxpayers and a city's decision to stop collecting on certain assessments. Despite an invitation by the dissent, the Court refused to say "enough is enough" to continuing pressures on the Equal Protection Clause. The Supreme Court rarely grants certiorari to state tax cases, and the decision in Armour shows that taxpayers will continue to have an high burden when they do reach the courthouse steps.

Benjamin A. Blair, Esq. is a partner in the Indianapolis office of Faegre Baker Daniels, the Indiana member of American Property Tax Counsel, 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.

Stephen H. Paul is a partner in the Indianapolis office of Faegre Baker Daniels, the Indiana member of American Property Tax Counsel, 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..

"For the last few years, the country has been mired in a deep recession, which has severely impacted tax values. In determining assessed values, assessors don't have an understanding of —or ignore the realities of— the impact of the recession on property owners. One example revolves around the capitalization rate that should be used under the income approach to value..."

Interview with American Property Tax Counsel's president, Stephen H. Paul, as published by GlobeSt., January 2012

CHICAGO-Fighting for every scrap of legal tender has become an important part of commercial real estate, as loans today require much more cash and fights ensue about property value loss.

The locally based American Property Tax Counsel is an advocate in this fight for real estate owners. The group is comprised of 32 member firms and more than 100 attorneys from across the country selected for membership based on their reputations for practice excellence in their respective jurisdictions.

Recently, the group held their annual election and selected Stephen Paul with Indianapolis-based Faegre Baker Daniels as this year's president. He talked recently with Globest.com about his insights into the current post-recession era, and what owners can do to retain as much value as possible.

Globest.com: What are your thoughts upon being elected president of APTC?

Paul: The legal issues that have arisen since APTC was founded 20 years ago have changed substantially. My goal is to continue the tradition of making our member firms familiar with the most current issues and solutions, from both the legal and the valuation perspectives. Doing so will allow us to continue to best serve our member firms' clients.

Globest.com: What do you see as the most significant issue in property tax litigation today?

Paul: For the last few years, the country has been mired in a deep recession, which has severely impacted tax values. In determining assessed values, assessors don't have an understanding of —or ignore the realities of— the impact of the recession on property owners. One example revolves around the capitalization rate that should be used under the income approach to value. Assessors utilize pre-recession information that is not applicable to the realities of today. Taxpayers need to closely scrutinize the data used by assessors in developing the cap rate employed in their valuation of the owner's property.

Globest.com: Any other issues that you see this year that will affect property tax litigation?

Paul: Most states define taxable value as market value in exchange, that is, what a willing buyer would pay and a willing seller would accept. Many assessors, however, attempt to utilize market value in use instead, which can translate into an unlawful value. For example, imagine a manufacturing facility built forty or fifty years ago, but which continues to serve the purposes of its owner. The property may be more valuable to the owner in its current use than it would be if the owner chose to sell the vacant building to a buyer. Did the assessor value the taxpayer's property employing a value in use concept?

Globest.com: Has the recession caused any issues involving how sales are compared to one another?

Paul: Specifically when valuing a property under the sales comparison approach, issues arise as to which sales should be considered and which should be ignored. As the economy —including the real estate market— remains in a deep recession, a large number of comparable sales involve foreclosed properties. We see assessors trying to disregard the values of those foreclosures, when in fact foreclosed properties may be the only market. The savvy taxpayer will determine whether the assessor has failed to include foreclosures in its comparables.

Globest.com: What are some of the ways assessors inappropriately inflate property value?

Paul: Assessors sometimes attempt to use an allocated portion of the recorded sale price in a bulk transaction sale. However, that price usually reflects other factors, such as the value of intangibles, or the benefits to that particular owner from the economies of scale of owning multiple operational buildings. In other cases, assessors will try to rely on reported Section 1031 exchange values. That is also inappropriate, though, because those values include considerations that are wholly aside from the value of the realty. Make certain that only the value of the real property is being used to determine the valuation of your property for property tax purposes.

Globest.com: What are some issues you see arising as the real estate markets start to recover?

Paul: From a macro point of view, the increasing level of federal government debt will mean that programs and expenditures heretofore made at the federal level will be pushed onto state and local governments due to the burgeoning federal deficit. Local communities will be under even more pressure to raise revenue. The greatest source of revenue for local governments is property tax. So, as was the case during the Reagan presidency, assessors will become more aggressive in attempting to raise revenue to satisfy their local budgets, and that will fall on the shoulders of property owners. In order to assure fair property taxation, owners must carefully review their tax assessments to ensure that no inappropriate factors are used by assessors in valuing their property.

Stephen H. Paul is a partner in the Indianapolis office of Faegre Baker Daniels, the Indiana member of American Property Tax Counsel, 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.

"Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method."

By Stephen H. Paul, Esq., as published by Commercial Property Executive Blog - May 2011

Appraisers can choose from three approaches to determine what a buyer would pay for a commercial property. But which approach is the most appropriate method of valuation?

The cost approach assumes that buyers will pay no more for a property than it would cost them to build an equal substitute. The appraiser calculates the cost to build the property and subtracts physical, economic, and functional depreciation.

Appraisers prefer this approach for newer properties that lack an operating history. The cost approach is also preferred for unique or specialty properties because no comparable properties may exist.

The income approach assumes that buyers will pay no more for the commercial real estate being assessed than it would cost to purchase an equally-desirable, substitute investment. The appraiser calculates the net income from the property over a given number of years, and discounts the result to its present value.

Appraisers prefer the income approach for income-producing properties that are typically bought and sold by investors. However, this approach requires accuracy in setting the interest rate and predicting future expenses.

The sales approach assumes that buyers will pay no more for the property than it would cost them to purchase an equal substitute. The appraiser locates sales of comparable properties and adjusts the prices to reflect the subject property. Although this approach may be the most accurate in that it provides a price in a particular market, finding a truly comparable property can sometimes be difficult.

Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method. A buyer would not pay more for a property than it would cost to build, unless something else was included in the value. Anything above the value given by the cost approach must be business value, which is excluded from value calculations for property tax purposes.

Stephen H. Paul is a partner in the Indianapolis office of Baker & Daniels LLP, the Indiana member of American Property Tax Counsel, 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..

"Businesses today have greater difficulty than ever before in predicting future space needs as business requirements and market conditions change rapidly. Federal, state and local laws and regulations, too, have become unpredictable..."

By Terry Gardner, Esq., and Stephen H. Paul, Esq., as published by The Leader, January/February 2011

Technological advances are rapidly altering the way corporations use commercial real estate, and recognizing these fundamental shifts can have a profound effect in efforts to reduce property taxes.

Our world changed at an incredible pace in the last 100 years, and those changes have accelerated in the 21st Century. As one technology enthusiast observed in 1999, "From 1946 until now, if the automobile had been improved as much as the computer has been improved, you'd have a car that would go a million miles an hour and cost a penny!"

There was little telecommuting 10 years ago, when the average cubical size ranged from 50 to 75 square feet and the BlackBerry was the latest fad in a mobile technology industry still in its infancy. Corporate campuses with sprawling Frank Lloyd Wright-style buildings were the norm. Today those edifices of expansive glass, with their inefficient angles and giant atriums, are considered too expensive to maintain and are becoming the exception rather than the rule.

Technology and the commercial real estate boom that ended in 2007 have combined to fuel a dramatic shift in the use of commercial space from the aesthetic to the practical. Companies realize that every dollar saved by a more efficient use of real estate not only makes them more environmentally responsible, but also goes directly to the bottom line.

The New Workplace

At Indianapolis-based health benefits provider WellPoint, more than 6,000 associates work from home, and as with many other businesses, that number is increasing daily. Most of these associates almost never need to come into the office. At least 1.4 million square feet of commercial office space would be required to house these 6,000 associates. Most of the space once occupied by these telecommuters has been or will soon be returned to the landlord.

Today, preferred venues for companies like WellPoint are square or rectangular in shape, utilize a central core and are easy to maintain. More efficient space design and better technology are changing the physical layout and proportions of the workspace itself, as well. Innovations such as flat screen monitors replacing the cumbersome CRT monitors of old have decreased cubicle sizes to as little as 35 square feet, but have driven up parking requirements to five or six spaces per 1,000 square feet of leased space.

In addition to work-at-home programs, other alternative workplace strategies including hoteling, desk sharing, and more have all come of age. Space once used to provide each individual with a large cubicle or enclosed office is rapidly becoming obsolete.

Businesses today have greater difficulty than ever before in predicting future space needs as business requirements and market conditions change rapidly. Federal, state and local laws and regulations, too, have become unpredictable. As a result, lease flexibility is now a fundamental requirement for many tenants. Lease terms are shorter and often come with enhanced termination and contraction options.

The need for less space, evolution of lease terms, and collapse of the capital markets have led to a substantial loss in value for commercial real estate. But for parties responsible for paying property taxes, this dark cloud has a silver lining in the form of a significant opportunity to reduce the assessed value of real estate in most markets.

Economic factors affecting value

A property's value is driven not merely by the inherent qualities of the asset itself, but also by market factors. The Appraisal Institute, the recognized leader worldwide in real estate appraisal education, has identified four predominant and interdependent influences on property values, rooted in fundamental economic principles of supply and demand. Those are utility, scarcity, desire, and effective purchasing power.

Utility and scarcity weigh in on the supply side of the equation as the ability of a property to satisfy users' needs and desires, in context with the anticipated supply of properties relative to demand. Desire and effective purchasing power are on the demand side, and take into account individual wants beyond essential needs, and the market's ability to pay for property. By looking at these four influential factors, it's easy to see how property values have suffered from evolving appetites for office space and from the recent trends in lease terms and the capital markets.

For example, properties with atriums and other large open spaces are expensive to heat, cool, and maintain. Such features provide little utility, and a surplus of these properties exists on the market. Pair that surplus with a decreasing desire in the market for large expanses of unusable space, and the value of these properties declines.

Or, take into account the increasingly strong position tenants command to negotiate favorable contraction and termination provisions in leases. Clearly, this trend is a reflection of both the surplus of space in the market and a general inability or unwillingness to pay a higher price for unusable property or be compelled to accept less favorable terms.

Translating market influences into assessment reductions

In order to understand how these market dynamics translate into reduced property tax assessments, economic factors influencing value should be viewed within the context of the accepted approaches to property value. The predominant methodologies are the cost approach, sales comparison, and income capitalization.

The first of these approaches to value generally focuses on the replacement cost of the improvements, assigning value upon examining the cost of developing similar structures. This value is adjusted to account for the property's age, condition, and usefulness. The latter point is where inefficient designs come into play as elements of functional or economic obsolescence.

Functional obsolescence refers to the loss in utility resulting from factors that would make it difficult to modify the property for a particular use. Building characteristics tending to contribute more to the aesthetic than to the practical enter into this calculation of functional obsolescence. Enormous atriums, indoor gardens, arboreta, and water features, as well as odd angles and unique architecture, often trace to the preferences of a one-time, build-to-suit tenant and detract from the building's usefulness to subsequent tenants.

Most cost approach values are based on replacement cost, or the cost to substitute an asset of similar size and use but with contemporary materials and design. Because an assessment on the basis of replacement cost doesn't contemplate reproduction of an exact replica, unusable space is excluded from the calculation and results in a lower value.

The public's appetite for sprawling improvements that are distinctively designed and aesthetically pleasing has yielded in the last decade to desires for efficiency and simplicity. To the extent that the property owner can show that tastes have changed in the market, these inefficient design characteristics can demonstrate economic obsolescence, which occurs because of factors outside of the property itself and also reduces the property's value.

The sales comparison approach entails an analysis of sales and listings of similar properties to arrive at an assessed value for a property. The comparable sales used in this analysis should be adjusted to account for variances between the comparables and the property being assessed, including (in some states) the terms of leases on the property. If the comparable sales selected involve inefficient designs that have become abundant on the market and for which the market's desire is dwindling, the comparable sale prices should indicate a reduced willingness to pay a high price for such property.

Sales comparison analysis should employ the most recent sales of similar properties. This way, the sales also reflect latest real estate market trends.

For income-producing property, the income capitalization approach will likely reflect the decreased utility of, and demand for, an inefficiently designed building. Under this approach, property value is assessed by capitalizing annual net operating income. Recent lease activity should reveal terms favoring tenants, as well as increased market vacancy, softening rental rates, and tenant preferences for smaller and simpler designs.

In the case of property encumbered by long-term leases, comparable properties with more recent leases may be reliable indicators of the property's current income-producing capability.

Each approach should reveal that technological and market shifts reducing the utility of oversized, inefficient space, as well as the market's desire to pay for such space, have reduced the taxable value of many commercial properties. Technology is changing ever more rapidly in the 21st Century, and taxing jurisdictions should be open to consider such evidence for its impact on reducing values.

Stephen H. Paul is a partner in the Indianapolis law firm of Baker & Daniels LLP, the Indiana 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.. The authors thank Fenton D. Strickland of Baker & Daniels for his contribution to this article.

Terry Gardner is Corporate Real Estate Director for WellPoint Inc., an industry-leading healthcare benefits provider headquartered in Indianapolis, Ind.