Ancillary services have become a crucial revenue generator in student housing and can help owners improve occupancy, justify higher rents and increase tenant satisfaction. In an industry that often correlates income with market value, however, it is critical to distinguish ancillary service revenue from real estate value and property tax liability.

Failure to properly distinguish between real estate and intangible business assets can lead to unfair valuations and excessive property tax bills. Simply put, real estate is land and improvements to that land, such as buildings. Intangible assets, as the term suggests, cannot be held or touched. Examples include business service operations and partnership contracts with third parties.

To help taxpayers recognize the intangible components of their private, off-campus student housing operations, we will review some of the most popular services that owners are using to boost revenue today. Then we will explore strategies for managing valuation and tax implications of these non-real-estate income streams.

Selling premium amenities and convenience

Owners and operators working to improve the financial performance of their off-campus properties know that increased rents and occupancy are not the only ways to drive revenue. By adapting to student renters' changing wants and needs, providers are turning ancillary services into significant revenue producers.

Here are a few of the key services at many properties today:

High-speed internet. Working with a provider to offer broadband internet connectivity as a premium feature can generate hundreds of dollars per unit annually for a student housing operator.

Fitness centers. Property managers know that offering tenants access to an on-site or nearby fitness center can justify increased rental rates. Some properties partner with a local fitness center to ensure access for their residents or to provide on-site programming such as yoga classes.

On-site laundry services. This revenue generator is a no-brainer, which is why landlords for decades have offered access to coin-operated washers and dryers. On-site laundry facilities at a 100-unit apartment building can easily generate $10,000 annually. With student housing's higher density, operators have the potential for more substantial revenue. Owners without laundry facilities may be able to partner with a nearby laundry or dry cleaner to offer these services.

Movers. When a new tenant signs a lease agreement, some student housing managers provide the new resident with an email link or advertising material from a local moving company offering moving kits, boxes, packaging tape or services. The referral agreement behind this relationship is yet another potential income producer for the landlord.

Advertising. Student housing managers often sell advertising to local businesses. Restaurants, retailers and service providers may buy ad space in tenant emails or plaster vinyl ads on the outside of the property's elevator doors. Partnerships with area restaurants or other businesses may also bring in referral fees or commissions.

Housekeeping: Many student housing owners have taken a page from assisted living operators' book by offering cleaning service options to their residents.

Separate ancillary revenue from real estate value

It is crucial for off-campus housing providers to differentiate ancillary services revenue from the real estate value of the property and to ensure the local tax assessor recognizes this distinction when valuing their property for taxation. This is important because ancillary service revenues represent money derived from intangible business assets rather than from the real estate.

The owner of a student housing property with ancillary revenue streams should track this income specifically and separately in record keeping. Resist the temptation to throw specific ancillary income into a catchall "other income" line item on the property's income and expense spreadsheet.

When student housing properties trade hands based, in part, on revenue attributable to ancillary services, their improved economic performance generates higher sale prices than do properties under less creative management. Over and above the total sale prices reported to the public, were an assessor or appraiser to include revenue from ancillary services in property valuations, it would lead to inflated assessments.

Accurate assessments should reflect only the real estate value excluding business income. And properties with extensive ancillary services might appear more valuable compared to those without, even if the actual real estate is comparable.

Owners and managers of private, off-campus student housing can help to ensure fair property valuations and tax liability by conducting annual reviews.

Regular and careful reviews of assessments can identify and help correct any discrepancies, saving the property owner money in reduced tax bills. If a property is over-assessed, consider challenging that assessment. Each jurisdiction presents unique rules, laws and challenges requiring careful and informed decision making, Taxpayers often find it helpful to consult an experienced, local property tax professional before deciding whether to begin a valuation challenge.

Not long ago, assessors' student housing properties valuations generally struggled keeping pace with the rising market.College enrollment was high, rent growth outpaced expenses and student expectations lined up with most newer facility amenities. However, the COVID-19 pandemic and its fallout changed the game.

Property taxes are often the single highest expense on a property's profit and loss statement. When market changes make student housing less profitable, the tax burden should not be allowed to remain high. When this occurs, the assessor's property valuation needs to be challenged and reduced.

Projecting Income:Look Forward, Not Back

Many jurisdictions assess student housing properties' value using a cost approach.A computer system estimates the cost to build the property new, then deducts physical depreciation based on the property's age. Due to skyrocketing construction costs, those depreciation deductions are outpaced by base cost increases. It is common to see cost-based values increase despite struggles facing the real estate market. Owners can combat increases by appealing the assessor's value.

When a student housing property owner files an assessment appeal, the appeal review board often evaluates the three prior years' operating income. This allows the appeal board to develop an income model intended to represent stabilized operations. Then the net income is capitalized, producing an estimated market value. When the market rises and rent increases, looking at the past three year's performance is probably a favorable method for taxpayers. However, in a flat or falling market, determining value based on past success proves unfair. Property values' steady upward trajectory, by and large, has stalled out given the gut-punch of 2022 interest rate hikes. Capitalization rates have risen along with the interest rates, though it becomes difficult to see clearly because sales transaction volume slowed to a trickle. Sellers would rather sit on their property than swallow the loss the current market forced on them.

For student housing specifically, it is not uncommon for brokers to cite 15% to 20% market value declines from early 2022 to early 2023. In addition to general market woes, some developers expect college enrollment to drop in the near future due, in part, to fewer students graduating from high school.This will make leasing more difficult and put downward pressure on rents and occupancy. Falling rental income should be taken into consideration by the board or tribunal hearing a property tax appeal.

Projecting Expenses: The Compounding Costs of COVID

Waves of new development during the late 1990's and mid-2010's saw student housing units grow exponentially.At the time, they were state-of-the-art facilities with all the amenities a student could desire. For some, common areas evolved from utilitarian waiting rooms to shared workspaces or workout gyms.For others, bathrooms were no longer shared with a full suite, but only a single roommate.

When the property's design fails to meet changing tenant expectations, that produces functional obsolescence. Many boom-time properties now suffer functional obsolescence.Worrisome trends that predated COVID-19 have been fast-tracked by the pandemic, becoming major problems.

Most people, including future college students, were quarantined for months and developed new tastes and behaviors. Student tenants are not as tolerant of sharing a bathroom with a roommate. One-to-one bathrooms are no longer a luxury in most markets, but trying to retro-fit a property to achieve the best bed-to-bath ratio often fails the cost-benefit analysis. When a design deficiency can't feasibly be corrected, it is known as incurable functional obsolescence.

Online shopping became a near-necessity during quarantine, reshaping our consumer habits long-term. When a building full of button-clicking students receives more Amazon boxes than envelopes, there better be package lockers or another delivery management system to handle the volume. Maybe some unutilized common area space presents an easy opportunity to convert, making this type of obsolescence curable. Even so, the cure does not come without landlord expense.

Not all new expenses involve obsolete building design. New cleaning protocols originated during the pandemic but have not receded with the COVID case count. The "janitorial" line item has swollen, further narrowing landlord margins.

Even if the building is clean, it may not be tidy. Kids who were forced to stay home for meals tend not to go out as frequently. They order-in, and they party-in, too. That creates a lot of trash. Kids do not appreciate having to haul trash down a flight of stairs or ride with it down an elevator. Trash chutes appease them, but not if the building doesn't have one.

Rising operating costs are not all associated with COVID. For example, HVAC systems that use a coolant being phased out by new regulations will have to be upgraded to comply. Also, insurance, payroll, and other outside service costs have increased with general inflation.

Increasing operating expenses drive down a property's net income and should be accounted for by tax appeal decision-makers.

Question the Assessor's Valuation

When property owners appeal their assessment based on a drop in income, "bad management" becomes the common refrain heard from assessors. This implies the property is worth more than the income indicates, because it has been poorly operated. Sometimes this is true, but if a property suffers lackluster performance caused by unavoidable market changes, the assessment should account for that. Taxpayers would be wise to seek seasoned property tax counsel for advice as to what relief may be available.

​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.