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Property Tax Resources

Jun
06

Benjamin Blair: Creative Deal Structures Can Yield Tax Benefits

Managing expenses is one of the best ways to ensure the long-term profitability of investment properties, and prudent developers know the importance of carefully monitoring and challenging property tax assessments. But student housing, as a subsector populated largely by tax-exempt educational institutions, presents unique opportunities to minimize taxes for some projects.

Excepting abatements and other local incentives, there are two principal ways to minimize property taxes: The property can be entitled to a statutory tax exemption, or the property can be deemed to have a value of zero dollars. In certain instances, creative structuring can take advantage of these options to improve the developer's cash flow and returns.

Beneficial vs. actual ownership

One of the most potent ways to minimize property taxes is a statutory exemption. For university-owned housing, exemptions will almost always eliminate the tax bill before it arrives in the mail. But what if the property is owned by a private developer, not the university?

Although private ownership by a for-profit entity often sentences real estate to a lifetime of property tax liability, some states disregard formal ownership for property tax purposes, focusing instead on who benefits from the asset. In states adopting this "beneficial ownership" doctrine, the law may treat privately owned properties the same as university-owned real estate, entitling them to exemptions otherwise limited to properties used for educational purposes.

Consider the example of a small private college that wants to develop new on-campus housing, but lacks the resources to borrow the necessary funds to construct the building. Instead, the school contracts with a private developer, which builds the student housing and leases it to the college. The school then operates and maintains the property as student housing, just as it would any other dormitory.

Even though a private developer owns the structure, the benefits of the building go to the college, which may be deemed the beneficial owner of the property. Because the college's intent is not to earn a profit, but rather to support its educational mission by providing housing for its students, the property is exempt.

This structure still allows the developer/owner the right to earn a reasonable return on its investment in the property. This result is logical when one considers that the college's intent is to finance the construction of on-campus housing. If the college financed the construction of a dormitory with a bank loan, the school would not be disqualified from claiming an exemption just because the bank earned a return on its loan.

Precluding profit in this manner would effectively prevent any educational institution from borrowing funds at market rates to finance any construction. Just as the bank is entitled to a reasonable return on its loan, the student housing developer is entitled to a reasonable return on the lease.

Of course, beneficial ownership works in both directions, potentially making an otherwise-exempt property taxable. If university-owned property is leased to a private party who uses it to make a profit, then the property would likely not be entitled to an exemption. Even though the true owner is an exempt educational entity, the beneficial owner is not exempt.

Leaseholds without market value

Even when a property lacks a statutory exemption, however, it will not incur property tax liability if it is deemed to have a negligible market value. An assessed value of zero dollars will always result in zero taxes owed.

A recent case from the West Virginia Supreme Court shows how a new student housing development – or, at least, the developer's leasehold interest in the development – could properly be assessed as having no market value.

In that case, a university leased land to a developer for the purpose of developing student housing with a retail component. The developer constructed the improvements on the leased land at its own expense and transferred title of the new building to the university, which executed a sublease to use the student housing. As the subtenant, the university offered the on-campus housing to students, collecting rent and turning it over to the developer, who then returned 50 percent of the net cash back to the university as a payment on its lease.

The university operated the residential facilities, therefore, while the developer was compensated for constructing the improvements and retained the right to sublease the retail space. The developer's interest in the property was a leasehold.

Because university-owned property is exempt, the university's interest in the property was not taxable. But in West Virginia, leaseholds are taxable real property interests, meaning the developer's interest needed to be assessed. The county assessor concluded that the developer's interest in the property had a value independent from the university's exempt interest, and assessed that interest. The developer challenged the assessment, arguing for a zero value.

The case eventually came before the state Supreme Court, which held that the value, if any, of a leasehold interest is based on whether the leasehold is economically advantageous to the lessee and freely assignable, so that the lessee can realize the benefit of the lease in the marketplace. After all, market value is measured by what the interest could garner if sold on the open market.

If the lease could not be freely assigned to another party, it would have no value in the marketplace. Because the lease was drafted in a way that the assessor conceded was not freely assignable, the Court affirmed that the value of the developer's leasehold interest was zero.

Beware potential pitfalls

The applicability of these strategies to a particular project is fact-dependent. For example, some states, especially those with large amounts of public lands, tax possessory interests. In those states, a government-owned property leased to a private entity can be taxed if the private entity has a "possessory interest" in the real estate. Likewise, privately owned improvements on exempt land can be taxable because the tax is being imposed on the improvement, rather than on the whole property. And assessors eager to increase the tax base can still challenge even the best structuring.

Not all development deals will be ripe for these types of exemption-planning opportunities, nor will all student housing developers find these strategies compatible with their business objectives. Competent tax counsel can help developers weigh the myriad factors that may determine what strategy can deliver the best returns.

But property taxes are one of the largest ongoing expenses of property ownership, so opportunities to minimize their impact on a project's financial results deserve full consideration. With some creativity, developers can improve their own profitability while also helping their academic partners achieve their goals. 

Benjamin Blair is a partner in the Indianapolis office of the international law firm of Faegre Baker Daniels LLP, the Indiana and Iowa member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Apr
26

Add Value Through Correct Valuation

Even in a booming market, managing expenses is the best way to ensure the long-term profitability of investment properties. For most student housing, the largest expense after debt service is property tax.

Assessors in college towns are happy to shift the tax burden onto out-of-town students and investors in student housing communities. And due to the perplexing assessment systems in most jurisdictions, owners and developers of student housing communities often treat tax assessments as a given, making appeals the exception rather than the rule. Yet any reduction in the tax burden can substantially increase profitability, so prudent owners monitor tax assessments closely.

Most ad valorem tax disputes hinge on property value. Developers are adept at valuing assets for investment, but there are substantial differences between taxable value and how much a property is worth as an investment. Knowing these differences can protect owners from overzealous assessors.

Identify the right income

Because student housing communities are income-producing properties, developed and purchased for the high-quality income streams they generate, most assessors argue that capitalized income is the best indication of their real estate value. Accordingly, assessors often ask for the property’s historic income and expense information. Taxpayers should be hesitant to provide the property’s operating statements without considering appropriate caveats, however.

In most states, property tax assessments reflect the property’s market value. Consequently, the assessor should value the asset using market levels of rent, vacancy, and expenses – not the property’s actual financial results. Just because the subject student housing operator maximizes revenues, for example, doesn’t mean that all of its competitors do.

Consider vacancy: Because of the school calendar, many student housing communities generate the majority of their annual income in a nine-month window and sit nearly vacant over the summer months. That equates to a market-wide effective vacancy of 25 percent. The fact that one complex appeals to summer students does not mean that competing properties should be valued as fully occupied year-round.

Further, unlike most standard apartments, the rent a student housing community can generate is attributable to substantial non-realty components. Most units are furnished, and rent often includes utilities, premium cable television, high-speed internet and other amenities. As a result, the income stream is not exclusively attributable to the real estate, but to personal property, intangibles, and business value as well. Likewise, some developments have favorable contracts with the university whose students will be housed by the community. Such non-realty components are not taxable, and must be removed. Failing to cleanse the income stream solely to its realty component can result in an overstated, overtaxed property value.

Scrutinize comparable sales

In certain markets, evaluating the selling prices for other student housing communities may be a valid method of determining a property’s taxable market value, but assessors often misinterpret that sales data. Just as a property’s income stream reflects more than the value of the real estate, a sales price – usually based on the same income stream – may reflect more than the value of the realty alone.

The most relevant sales for comparison are those where the real estate transacts without any personal property, intangibles, or business value. Since such sales are rare, an assessor using the sales of nearby student housing communities must take care to remove the value of everything but the realty. This task, often overlooked by assessors, requires identifying and measuring hard-to-value assets with certainty.

Moreover, comparable sales have to be adjusted to account for differences between the sold property and the property being assessed. Three communities might all have the same number of beds, but one might have mostly one- and two-bedroom layouts, while another has more community amenities that appeal to a different mix of students. They may serve different schools with different demographics. If the differences between the properties affect their respective rents, then the sales prices should be adjusted accordingly so they best match the configuration of the subject property.

In the absence of sales of purpose-built student housing, some assessors might be tempted to use sales of other types of multifamily housing. Despite superficial similarities, the properties compete in different markets, which appear as structural differences between the properties. An assessor failing to account for such differences may be making a fundamental error.

Cashing in on unusual cases

As the student housing market grows and matures, a particular community may face other circumstances that require a closer look during tax season. For example, public-private partnerships (P3s) are becoming more common in the student housing marketplace. Whether a taxpayer enters a P3 for monetization, development, or operational purposes, the agreement’s characterization can have substantial property tax consequences. Parties to P3s should keep taxability in mind as they draft contracts.

Similarly, in some states dormitories are exempt from property tax because they are deemed educational property. This exemption has historically extended to dormitories owned and operated by colleges and universities. But some properties owned or managed by third parties may still qualify for exemptions because, for example, the school can be deemed the beneficial owner of the property. Of course, the inverse can also be true, so operators should be cautious when drafting contracts so as not to convert an exempt property into a taxable one.

As the student housing market continues to surge, assessors are eager to expand the local tax base by capturing a piece of that growth. But by focusing on the key distinctions of the student housing market, diligent owners can improve the profitability of existing properties and free capital for new investment.

 

 Ben Blair jpgBenjamin Blair is an attorney in the Indianapolis office of the international law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa 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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Aug
22

How to Fight Aggressive Property Tax Assessments

The student housing market is robust, generating strong market data that tax assessors are using to support increasingly aggressive property tax assessments. Thus, student housing owners must monitor their property values and arm themselves with the tools to fight excessive valuations.

Forecasters expect the student housing market to grow for the next several years, primarily because of its stability. Healthy investor interest led to a 71 percent year-over-year increase in student housing sales volume at the end of the third quarter of 2015, according to Real Capital Analytics. In addition, the market’s average overall cap rate was down 37 basis points from the first quarter of 2015 to the first quarter of 2016.

Combined with increased demand for beds that accompanies accelerating enrollment at the largest universities, these healthy fundamentals will encourage assessors to boost property tax assessments. In many cases, assessors will produce inflated valuations that cannot be supported by market data or realistic operating scenarios.

Student housing owners should consider the following issues to combat aggressive assessments:

Evaluate the approach

Assessors commonly derive a market value using one or more of the three classic approaches to value: cost, income or sales comparison.

The cost approach is arguably the least reliable method if the property is more than a few years old, especially given the difficulties of estimating depreciation and obsolescence factors for older properties. An assessor will most likely rely on an income and/or sales comparison approach when valuing student housing. Taxpayers can achieve lower assessments by disputing how the assessor has applied a valuation methodology to a specific property.

Challenge sales data

Assessors are using the sales comparison approach more frequently, given the huge sale volumes previously mentioned. Student housing owners should remind assessors that a sale price does not necessarily equate to market value.

While discussing comparable-sales data with the assessor, the taxpayer can sometimes discredit a sale’s relevance by outlining the physical and economic differences between the property sold and the assessed property. Point out to the assessor the factors influencing a buyer’s decision to purchase a property, which may make the sale incomparable to the taxpayer’s property.

Did the assessor reference any portfolio purchases in the sales comparison? Point out that properties in a portfolio are typically priced as a group, and may not reflect market value.

Finally, emphasize buyer motivations such as time constraints or income tax consequences that affected the price of the comparable property. Owners should consider a tax appeal even if the recent purchase price of their complex is higher than the current property tax assessment. Buyers pay for properties based on factors beyond real estate, so a purchase price should provide no more than a touchstone for an assessor.

Taxpayers should outline the factors they considered in purchasing the property, such as special financing considerations. Show how the property’s performance differs from projections made at the time of purchase.

Sharing the purchase price may lead to a higher assessment, but student housing owners can mitigate the amount of the increase with a meaningful purchase price discussion with the assessor.

Beware incompatible income comparisons

Properties built and/or operated specifically as student housing projects are often referred to as purpose-built properties. An alternative student housing solution in college areas is conventional, market-rate apartments, also known as student competitive apartments.

On the surface, purpose-built and student competitive projects are similar in use and function. When an assessor is using an income approach to value, however, the properties’ differences become significant.

Competitive properties usually include more studio and one- or two-bedroom apartments, while purpose-built properties have more three- and four-bedroom units. Competitive complexes rent by the apartment, while purpose-built properties rent by the bed. Rental rates and amenities also can differ dramatically between the two property types.

In an income approach, assessors typically use market-driven rent, vacancy, and expense factors to arrive at a net operating income figure that is then capitalized using a market-driven capitalization rate. The most common mistake assessors make using this approach is applying competitive market data in their analysis rather than purpose-built market factors.

Student housing owners should be quick to point out the differences between these two property types: For example, competitive apartments are valued per square foot, while purpose-built housing is valued by unit or bed.

Owners should emphasize occupancy fluctuation differences between competitive apartments and a purpose-built property, which may have low occupancy during the summer. Also point out the influence of the on-campus housing supply on the performance of an off-campus, purpose-built project.

Finally, be mindful of how a property’s distance from campus affects rental rates. There is typically a direct correlation between proximity to campus and higher rent levels, leasing velocity and occupancy for purpose-built properties. The correlation isn’t as strong at student competitive properties.

Even if an assessor is using appropriate data from comparable purpose-built properties, owners should challenge the market factors in the assessor’s analysis with data taken directly from the property’s current and previous year’s operating statements, if such data is in the property owner’s favor. An operating statement can help distinguish the owner’s property from projects that lead to higher assessments. Pointing out specific income and expense items can show trends in rental rates, occupancy and expenses that differ from the market trends alleged by the assessor.

Even in a strong market, student housing owners should constantly monitor their property tax assessments, and have the courage to combat assessments derived from sales or income data.

Davila Photo 3Gilbert Davila is a partner in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. Davila can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Oct
30

Six Ways to Reduce Student Housing Property Taxes

Advice on one of the biggest hurdles in acquiring -- and owning -- off-campus student housing properties.

Property taxes can have a huge impact on a student housing project's bottom line, and that expense is growing as assessors across the country aggressively increase valuations. Student housing owners should ask themselves the following questions as a part of any effort to combat excessive valuations.

1. Is My Property Data Correct?

Assessors' records commonly contain errors regarding a property's age, square footage, leasable area, number of units, number of beds, unit mix and amenities. An error can significantly increase a property's assessment.

Providing a current rent roll to the assessor can correct many of the above-referenced mistakes. Consider providing a property site plan and marketing materials that show the project's floor plans and amenities. Correcting basic errors in the assessor's records remains the simplest path to a lower tax assessment.

2. When Will My Property Be Re-Appraised?

Assessment schedules vary from state to state and sometimes county to county. Many jurisdictions appraise commercial property annually, while some opt for every three to five years. A handful of jurisdictions reevaluate a property's assessment only when the asset sells. Student housing owners should learn their jurisdictions' appraisal rules, since this can factor into a property tax appeal.

3. How Did The Assessor Arrive At My Valuation?

Assessors commonly derive market value using one or more of the three classic approaches: cost, income, or sales comparison. Cost is arguably the least reliable approach if the property is more than a few
years old, especially given the difficulties of estimating depreciation and obsolescence for older properties. In valuing student housing, an assessor will most likely rely on an income and/or sales comparison approach. Taxpayers have reduced assessments by disputing how the assessor applied a valuation methodology to a specific property.

4. How Did The Assessor Apply The Income Approach To Valuation?

In an income approach, assessors typically use market rent, vacancy and expense factors to arrive at an annual net operating income figure and then apply a market capitalization rate to calculate value. Often, the market factors used in the assessor's income approach reflect data taken from properties that are incomparable to the property being assessed.

The most common mistake assessors make when using the income approach for student housing is applying conventional apartment data in their analysis. Student housing owners should explain the differences between these two property types, especially when discussing values per square foot used in conventional apartments versus values per unit or bed in student housing. Also, owners should emphasize seasonal occupancy fluctuation differences between a student housing property, which often experiences low summer occupancy, and a conventional apartment project, in addition to the influence of on-campus housing supply on the performance of an oft-campus student housing project.

Even if an assessor is using student housing market factors in a valuation analysis, the owner should challenge the market factors with data taken directly from the property's current and previous year's operating statements, if such data is in the property owner's favor. Specific income and expense items can show trends in rental rates, occupancy and expenses that differ from the market
trends alleged by the assessor.

5. How Did The Assessor Apply The Sales Comparison Approach To Valuation?

Aggressive assessment increases often stem from an assessor's reliance on the recent sales prices of other student housing properties. A property owner can usually discredit so-called "comparable" sales by outlining the physical and economic differences between the properties sold and the assessed property.

Specifically, the owner can point out to the assessor that the factors influencing a buyer's decision to purchase a property cannot be known unless the assessor was a party to the transaction. For example, a purchaser may have obtained below-market-rate financing, or might have been motivated by time constraints or income tax consequences. Make sure that the assessor understands the meaning of comparability.

Many student housing owners worry that a recent purchase price will increase their property's assessment. Owners should consider a tax appeal even if the recent purchase price of their complex was higher than the taxable value of the property, however. Buyers analyze factors extending beyond real estate in determining what they can pay for properties. As a result, a purchase price should provide no more than a touchstone for an assessor.

Taxpayers arguing against the assessor's use of a purchase price as a value basis should outline for the assessor the considerations that affected the price, such as special financing. Also explain how the actual performance of the property differs from projections made at the time of purchase. A purchase price may lead to a higher assessment, but student housing owners can mitigate the increase through a discussion with the assessor.

6. Did The Assessor Consider Equality And Uniformity?

Most taxing jurisdictions require equal and uniform assessments among comparable properties. An equal and uniform argument is separate from a discussion about a property's market value. Assessors often value student housing projects without considering the assessment of like properties, which presents an additional opportunity to argue for a reduced assessment.

The assessment of a student housing property should fall within a uniform range of values for comparable properties. Student housing owners should compare their property's assessments to comparable properties on a per-unit or per-bed basis. Assessors often compare by square footage, which is inappropriate for student housing.

Another unit of comparison for student housing owners is to analyze the gross rent multiplier ratio between comparable properties. If an owner's property is assessed disproportionately higher than the comparable properties on an appropriate unit of comparison, the taxpayer can argue for a value reduction based on equality and uniformity, regardless of the assessor's market value claims.

Owners of student housing should consistently monitor their property tax assessments.

Asking the appropriate questions can lead to effective strategies to reduce taxable values.

DavilaPhoto
Gilbert Davila is a partner in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. Davila can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

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