Commercial property owners may still reduce taxes based on COVID-era interest rate cuts, but that window may be closing.

The Federal Reserve finally delivered a much-needed reprieve for investors by lowering the federal funds rate by 0.5% on Sept. 5. This reduction is especially welcome after an extended period of rapid interest rate hikes. For commercial property owners, however, a window may be closing on the opportunity to reduce property tax assessments based on the low interest rates that reigned during the COVID-19 pandemic.

Mortgage rates have eased slightly this year from a peak in October 2023. The average 30-year mortgage rate reached a 23-year high of 7.79% the week ending Oct. 26, 2023, marking the end of its climb from a staggering historical low of 2.66% in December 2020, according to the Freddie Mac Primary Mortgage Market Survey.

This striking contrast is crucial for commercial property owners, particularly those who bought their properties between early 2020 and the summer of 2022. That's when historically low interest rates had the 30-year mortgage rate bouncing along as low as 2.10%.

An investor who purchased commercial real estate in this timeframe may still be enjoying a favorable mortgage rate locked with their acquisition. By the same token, the property tax assessment on that transaction might still reflect an inflated purchase price from those years, owing to the effect that ultra-low-cost debt was having on market pricing at the time.

Today, taxpayers in this position may be able to argue that current market conditions no longer support that valuation, providing an opportunity for an assessment reduction and tax savings.

Learn the law on assessments

A taxpayer deciding whether to appeal their assessment should begin with an understanding of the objectives and legalities governing the assessor's actions. Most jurisdictions assess property based on a percentage of its fair market value at a specific date, often Jan. 1 of the tax year.

Assessors frequently rely on market sales data to estimate value, giving significant weight to recent sales involving the subject property. But the sharp change in interest rates, coupled with stricter lending standards, recently has led to a significant slowdown in commercial real estate transactions.

Because the assessor relies on sales data, this lag in transaction activity means they may not fully capture the impact of today's financial environment on current pricing and property values. For taxpayers, this presents an exciting opportunity to argue for reduced assessments.

To successfully claim a reduction, it is critical for the taxpayer to understand how the assessor valued their property and how current market conditions differ from those at the time of acquisition. For instance, if the property is being taxed based on transaction values from 2020-2022, the taxpayer could reasonably argue that its worth has since decreased due to inflation, the rise in interest rates, and tightened lending standards.

In preparing arguments for a reduced assessment, the property owner should be ready to show how conditions and trends that drive commercial real estate value support their call for a lower valuation. Several key factors are weighing down real estate values today, including rising interest rates, inflation, elevated operational costs, and anemic rent growth.

Vacancy rates remain high across many commercial sectors and rent growth has slowed. Lenders are adhering to strict terms on allowable loan-to-value ratios, reserves and other requirements, even after the Federal Reserve's recent rate cut. The Federal Reserve's July 2024 Senior Loan Officer Opinion Survey reflects that tighter lending standards and limited demand for commercial real estate loans are still in effect.

Commercial property prices fell by 7% over the past year and are down 21% since March 2022, according to Green Street's Commercial Property Price Index. Taxpayers can leverage this valuation decline when seeking a property tax assessment reduction.

Show effects of change

When meeting with the assessor or tax review panel, demonstrate the property's decreased value by comparing the lending environment and market conditions from the time of purchase with those at the most recent assessment date. Additionally, present any other salient factors, like the inflationary pressure on insurance, maintenance, and operational costs. While rents may have risen, assess whether that increase is sustainable or inflated considering today's higher tenant improvement costs.

Taxpayers should decide whether they need third-party experts to support their case. An experienced appraiser can provide an objective valuation and serve as an expert witness if necessary.

Even taxpayers who believe they have a good grasp of their property's worth can benefit from the advice of a recognized third-party expert, who can strengthen their case by explaining and substantiating the data to the assessor. An appraiser who is educated about the local submarket and who can convey that knowledge in a format this is easily digestible will likely raise the chances of success.

The window is closing

This opportunity will not last long. The further removed the assessment year is from the low-interest-rate period associated with the property's inflated assessment, the less relevant those conditions will be in seeking and supporting a property tax reduction. Moreover, the longer a property's assessed value remains unchanged, the harder it becomes to argue for a reduction.

Taxpayers can increase their chances of success by working with knowledgeable local appraisers and advisers familiar with property tax law in the subject property's jurisdiction. Preparing for a possible trial will often lead to a favorable settlement before reaching that stage.

Taxpayers should seize this chance now to secure the tax savings they deserve, before the opportunity is gone.

Highest and best use analysis can be a key to reduced property tax valuations, observes Timothy A. Rye of Larkin Hoffman.

Ad valorem property taxes reflect real estate value, and in most states, assessors value a subject property at market value based on its highest and best use. Although assessors often assume the current use is highest and best, taxpayers who analyze their property's usage may discover an opportunity to reduce their assessment by showing its optimal use has changed.

What is highest and best use?

Highest and best use is the "reasonably probable use of property that results in the highest value," according to the Dictionary of Real Estate Appraisal, 6th Edition. Along with that definition the publication includes four criteria the highest and best use must meet, requiring that the use be legally permissible, physically possible, financially feasible, and maximally productive.

For property tax valuation, assessors, appraisers and property tax attorneys need to consider each factor in a highest-and-best-use analysis. For most properties, determining whether the current use is legally permissible or physically possible is easily ascertained by answering the question, "Can the property do what it is doing?"

Determining whether a use is financially feasible or maximally productive is trickier. Financial feasibility of the current use may be as simple as identifying whether the property generates a positive net operating income, or if it would be cost prohibitive for the user to replace the space with an alternative property.

The analysis gets more complicated when trying to determine whether the use is maximally productive.

Take the example of an aging office building with declining occupancy. Should the owner invest money in building improvements with the goal of attracting more tenants, or is it better to vacate the building and convert it to multifamily use?

In this example, the first option would require a discounted cash flow analysis that considers an extended period of renovations, tenant improvements, vacancy loss during lease-up, and leasing commissions. In other words, the building would be valued as though it were stabilized at some point in the future, the costs associated with achieving stabilization would be deducted, and the future value and investment costs would be present valued to the valuation date.

Alternatively, the property could be valued like a new development with the projected use as multifamily. Whichever use has a greater value in today's dollars is the winner, or maximally productive use, and therefore the highest and best use.

The tipping point

When does a property's current use stop being its highest and best use? It could be when new development is in high demand and buyers will pay more for the land alone than they will for the property with existing structures.

It could be when the property is losing tenants and accumulating significant vacancy. The market sees the building as less appealing, and the remaining tenants start looking for more vibrant properties. Or it could be when the building is simply worn out and the cost to fix or restore it is greater than its value would be after repairs.

Every property will have its own unique set of circumstances to signal the practical end of its current use, but once a usage starts to tip, it seldom comes back. When the tipping point arrives, the highest and best use changes, and can have a profound impact on valuation.

Usage drives taxable valuation

When a property's current use is no longer highest and best, the property tax valuation likely should change too. While property tax assessments are generally based on the highest and best use, the mass appraisal techniques assessors employ to value properties are unlikely to incorporate highest and best use changes. The volume of properties assessors must value is simply too large to include individual highest and best use analyses.

As a result, it is up to taxpayers and their property tax counsel to identify when the highest and best use has changed and bring it to the assessor's attention, either informally or through a property tax appeal. In preparing arguments for such a meeting, remember that valuations based on highest and best use require data reflecting the highest and best use.

For example, if an office building is no longer viable as an office, but rather its highest and best use is conversion for multifamily residences, then the comparable sales should comprise sales of buildings that are also facing a change to multifamily. Using sales of stabilized office buildings as comparable sales would result in improper valuation of the subject property hypothetically stabilized with office tenants, rather than pursuant to its actual highest and best use.

Commercial real estate markets are experiencing significant changes, straining many property operations and owner cash flows. As a result, it is critical to carefully analyze highest and best use when reviewing property tax assessments.

Justices recognize owner rights extend to surplus proceeds from properties sold after tax sales.

Federal courts rarely adjudicate property tax matters, which have traditionally been the province of state courts. In May 2023, however, the U. S. Supreme Court issued a unanimous decision in a case that squared state property tax law up against the Fifth Amendment takings clause, which prohibits taking private property for public use without just compensation.

Taken for taxes

The events leading to Tyler vs. Hennepin County, began in 1999, when Geraldine Tyler purchased a Minneapolis condominium that she occupied until she moved into a seniors housing community in 2010. Ms. Tyler retained ownership of the condominium but failed to pay property taxes on it for several years, resulting in approximately $2,300 in unpaid taxes and $13,000 in interest and penalties.

Acting in accordance with Minnesota tax forfeiture procedures, Hennepin County seized the condominium and sold it for $40,000. This extinguished Ms. Tyler's $15,000 tax debt, and Hennepin County kept the remaining $25,000.

Minnesota's tax forfeiture procedure required the county to give the delinquent taxpayer adequate notice of the tax sale; notably, the procedure lacked a mechanism for a delinquent taxpayer to assert a claim to any sale proceeds remaining after paying off the tax debt.

Ms. Tyler brought a putative class action suit against Hennepin County in Minnesota federal court alleging that Hennepin County's retention of $25,000 in excess proceeds from the sale of her condominium was a taking of property without just compensation, and therefore an unconstitutional violation of the takings clause. The lower courts rejected her claims, and the case made its way to the U.S. Supreme Court.

The Supreme Court first noted that the takings clause does not itself define private property which, if taken by a state, requires compensation. The Court then conducted a thorough analysis of historical practice and traditional property law principles to determine that the surplus value remaining after a forfeiture sale constituted compensable property under the takings clause.

The Court concluded that the right to surplus proceeds is simply an extension of the corresponding interest in the underlying property. Thus, the Court recognized that a taxpayer's compensable interest in property applies to the underlying property itself and to equity in that underlying property in the form of excess proceeds generated from a forfeiture sale of that property.

Accordingly, while Hennepin County had the power to sell Ms. Tyler's home to recover the unpaid property taxes, it could not use the tax debt "as a toehold" to confiscate more property than was due, the Court stated. Doing so effected a "classic taking in which the government directly appropriates private property for its own use," such that Ms. Tyler was entitled to just compensation from Hennepin County.

Mechanisms mandate?

Unfortunately, the Supreme Court's recognizing a property right in surplus proceeds does not mean that states must now automatically return surplus proceeds to delinquent taxpayers. Nor does it directly address how states should administer their tax forfeiture sales to prevent infringing on taxpayers' constitutional rights.

But the Court did give some guidance in Tyler as to what statutory measures might prevent a takings clause violation. The Court cited Nelson vs. City of New York, decided in 1956, in which the city foreclosed on properties for unpaid water bills. Under the applicable ordinance, the aggrieved property owners had an opportunity to request the surplus from any sale by filing a timely answer in the foreclosure proceedings asserting that the properties had a value exceeding the amount due.

The property owners failed to do so, however. The Supreme Court held that, because the owners did not take advantage of this procedure, they forfeited their right to the surplus. Because the ordinance did not absolutely preclude an owner from obtaining the proceeds from a judicial sale but simply defined the process through which an owner could claim the surplus, there was no takings clause violation.

States are already reacting to the Tyler decision. In New Jersey and Virginia, courts have struck down state court tax sale procedures as unconstitutional under Tyler. Nebraska has amended its tax sale statutes to conform with Tyler.

Louisiana is following suit: Under current law, a tax sale grants the purchaser a prospective ownership interest in the form of a tax lien. This lien represents a claim on the property but does not confer immediate ownership rights. The purchaser can acquire full ownership after the redemption period has passed.

After Tyler, the Louisiana Legislature proposed amending the state's constitution to require adding to the state's tax sale procedures a process for delinquent taxpayers to claim any excess proceeds from a tax sale. The measure must be approved by the electorate and is on the December ballot for voter consideration.

Chief Justice John Roberts noted in Tyler that a taxpayer must render unto Caesar what is Caesar's, but no more. While states are conforming their laws to Tyler, taxpayers and aggrieved property owners must still comply with governing statutory procedures to claim their surplus and prevent Caesar from getting more than he is entitled to.

Lawmakers have the opportunity to transform onerous tax mechanisms into programs that boost affordable housing development.

Together with high rent and exorbitant property values, the real property taxes that fund necessary services in New York State make housing affordability a significant concern for low- and middle-income residents. To ensure a sufficient supply of affordable housing, the state must address the ad valorem levy, whereby taxes derive from a property's market value.

This article examines the critical interplay between New York's property tax policies and housing affordability. While some taxing mechanisms hinder the development and availability of affordable housing, adjustments and a few additions to those practices have the potential to promote the affordable sector.

Exemptions, Incentives

New York's real property tax system supports a complex framework of entities that rely significantly upon property tax levies to generate revenue and fund their budgets. Property taxes, assessed at the local level, support essential services such as public schools, police, libraries, highway departments, fire districts, open space preservation, out-of-county college tuition and the New York State Metropolitan Transportation Authority, among others.

To encourage the development of affordable housing and ease the burden that real property taxes can impose on developers and owners in the sector, New York offers several tax exemptions and incentive programs. Availability and benefits for some of the programs vary depending on a project's location.

One such option for developers is the 421-a Tax Incentive Program, also known as the Affordable New York Housing Program. Aimed at developers of new-construction multiunit housing, the program can provide full property tax exemptions during construction, followed by a graduated phase-in to normal taxation once the project is completed. In exchange, applicants must reserve a portion of the units to rent at affordable rates.

Another option, originally enacted by the federal Tax Reform Act of 1986, is the Low-Income Housing Tax Credit Program. This gives state and local agencies the authority to issue tax credits for the acquisition, rehabilitation, or new construction of rental housing targeted to lower-income households. Developers receiving these credits can then sell them to investors, generating equity for the project and reducing their need for debt financing. While this may not be a direct property tax exemption, it can significantly promote the financial feasibility of affordable housing developments.

A third initiative was created by The Housing Trust Fund Corp. as a subsidiary public benefit corporation of the New York State Housing Finance Agency. It provides funding to eligible applicants to construct low-income housing or to rehabilitate vacant, distressed, or underutilized residential or non-residential property to residential use for occupancy by low-income individuals. These funds often come with property tax exemptions or abatements, reducing operating costs for affordable housing providers.

In addition to these broad exemptions, individual homeowners may qualify to ease high property tax costs via incentives such as the School Tax Relief Exemption or exemptions for senior citizens, veterans, people with disabilities, clergy, and certain agricultural properties, among others. A property tax professional can help developers or homeowners determine what programs are available to reduce the tax burden for their property.

Challenges, Criticisms

Despite the evident benefits these programs bring to communities, critics argue that property tax exemptions can create inequities in the tax system. Large developers might benefit disproportionately from programs like 421-a, for example, while smaller property owners bear a more significant tax burden. Additionally, critics argue that tax-abatement-based programs fail to address other challenges that impede the creation of new affordable housing. Affluent neighborhoods, for instance, often resist new affordable housing projects, thwarting development efforts and perpetuating socioeconomic divides.

Administering property tax exemptions and deciphering potential incentives can be complex and burdensome. Developers must navigate convoluted application processes and compliance requirements, which can delay projects and increase costs. Local governments also face challenges in ensuring proper implementation and monitoring of these programs. Real or perceived complexities associated with application processes for permitting, financing and incentives often constitute a barrier in themselves, discouraging developers from undertaking new affordable housing projects.

Ongoing underserved renter demand for affordable housing suggests the current assortment of incentives is failing to achieve the desired outcome, which is to ensure an adequate supply of affordable housing. Rising construction costs, limited availability of suitable land, and community opposition exacerbate this imbalance, resulting in a persistent gap between the number of affordable units needed and those available.

A Call to Action

New York lawmakers have the opportunity to boost affordable housing efforts by enhancing the effectiveness of property tax policies that promote the sector. Simplifying the application and compliance processes for tax incentives would be a significant first step that would encourage more developers to participate.

Following on the theme of simplification, the state should consider creating a centralized information hub with dedicated support for all development incentives. This would give developers a single resource to help them navigate the bureaucratic landscape and complete new affordable projects successfully.

Answering the call for more affordable housing will require more than tax abatements, however. Leaders must find ways to increase funding for affordable housing programs. Additionally, offering low-interest loans, grants, and technical assistance to non-profit developers would enhance their capacity to deliver affordable units.

New York State's real property tax system plays a crucial role in shaping the affordable housing landscape. While current tax exemptions and incentive programs provide some essential support, challenges remain in achieving equity, efficiency, and adequate supply. By refining these policies and addressing systemic issues, New York should be able to make significant strides toward ensuring that affordable housing is accessible to all its residents.

Taxpayers transforming office buildings into living space can argue for a lower property tax assessment.

The conversion of obsolete office buildings to new uses is a growing trend in many markets, especially in dense urban centers. Unfortunately, properties under reconstruction can continue to incur hefty property tax bills, even when the asset lacks a rent stream to help offset the owner's costs.

The right arguments can help these taxpayers reduce their property tax liability during a building conversion, however, and set the stage for an accurate, fair assessment of the asset's adjusted market value under its new use. The taxpayer's challenge is to understand how reconstruction affects market value and to show assessors how those forces affect taxable value.

Obsolescence and opportunity

Demand for office space was already faltering when the COVID-19 pandemic accelerated occupancy declines. Since then, remote work and space sharing among office workers has further reduced the amount of offices companies need, with many tenants returning space to property owners as leases mature.

Normally, appraisers value multitenant office buildings under an income approach, attributing rental income per square foot as a starting point for valuation. When the space loses market viability, the per-square-foot rent variable declines and lowers the net valuation for tax purposes.

Expanding this result over an entire central business district can erode the tax base significantly as older buildings lose value. Many older properties struggle to compete with newer spaces, in addition to suffering from declining post-pandemic user demand. In essence, the older office towers were hampered by economic obsolescence.

Downtown office vacancy rates now exceed 25 percent in many major cities, dealing a significant blow to market value and, subsequently, tax value. Obviously, owners and city government share a common goal of maximizing property usage, which increases revenue to the owner and tax value to the government.

One solution gaining traction in markets with strong residential demand is converting obsolete office buildings to residential apartments or condominiums. This is a multistep process that can take considerable time, possibly spanning one or more tax years.

Investments in time

The first task in a conversion is to empty the building, an often protracted process that simultaneously reduces the property's income and market value. Waiting for each lease to expire while revenue streams decline can be an expensive exercise. Taxpayers should ensure that the assessor has factored in this negative movement in the building's value under the income approach. When few tenants remain, the owner may choose to buy out the remaining leases.

Reconstruction begins with demolishing building components that will not fit the future use. For example, suspended ceilings commonly used in office buildings are unsuitable for living spaces and would need to be removed.

While this phase can start before the building is completely empty, it cannot be finished until the building is unoccupied. During this period, the income generated is virtually zero and has a continued negative effect on the building's market value and taxable value.

The project design will be partly determined by the local apartment market. Creating a product that will compete successfully for tenants has a direct impact on cost, finish work and amenity choices. During this stage, the owner is incurring costs without generating income from the property.

Because the building is as an empty space during conversion, income-based valuation methods no longer apply. Appropriate value would be that of an old, empty building that is economically obsolescent. Further, the value would be lower than when the building still had office tenants.

New beginnings

The building owner can begin to attract potential residents during the conversion. While tenants may sign leases, they will not be paying rent until the building has received a certificate of occupancy from local government.

This marketing period is an extension of the construction phase that could bring the start of a residential rent stream closer by having tenants lined up. This gives the owner a vision of future value and may also allow a return to the income approach to valuation by more clearly defining the property's function.

Once the property is available for residential use, a different revenue stream will begin and grow as tenants lease the units. Clearly, taxpayers should make sure assessors apply the income approach as the building moves toward full occupancy. Residential units typically generate lower rent per square foot than office properties, but healthy occupancy will more than make up for the slight reduction from the asking rental rate on an obsolete office building in a declining market.

Usage conversion is a long and meandering trail that a property owner must travel before a new use can begin to generate revenue and a return on investment. By protesting tax assessments that fail to reflect the asset's diminished value during this process, taxpayers can at least defend against an unfair tax burden.

The steps outlined here for transitioning from office to residential space have many moving parts and presuppose the owner has identified residential demand to support the new use. Many urban cores have experienced an uptick in urban living, however, and with the right circumstances, many old buildings can be converted for increased use. Consequently, while the process is time consuming, the net result may prove invaluable to the owner and taxing authority.

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.

Outdated valuations create risk of assessment increases under Shelby County's 2025 reappraisal.

In late 1811 and early 1812, West Tennessee's New Madrid Fault produced several earthquakes greater than magnitude 7.0, swallowing the town of Little Prairie, Missouri, in liquefaction and temporarily reversing the flow of the Mississippi River to crest its banks and create Reelfoot Lake.

Almost 200 years later, pseudo-scientist Iben Browning infamously sparked an earthquake frenzy by predicting another major New Madrid quake would occur on Dec. 3, 1990. School children of the 1990's likely still remember earthquake drills in the classroom and "earthquake kits" (trash cans filled with food, water and medical supplies) assembled and stored in basements and garages for years after.

Fortunately, Browning's prognostication was a dud and nothing happened. Still, those living above the New Madrid Fault today know in the back of their minds that "The Big One" could hit at any time.

For taxpayers, that time may be 2025, when Shelby County Assessor Melvin Burgess will reappraise properties countywide to 100 percent of fair market value for the first time since 2021. It may not shake buildings to the ground or flood low-lying areas, but the 2025 reappraisal could do grievous damage to unprepared taxpayers.

Market heat builds pressure

During the Shelby County reappraisal in 2021, the market was recovering from the 2020 slow-down in lending and sales transactions due to COVID-19. The assessor seemed to take the pandemic into account, refraining from aggressively capturing all of the market's growth from 2017 to 2019.

Low interest rates helped transaction volume accelerate in 2021 and the first half of 2022, however, quickly putting distance between the assessor's mercifully low appraisals and actual market value. The real estate market cooled after interest rate hikes in late 2022, but the value differential was already significant. A sales ratio study by the Tennessee Division of Property Assessments indicated the overall level of assessor's value in Shelby County was 75.87 percent of actual market value by Jan. 1, 2023. That ratio could be even lower for individual properties.

Shelby County's 2025 reappraisal program will aim to eliminate such undervaluations. The bigger the current undervaluation, the bigger the taxpayer's potential increase next year.

This is a major flaw in long reappraisal cycles: Undervaluations expand over the course of the cycle like geothermal pressure until the difference suddenly, and sometimes catastrophically, vaporizes in a single year with a massive increase in assessed value.

These delayed assessment adjustments and resulting tax increases make budgeting more difficult than would more frequent but less dramatic reappraisals. The Tennessee Legislature has been considering shorter reappraisal cycles, but none of the proposals have passed both houses yet.

Bad timing for a big setback

Property tax increases are never convenient, but 2025 could be especially poor timing. If interest rates stay relatively high and operating expenses keep rising, tax increases may arrive when there is no room to accommodate them in over-stressed taxpayer budgets.

Even in 2024, a non-reappraisal year, the mayor of Memphis has proposed a monstrous tax rate increase for properties inside the city. It is doubtful the city will raise rates as much as the mayor wants, but a 2024 increase in city taxes before the assessor's 2025 reappraisal could create back-to-back blows that are hard to absorb.

Preparing for "The Big One"

Hiding under a desk or filling a trash can with supplies will not stop a major assessment increase in 2025, but there are other ways to prepare.

1. Understand the timeline. The assessor will formally certify 2025 values by April 20, 2025, but value-change notices are expected around mid-March or early April. Appeals must be filed to the Shelby County Board of Equalization, with a likely deadline of June 30. The city of Memphis sends tax bills around July that are due by the end of August. Shelby County taxes are due by the end of the following February.

2. Anticipate the increase. Don't be caught off guard by a higher tax bill. It is important to estimate the assessor's reappraisal value and develop a realistic 2025 property tax budget. If the assessor's new value is unreasonably high, it can be challenged through a timely appeal to the Shelby County Board of Equalization. Some amount of increase is likely to be fair and supportable, however, so adjusting tax escrows in advance would be prudent.

Property tax professionals can help

Preparing for the 2025 reappraisal needn't be a daunting process. A property tax professional can provide a tax estimate in preparation for the 2025 reappraisal, and if the assessor's new value is too high, file an appeal.

Taxpayers preparing for The Big One to rattle their real estate would be well served to consult a property tax professional in advance. An experienced advisor can help identify the fault lines of undervaluation and brace-up vulnerable budgets before the reappraisal strikes.

To tax assessors, an investor's single-family, build-to-rent neighborhood is a cluster of separately valued properties.

Multifamily investors are accustomed to paying property taxes based on an assessor's opinion of their asset's income-based market value. But for the growing number of developers and investors assembling communities of single-family homes and townhomes for rent, tax assessment is more complex and potentially troublesome.

The difficulty for these taxpayers is that most assessors shun the income approach to valuing single-family rental properties. In the following paragraphs, we examine the roots of this common assessor stance, and explore strategies that may help taxpayers argue for a more predictable, apartment-like treatment for their single-family rental communities.

Similar, but different

Multifamily construction has delivered a tremendous volume of apartment properties over the past decade. Once stabilized, these assets have been relatively simple to value by relying on market rents, occupancy, expenses, and cap rates.

On the heels of this apartment construction, the nation is seeing a proliferation of investor-backed, single-family construction and acquisitions of large blocks of homes and townhouses for use as rental properties. This may take the form of constructing a multitude of homes or townhomes in a single development. Alternatively, it may involve the acquisition of many existing homes or townhomes in a localized area.

A concentration of adjacent or proximate single-family residences operated as rentals can enable owners to achieve economies of scale for management, maintenance, groundskeeping, repair and similar costs, similar to the operation of a large apartment complex or group of complexes. In most jurisdictions, however, the similarity between apartments and communities of rental homes and townhomes doesn't extend to valuation for property taxation.

As a rule, houses and townhomes are individually platted and therefore have separate tax parcel numbers. For existing properties acquired from third parties, this is expected. When it occurs with new construction, however, it typically results from the developer's decision to create true townhouses and single-family houses, as opposed to a traditional rental complex. The reasoning for this decision may be complex, but at the gate it appears to be a protective measure to allow for subsequent sales of the units.

For taxing purposes, each separate parcel – house or unit – is valued separately and independently, just as if individually owned and occupied for personal use by a homeowner. The taxing authorities value these properties using a market-comparable-sale approach, just as if the units were individually owned for personal use.

This is causing a good deal of consternation among investors who seek to have the units valued utilizing the income approach, and for those who would like to value assembled units collectively. The owner of a row of inline townhomes, for example, may prefer to have the properties valued as one economic unit, in the nature of an apartment complex.

Case law insights

The North Carolina Property Tax Commission in two recent cases affirmed that assessors must use the comparable sales approach to individually assess independent, platted rental homes. In those cases, (Mingo Creek Investments III LLC and American Homes 4 Rent Properties One LLC), commissioners set forth numerous reasons for their decisions.

Those cited factors included a legal requirement that each separately platted parcel be separately taxed. Additionally, the common owner was able to sell off a single unit at any time, and lacked an apartment owner's common control over amenities and other units. Not all units in a particular development are necessarily owned by the same entity, and in the cited cases there was a history of buying or selling of the individual units or neighboring units.

Assessors often make the policy argument that where single-family rental units exist in common with units that are individually owned for personal use, applying a different valuation method to those held for rent would create inequitable results. It would also raise uniformity concerns, because similar properties would be taxed differently. The same inequity issue that applies to a rental residential unit also applies to homes used as vacation rentals. To value rental single-family residences using an income approach and the neighboring, owner-occupied, single-family residence by the comparable sale approach would create inequities and a lack of uniformity.

Taxpayer tactics

So, where is the investor to go from here?

The elements addressed in each of the two Property Tax Commission decisions issued thus far, together with the policy considerations, limit the taxpayer's options. An investor or developer could common-plat the residential rental units in the development stage, creating a single plat that could be more readily valued with an income approach.

If the owner or developer is unwilling to common-plat the assemblage of rental homes or townhomes but seeks to have them valued for tax purposes under the income approach, it appears they would at least have to consider imposing common control restrictions on the parcels to create, as nearly as possible, the functional equivalent of an apartment complex.

For example, a development or ownership regime could impose not only common ownership but also common control over all the units, including a prohibition on the sale of individual units, or perhaps restrictions that the sale of a specific unit would not release that unit from the common control mechanism. Such a mechanism would be akin to a 100 percent developer-controlled homeowners association.

From a practical perspective, the developer could prohibit investors from selling individual properties until the developer chooses to start divesting itself of the project piecemeal. At that time, the developer could amend the restrictions, since it would still have total control because no units had been sold, and therefore no third parties had vested rights. At that time, it is likely the taxing authority would change the valuation method to a comparable sales approach.

Further, the developer would most likely need to ensure that the units under such common ownership and control would be physically distinct from neighboring properties. For example, all the units could be in a designated subdivision or portion of a development, as opposed to being alongside units held for personal use by their owners. By so doing, the developer could hopefully remove the uniformity argument.

From a market perspective, the units held for rent under common ownership and control would never be for sale on the open market as single units, at least so long as the restrictions remained in place.

As to appraisal, the appraiser could either apply the income approach to each unit, or appraise the combined residences as one economic unit and then apportion value among the units, so that each tax parcel receives a separate value. This is not to say this approach would be accepted by a tax court, but it would address many of the concerns espoused to date against use of the income approach for separately platted residential units held for rent.

These valuation regimes described above may prove too restrictive for some investors, in which case they would appear stuck with the current process. In all events, before becoming wedded to any plan, taxpayers should at least run the numbers both ways – using income and comparable sale approaches – to be certain the value difference is worth the effort of contesting their assessment. 

Jaye Calhoun and Divya Jeswant of Kean Miller LLP on an assessment strategy that may help you trim your property tax bill.

Few states impose property tax on intangible assets such as a trade name, franchise, goodwill and the like. Indeed, some office buildings, industrial properties and big-box stores don't derive significant value from intangibles in the first place.

Intangibles are a significant income generator for many hotels, casinos, restaurants and other properties, however. For these assets, assessors are required to identify and exclude the value attributable to those nontaxable intangibles. The proper method to do so has been the subject of much debate.

Fortunately for taxpayers, recent case law is helping to clarify best practices for isolating and removing value attributable to intangibles from commercial assessments. By following the examples of taxpayers who have successfully applied alternative approaches, property owners across the country may be able to exclude a larger portion of overall property value as intangible and, in turn, lower the property taxes on their business real estate.

Scaling Rushmore

Although some assessors persist in applying the cost approach, most valuation professionals consider the income approach most appropriate for valuing income-producing properties. That is because a property's past, present and future or projected income inevitably impact its valuation.

Many assessors have traditionally applied the "Rushmore Approach" to exclude the value of intangibles from an income-based valuation. This essentially deducts management and franchise fees from a property's net income, treating those amounts as a proxy for the value of intangibles.

Many taxpayers reject the notion that the Rushmore Approach can account for the full value of intangibles. Some of these property owners and their appraisers have countered with the "Business Enterprise Approach," which seeks to remove the often significantly higher revenue generated by intangible assets. This approach is sometimes called the "Income-Parsing Approach" because it requires going-concern income attributable to intangibles to be parsed and stripped from taxable property income.

A spate of decisions over the last few years, particularly concerning hotel valuation, has created a growing momentum favoring the Business Enterprise Approach. Taxpayers should be aware of the potential for significant tax savings with this approach.

Business enterprise successes

The most significant recent cases in which taxpayers successfully argued for using the Business Enterprise Approach are in two states known for high property taxes: Florida and California.

The first is Singh vs. Walt Disney Parks and Resorts U.S. Inc., a 2020 case dealing with the valuation of the Disney Yacht & Beach Club Resort adjacent to Epcot. A Florida appellate court categorically ruled that the Rushmore Approach fails to remove all intangible business value from an assessment. The court was simply unconvinced by the assessor's arguments that deductions for franchise and management fees can remove the entire intangible business value.

Another encouraging decision occurred in 2023, SHR St. Francis LLC vs. City and County of San Francisco. A California appeals court considered various income streams of the Westin St. Francis hotel, including its management agreement, income from cancellations, no-shows and attritions, in-room movies, and guest laundry services.

The court held that it was insufficient to simply deduct the management fees because income from a nontaxable, intangible asset like a management agreement should include both a "return of" and a "return on" that asset. In other words, the owner would expect to generate a profit, or income-based value over and above the cost of the management agreement. The court found that the assessor failed to present evidence that the management agreement's value did not exceed management fees.

In dealing with the remaining items, the court drew a dividing line between "intangible attributes of real property" that merely allow the taxable property to generate income (cancellations/no shows/attritions) and are therefore includible vs. "intangible assets and rights of the business operation" utilizing the real property. These latter assets and rights, including in-room movies and guest laundry services, relate to the intangible business operation and are, therefore ,excludible from income-based, taxable property value.

Another widely reported decision from 2023 is Olympic and Georgia Partners LLC vs. County of Los Angeles. The appellate court in this case pointed out a key flaw in the Rushmore Approach. That it is unlikely the deduction of franchise and management fees could fully account for the value of intangibles because no owner would normally agree to fees "so high as to account completely for all intangible benefits to a hotel owner."

Half Moon Bay legacy

Several recent decisions cite SHC Half Moon Bay LLC vs. County of San Mateo, a 2014 California case involving the Ritz Carlton Half Moon Bay Hotel's workforce, leasehold interest in the employee parking lot, and agreement with a golf course operator. The appellate court explicitly acknowledged that the deduction of management and franchise fees from the hotel's projected revenue stream did not properly identify and exclude intangible assets.

Taxpayers throughout the country have successfully made these same arguments. In 1300 Nicollet LLC vs. County of Hennepin, a Minnesota court in 2023 took stock of case law across the country and observed that although the two methods have been competing for 20 years, there is an emerging preference for the Business Enterprise Approach and increasing skepticism of the Rushmore Approach.

Some states such as New Jersey continue to rigidly administer the Rushmore Approach, while other states consistently uphold the Business Enterprise Approach, at least in recent years. Yet other states view both methods as potentially reasonable for an assessor to apply; some of those cases may have more to do with the standard of proof during appellate review. There are also states such as Louisiana in which the issue is yet to be dealt with judicially, arguably giving taxpayers an opportunity to get ahead of the curve.

Clearly, taxpayers and their commercial appraisers should determine whether the assessor has properly excluded maximal value for intangibles in valuing their income-producing properties for property tax purposes. In particular, appropriately applying the Business Enterprise Approach can generate significant property tax savings on commercial real estate and may be worth pursuing.

Below is a property owner's guide to reducing the taxable value of contaminated real estate.

Valuing contaminated properties presents numerous challenges due to the complexity and uncertainty that contamination entails. The presence of hazardous substances or pollutants can affect both a property's value and potential uses. As an assessment must reflect market value, contamination can significantly impact taxable valuation.

Determining the extent of that impact requires careful consideration of legal, technical, and economic factors as the valuation of contaminated properties is governed by a combination of statutory law, regulatory guidance, and case law. Yet these are the fields a taxpayer with contaminated real estate must tread to evaluate assessments for fairness and, if necessary, to appeal an unfair assessment.

Tax assessment review proceedings are crucial mechanisms for all property owners to ensure fair and accurate assessments. These proceedings provide avenues to challenge property assessments they believe are incorrect or unfair. Understanding the process, timelines, and legal considerations involved is essential for property owners, assessors, and legal professionals alike.

Most real estate taxes in the United States are ad valorum or "according to value." Thus, the owner of a high-value property would expect to pay more real estate taxes than the owner of a lower-value parcel. While the exact procedures to file a tax appeal can vary by state, all give property owners the right to challenge property assessments through various means, including administrative review, grievance procedures, and judicial review.

Four Preparatory Keys

To prepare for a tax appeal, the following important considerations should be addressed:

1. Assess contamination levels: Determining the extent and severity of contamination on a property requires expertise in environmental engineering, so expert assistance is a must. Documentary evidence can significantly strengthen a property owner's case during the appeal process. Procure this with expert testimony from environmental consultants, appraisers, and other qualified professionals to establish the impact of contamination on the property's value. Assessors may need to rely on those reports to understand and truly appreciate the contamination's nature and scope.

2. Estimate remediation costs: The price tag to remove or contain pollutants can vary widely depending on the type, quantity and spread of the materials involved, as well as the chosen remediation method. While there are state statutes concerning remediation and liability, those matters are also codified at federal levels within the Comprehensive Environmental Response, Compensation & Liability Act (CERCLA) of 1980, commonly referred to as the Superfund Law. If a site is designated a "superfund site," it will typically have a remediation plan with anticipated cleanup costs, which assessment professionals can rely upon in determining market value.

3. Gauge market perception: Market perception can play a significant part in valuation since contamination can have a negative impact on the property's appeal to potential users or buyers. Known as "environmental stigma," this can severely depress market values. Prospective buyers are typically hesitant to purchase contaminated properties, often leading to decreased demand and lower market prices.

4. Don't sweat legal liability: Property owners may face legal liabilities for environmental contamination, which can also affect the property's value. This, however, should have no effect on valuation in a tax appeal proceeding, because the statutory mandate to value property in a tax appeal according to its market value cannot be subordinated to environmental property concerns. Most significantly, any liabilities for contamination or remediation must be addressed in a separate proceeding outside the tax appeal.

More to Consider

The three accepted approaches to valuation in the context of a tax appeal are income capitalization, sales comparison, and replacement cost less depreciation. Unfortunately, none of these truly account for the presence of contamination and its negative influence on value. The effects of environmental contamination, and even stigma from nearby contamination, must be part of the valuation equation.

Local case law also plays a significant role in shaping the legal landscape surrounding contamination in tax assessment review proceedings. Many courts have recognized the impact of contamination on property values and have upheld adjustments to tax assessments to account for this factor. Additionally, these same courts have established principles regarding the burden of proof and evidentiary standards in contamination-related tax appeals.

For example, the seminal case in New York is Commerce Holding vs. Board of Assessors of the Town of Babylon. In this 1996 case, a property owner filed a tax appeal contending the assessed values should be reduced to account for contamination by a former on-site tenant. While New York's highest court held that "any fair and non-discriminating method that will achieve [fair market value] is acceptable," they concluded that contaminated property in a tax assessment review proceeding shall be valued as if clean, then reduced by the total remaining costs to cure the contamination.

Clearly, valuing contaminated properties in tax assessment review proceedings requires a nuanced understanding of environmental regulations, property valuation principles, and market dynamics. Assessors and property owners must navigate complex legal and technical challenges to arrive at a fair and accurate valuation that reflects the unique circumstances of each contaminated property. By employing appropriate valuation strategies and seeking expert guidance, stakeholders can ensure that contaminated properties are assessed fairly and in accordance with applicable law.