When a property's current use isn't highest and best, New Jersey jurisdictions can assess and tax based on hypothetical redevelopment.

It's hard to imagine a more dystopian world than one in which governments base real estate tax upon a hypothetical use other than a property's current and actual use. Unfortunately, taxing jurisdictions in New Jersey are doing precisely that, attempting to sustain inflated property tax assessments based upon unrealized development potential.

In New Jersey, property taxation is based upon real estate's fair market value. In simple terms, fair market value is the most probable sale price that a property would fetch in an open market transaction between a willing buyer and a willing seller. But simple terms, in commercial property valuation, can be misleading.

Taxable property value should reflect the bricks and sticks of real estate. The reality is that the purchase price for an income-producing property often includes consideration for more than bricks and sticks.

Untangling a Bundle of Sticks

When income-producing properties trade, the real estate is often encumbered by leasehold interests, service contracts, management agreements, personal property and other intangible business assets. These non-real-estate components affect value for buyers and sellers, but that value is not subject to property tax. To correctly isolate the taxable property value portion of a transaction price, assessors must identify and exclude consideration paid for non-taxable intangibles.

Allocating the purchase price paid to these various interests can prove challenging, especially when the transacted property is going to be redeveloped and the sale is made subject to approvals and permitting. A change to more favorable zoning can drastically affect overall market value and shift the values a potential buyer would ascribe to a property's various tangible and intangible components.

It's exceedingly difficult to assign a monetary value to redevelopment approvals in New Jersey, as the process can be long, arduous and incredibly complex. After an applicant's initial presentation to request general development plan approval from the zoning and planning boards, the time required to put shovels in the ground varies wildly from town to town and is contingent upon the scope, scale and nature of the redevelopment.

Just as it's difficult for buyers and sellers to assign value to the approval process, taxing authorities face similar challenges trying to come up with fair and reasonable tax assessments for properties that are in redevelopment limbo. In valuing the real estate, they must also value the redevelopment prospects woven into the selling price like extra branches intertwined in the property's bricks and sticks.

Analyzing Highest, Best Use

Ascertaining true fair market value often requires a highest-and-best-use analysis. New Jersey jurisdictions task municipal tax assessors with assessing real estate in a manner that reflects its true fair market value at its highest and best use. This requires the sequential consideration of all possible uses for the real estate that are legally permissible, physically possible, financially feasible and maximally productive.

But just as fair market value is in a constant state of flux, so too is highest and best use a fluid concept. Changes in market conditions, economic climate, consumer trends and even local politics can impact highest and best use. Some property owners actively seek redevelopment approvals to maximize their real estate's value, but other properties sit unused or underutilized until a buyer acquires the asset for redevelopment.

Valuing Redevelopments

A fact pattern that plays out regularly in the Garden State is that a redeveloper acquires a piece of underutilized real estate for redevelopment. The "as is" purchase price is severely discounted due to the lack of market demand for the property's current use and configuration. The redeveloper is also investing time, money, and risk in applying for rezoning and redevelopment approvals.

The redeveloper invariably wants to file a property tax appeal seeking an assessment reduction based upon the discounted purchase price and the lack of market demand for the property in its current condition. But taxing jurisdictions are not so quick to concede massive tax assessment reductions under this scenario.

New Jersey caselaw enables taxing jurisdictions to argue that where there is a reasonable probability of securing a zoning change for the redevelopment, the municipal tax assessor can value the subject property under an alternative highest-and-best-use theory. In other words, if the redevelopment is imminent or a foregone conclusion, the taxing authorities can attempt to value and tax the property as if those approvals were already in place.

Reasonable Expectation

Fortunately, the courts give municipalities a relatively high bar and difficult burden of proof to sustain property valuations based upon an alternative highest and best use and the reasonable probability of securing a zoning change. The caselaw is careful to distinguish reasonably probable use cases from those that are only remotely possible, aiming to deter unbridled speculation and pie-in-the-sky redevelopment scenarios that would yield unrealistic property valuations.

Notably, the Tax Court of New Jersey has identified specific factors that impact the probability of securing a zoning change for a redevelopment. Those include: emergent trends in land use and development; market interest in the development or redevelopment of the subject property or similarly situated properties; complexity and likelihood of success in securing approvals from local zoning and planning authorities; community support for the potential redevelopment activity; regulatory restrictions at the property; and timing of approvals.

Before pursuing a property tax appeal, property owners should be mindful of highest and best use. Just as redevelopers see an opportunity to revitalize or repurpose an income-producing property, taxing jurisdictions may see an opportunity to bolster tax rolls by reassessing an underutilized asset with redevelopment potential. Understanding the legal and practical implications associated with alternative highest-and-best analysis is critical to navigating disputes and ensuring accurate valuations.