The American Property Tax Counsel is proud to announce that Chicago, Illinois will be the site of an in-person meeting for the 2023 Annual APTC Client Seminar.

Save the Dates! October 11-13, 2023 - Fairmont Chicago, Millennium Park - Chicago, Illinois

THEME - Valuation on the Cutting Edge: Utilizing Data in an Evolving Market

APTC seminars provide an exclusive forum where invited guests can collaborate with nationally known presenters and experienced property tax attorneys to develop strategies to successfully reduce and manage property taxes.

FEATURED SPEAKERS

MEMBER SPEAKERS

Three key factors can help owners successfully appeal excessive taxes.

Those are the assessments on a mobile home community south of Austin, Texas, that in just two years increased nearly 200% in taxable value. This near-doubling rate of annual increase has become commonplace across the state, largely due to three practices tied to appraisal district methodology.

Taxpayers who understand and can show the inherent flaws in these trends will be better prepared to argue for a reduction in their assessments.

Cost or income?

The first factor that has brought significant changes to assessed value in recent years is that county appraisers have largely changed their valuation method from the cost approach to the income approach. Rather than calculating market value by summing up the land value with the value of any onsite infrastructure, some county appraisers are using Freddie Mac and Fannie Mae appraisals to support their value conclusions.

From these leased-fee appraisals, the appraisers attempt to derive income assumptions including site lease rates, utility reimbursements, and expense ratios. This is problematic because often the appraisals they are sourcing include more than the real estate value alone and may not reflect actual sales occurring in the marketplace.

Homes or vehicles?

The second factor that has resulted in changes in assessed value is that assessors value recreational vehicle (RV) parks and mobile home communities, two fundamentally different property types, using the same income model. This presents several challenges.

Typically, both community types lease lots for placement of tenant-owned units, but the similarities end there. The amount of business value differs between the two property types.

Established RV parks such as Yogi Bear's Jellystone Park Camp-Resorts, with name recognition and amenities, draw significantly more visitors than local parks that lack name or brand recognition. An established RV park could be compared to a Marriott or Hyatt hotel, reflecting their tenants' short-term rentals and because they inherently include untaxable business value when sold.

On the other hand, a mobile home community might be compared to an apartment property with longer-term tenants and minimal, if any, business value beyond real estate. Mobile home communities have little need for name recognition or amenities when the tenants own their homes. Due to the cost of moving a unit, it is a challenge for mobile home residents to move, thus leading to higher stabilized occupancy and minimal turnover.

Infrastructure also varies between the two property types, with mobile home communities requiring more substantial utilities than RV parks. These significant differences confirm the importance of using separate models to assess the market value or taxable value of the two asset classes.

In the spotlight

The third factor that has affected assessed value is the increasing attention county appraisers have given to these two property types. In recent years, investment in mobile home communities and RV parks has risen in popularity nationwide as investors seek reliable and steady cash flows. Additionally, the supply of well-located mobile home parks has dwindled as cities have grown and changed the highest and best use of land in their path. This has increased land values, resulting in higher assessed values – a trend that will continue in the future.

As county appraisers rework their models for these asset types, they often create discrepancies between how a property has been assessed in the past and what is physically on the property, namely the total number of units and the mix between mobile home sites and RV sites. Many of these discrepancies likely still exist going into 2023, which may provide an opportunity for property owners to contest their assessed values and argue successfully for a reduction.

Historically, RV and mobile home park owners have not felt the need to protest tax assessments as often as owners of other commercial real estate asset classes. That may be changing in 2023, making this the first year many owners file a protest on their assessments.

A guide to effectively challenge and reduce bloated tax valuations.

Nobody enjoys paying property taxes, especially when a property is over-valued. Single-tenant, net-leased properties seem especially prone to inconsistent and unfair assessments.

But challenging those valuations can be exhausting in a time when assessors are fearful and obsessed with the dreaded "Dark Store Theory." They vehemently oppose using sales of vacant properties to value their jurisdiction's store, the one with the full parking lot.

How can the taxpayer shut down the hype and bring the assessor back to the table for a reasonable negotiation? Well, that depends. Here are essential points to consider in forming a protest strategy.

Know Your State's Value Standard

Common sense tells us an appraiser must know what they are valuing before they value it. Yet, the failure to identify the property rights being valued often causes disagreement and confusion in tax appeals. These misunderstandings commonly hinge on the difference between fee-simple and leased-fee value.

The fee-simple estate of an income-producing property is essentially the value of the net income stream based on market-level rents, expenses and other variables. If the property benefits from a long-term, above-market lease, that revenue is irrelevant to the fee-simple value.

Before I finished that last paragraph, my phone rang. The caller was outraged because an assessor revalued his property at its recent purchase price. The property was clearly not worth what the taxpayer paid for it, he said, because the price was based on a net lease.

Maybe. Maybe not.

Before the caller purchased his property, it was exposed to the open market for willing buyers to make offers to the willing seller. The competitive process culminated in an arm's-length sale reflecting market value. How is that not what the property is worth?

That brings us to the second value standard, the leased-fee estate, which is essentially the value of the income stream from the actual lease in place. The caller's purchase price was exactly what the property's leased fee was worth.

So, before getting angry with assessors for relying on leased-fee sales, taxpayers should learn which property rights their state is valuing for taxation. If the state values the leased-fee rather than fee-simple estate, the taxpayer may not have a basis to complain.

Sales Won't Sell It

The "Dark Store Theory" is the term assessors apply to the use of vacant property sales in valuing occupied properties. From an appraisal theory standpoint, only vacant sales are appropriate for valuing the fee-simple interest in a leased property, because sales of leased properties exclude the right of occupancy, an essential right within the fee-simple estate.

This appraisal standard should be a boon to taxpayers challenging inflated assessments on leased properties. It's great to be right, but there's a problem. Using vacant buildings to value occupied buildings is a very tough sell to a tax panel, appeals court or other arbiter. The decision-maker's gut will turn.

Huge tax reductions have been achieved using vacant sales, so it can be done. It is spectacular in the moment, but legislatures and higher judicial bodies are likely to respond negatively. Legal victories that inflame assessors and politicians are not stable long-term solutions.

What About The Cost Approach?

Cost doesn't equal value, but sometimes estimating a newer property's replacement cost less depreciation is a good test of whether an assessment is reasonable. A cost calculation may support a value reduction, so it is worth considering in a protest strategy.

A common problem with the cost approach in net-lease tax appeals is the conspicuous difference between cost-based value conclusions and those based on income or comparable sales. If the property can't be leased or sold at a rate of return that supports its depreciated cost to build, the numbers will not line up, because there is obsolescence to account for. The decision-makers that hear tax cases dislike big obsolescence deductions, especially if the taxpayer quantifies those deductions using vacant property sales.

Many assessors use cost systems for mass appraisal, so understanding how the local system was developed is helpful. Sometimes assessors use base cost data purchased from third-party services and then tweak that information before entering it in their own systems. Tweaks can involve stretching out the useful life of properties in the source data to unreasonable lengths, or bumping default grades used for certain building types from, say, "average" to "good." Little modifications add up and may be solely to increase tax revenue.

Market Rent Is King

In a fee-simple system, a good way to approach a net-lease tax appeal is with the income approach. All net-lease properties are leased, meaning they produce income. It isn't hard for an assessor to convince a decision-maker in a tax case that the property should be valued by capitalizing its income.

The most crucial element of a fee-simple income approach is the market rent. To win a net-lease tax appeal based on income, the taxpayer must prove this one thing.

"But there is no market rent for my property type," the taxpayer says. "What am I supposed to use for rent?"

That's a real issue, because net leases almost always seem to be the product of a build-to-suit or sale-leaseback transaction, with no regard for the local market. So, how can the taxpayer prove market rent?

Go for Broker

Consider this: Commercial real estate brokers are opinionated about their markets. They know rent because it's how they feed their families. They can speak with credibility about the rent a building would command on the open market. Nobody knows market rent better, and they make powerful rebuttal witnesses who keep any off-base testimony by the assessor in check.

A broker can also be a helpful resource for the taxpayer's appraiser. They can point to meaningful, sometimes hidden information.

The combination of an appraiser's formal analysis with a broker's testimony about realistic market rent is potent and convincing evidence in a tax appeal.

Let's Be Reasonable

As the taxpayer's protest strategy takes shape, subject it to the old "reasonable man" standard.

Would a reasonable decision-maker look at the taxpayer's long list of vacant properties, compare it with the subject property that is open and thriving, and feel good about reducing the value?

Would a reasonable decision-maker look at an income approach based on a reasonable expectation of market rent for the subject building and feel good about reducing the value?

Pushing for the former may be zealous advocacy, but appearing unreasonable to both assessor and decision-maker is unhelpful. And even a victory, if it smells like overreaching, risks a legislative response. Resolving a net-lease tax appeal using a reasonable income approach is a superior long-term strategy.

Legal covenants often cause excessive property taxation for mall owners that are looking to redevelop.

Repurposing malls and anchor stores is a popular topic in community development circles, but legal restrictions make redevelopment extremely difficult. Often locked into their original use by covenants, malls and anchor stores are often grossly over-valued for property tax purposes. In pursuing a redevelopment, taxpayers should ensure the properties are fairly assessed and taxed.

Debilitating obsolescence

It is difficult to overstate the plight of malls and anchors. Gone are the halcyon days when the mall was everyone's shopping destination. There is even a website, deadmalls.com, devoted to failed malls. Credit ratings of most anchor store operators have fallen below investment grade. Commentators usually blame the retail apocalypse on ecommerce and shifting consumer spending habits.

COVID-19 exacerbated these trends and mall foot traffic has been slow to recover. Some chains, including Neiman Marcus and JCPenney, filed bankruptcy. Ecommerce volume surged in 2020 and 2021 before tapering in 2022. Ecommerce and brick-and-mortar sales have not yet reached an equilibrium.

One in five American malls have fully closed and remain "zombies" without a redevelopment plan, estimates Green Street Advisors, a commercial real estate analytics firm. A December 2022 Wall Street Journal article describing the "long death" of the White Plains Mall noted there is no shortage of dying malls. The article observed that converting enclosed shopping centers to other uses remains a "difficult feat." Repurposing, while much discussed, has not really happened.

The question is why. The answer relates, at least in part, to legal challenges inherent in changing the property's use.

Tied hands

Any property valuation begins with a highest and best use analysis. A basic assumption about real estate directs that the price a buyer will pay reflects that buyer's conclusions about the property's most profitable use. Competitive forces within the local market shape a property's highest and best use, but that use must reflect practical and legal restrictions.

Many people incorrectly assume that governmental requirements pose the only legal restrictions on use. Zoning ordinances may impose barriers, owners of neighboring properties may object to redevelopment proposals, or there may be other hinderances to changing the property's use.

Zoning limitations pale in comparison to restrictions in recorded easements and unrecorded operating agreements between mall owners and anchor department stores. While zoning may permit non-retail uses, private agreements generally do not.

Malls would be economically unfeasible without department stores and inline stores that symbiotically drive traffic to each other. Generally, anchors own their pads and inline tenants lease space from the mall owner. A typical mall is subject to two levels of private restrictions designed in an earlier day to promote the efficient functioning of the mall for retail stores.

Recorded operating restrictions or restrictive easement agreements (REAs) impact the entire mall and its anchors and are generally binding for 40 years or longer. Typically, substantive amendments to the REA require the consent of all parties, and their economic interests are not always aligned.

Unrecorded operating agreements govern the relationship between individual anchors and the mall owner. Terms typically address tenancy, hours of operation, required years of operation under a specified tradename and the size of each anchor and the mall. Operating agreements also generally restrict the size and construction of improvements on the anchor pad and regulate usage.

A simple example involves anchors using stores as a delivery point for ecommerce, a concept known as buy online, pick up in store (BOPIS). Many REAs and operating agreements severely limit implementation of this concept.

But what if the mall's highest and best use is no longer retail? Ecommerce and changed consumer practices undermine the REAs' and operating agreements' ability to ensure the property's success, but those private agreements are understandably focused on preserving retail usage.

The common party to these agreements is the mall owner, making the mall owner the logical purchaser when an anchor looks to sell. The potential economic return on any proposed redevelopment must be sufficient to encourage an entrepreneur to take the redevelopment risk for the mall and/or anchors.

Legal risk escalates the economic risk. For example, owners of some anchor properties seek conversions to multifamily or industrial use as salvation from the retail apocalypse. Even if they overcome zoning objections, attempts to change REAs and unrecorded operating agreement restrictions may require unanimous consent among owners with competing economic interests.

The anchor pad may not even be worth its unimproved land value since its use is restricted under the REAs and operating agreements to retail.

Property tax implications

While mall owners and anchors struggle to remain viable in the changed retail environment, ad valorem property taxes pose an immediate challenge. Most states value property as what a willing buyer would pay to a willing seller, but the pre-ecommerce glory of malls and anchors generally encourage high property tax valuations.

Assessors performing an income-based assessment seldom recognize how anchor chains' plunging credit ratings affect value. The sales-comparison approach is equally challenging, as anchor property transaction volume has plummeted since 2006.

Most sales involve a change to non-retail use and thereby require unanimous consent. Consent is easier to obtain when the new use increases foot traffic to the remaining inline tenants and anchors, but it is easy to envision anchors holding the process hostage in an attempt to force the purchase of their failing stores.

REAs and unrecorded operating covenants make calculation of an anchor's value extremely difficult. They also call into question the comparability of previous transactions to repurpose anchors in the same mall, since those anchors may have agreed to one specific new use but may object to another.

REAs and operating agreements often hamstring mall and anchor redevelopment. Most were signed before ecommerce and did not envision retail losing its vitality. The parties to these covenants often have divergent economic interests and perspectives, and the natural party to lead redevelopment – the mall owner – must overcome these hurdles. In the short term, however, owners should address highest and best use with assessors to reduce property tax burdens until the zombie can be brought back to life.

Amid talk of a downturn, Rachel Duck and Nick Machan of Popp Hutcheson PLLC offer some guidance.

As interest rates rise to combat inflation, recessionary pressure is the highest it's been since 2009. Moving into 2023, shifting market conditions have pummeled real estate values, many of which had experienced dramatic upswings during the prior 18 months. With market uncertainty and recessionary conditions bearing down upon them, property owners across the country may hope to see some relief in property tax assessments.

But does a recession equal falling property tax liability? To answer this question, it is essential to understand how a recession could influence assessed values of the various property types.

How Recessions Impact Market Values

During a recession, interest rates typically continue to climb. In commercial real estate, rising debt costs can translate to reduced transaction volume and price contraction as capitalization rates reflect buyers' increased risk. Worsening job markets and weak consumer spending may impact the demand for various property types.

Multifamily tends to be less sensitive than other property types to recessionary market conditions. During downturns, risk-averse individuals tend to prefer rental housing over homeownership. Additionally, inflationary costs can delay multifamily construction and limit supply, which helps avert supply surges that can lead to steep drops in rent and occupancy. To illustrate, while office, industrial, and retail rent fell between 14 percent and 17 percent during the last recession, multifamily rent only declined 8 percent overall.

Retail property responses to a recession vary by type, but market growth rates will likely slow across all types. Brick-and-mortar stores were already facing a potential "retail apocalypse" prior to COVID-19 as consumers increasingly shopped online. Traditional shopping malls could be the most severely impacted retail properties in a recession. Many Class B and C malls already face closure, driving many owners to repurpose them into industrial, multifamily, distribution, and even healthcare space.

Hospitality is among the most vulnerable property types in a recession, and hotel performance has been one of the most volatile over the last few years. Revenues for many properties cratered during the pandemic and some have been slower to recover than others. However, many hotels had recovered to near pre-pandemic levels in 2022, with some year-end 2022 revenues surpassing 2019 levels. Moving into a recession, pent-up leisure demand could help balance out the decline of business travel as businesses cut costs. Perhaps the biggest question marks in predicting the impact of a recession on hotel performance involve business travel volume and hotels' ability to sustain high average daily rates they adopted to increase revenue per available room and combat falling occupancy.

How Do Market Fundamentals Affect Assessed Values?

Assessors in most jurisdictions base assessments on some variation of market value, which is fundamentally the value at which the property would transact on the open market. Assessors weigh cost, income, and sales data to determine their initial valuations. They must, however, also value thousands of properties quickly, and therefore rely on mass appraisal techniques that may omit factors affecting individual properties.

Recessionary market conditions affect all three of the valuation approaches but will vary by property type, geographic area, and individual property metrics. For these reasons, a property owner's first step after receiving their assessments should be to determine whether the valuation is reasonable based on the individual market factors impacting their property as of the valuation date.

Assessors in most jurisdictions must also consider the equity of property values. Many states have laws protecting the equitable value of comparable properties, and assessors are generally intent upon making fair assessments.

Tricky Tax Rates

In addition to assessed value, the second piece of a property owner's tax liability is the tax rate. Should 2023's overall appraisal roll or tax base decline, property owners should not necessarily expect an equivalent decline in their tax liability.

Most taxing entities set their rates separately from, and usually after, assessors' determination of property values. Typically, there is an inverse relationship between a jurisdiction's tax rates and the tax base. If total valuations fall significantly, it is possible—and maybe even likely—that tax rates will rise.

As an example, imagine you own a small apartment building outside of Dallas, Texas. Due to market factors, your property's value fell to $9 million as of the Jan. 1, 2023, valuation date, down 10 percent from $10 million a year earlier. Excited, you prepare to pay a correspondingly 10 percent smaller amount on your 2023 property taxes.

The overall appraisal roll declined as well, however, and your applicable 2023 tax rate increased from 2.4 percent to 2.472 percent as a result. Instead of a 10 percent decrease, your liability shrinks 7.3 percent to $222,480, down from $240,000 the year before.

No one can predict tax rates with certainty, but owners would be wise to budget conservatively for anticipated tax liabilities. A 40 percent decline in revenue may not translate to a 40 percent decline in the assessed property valuation or ultimate tax liability for the tax year ahead. Partnering with an experienced, local property tax advisor can give owners peace of mind as they navigate the shifting market in this tumultuous year.

Tennessee's appeal process allows Nashville taxpayers to challenge the complicated assessment of new construction.

Over the past decade, Nashville has enjoyed a baffling explosion of growth that sent cranes shooting up all over the city, festooned with developer names like Bell, Clark and Giarratana. Highrise towers of glass and steel rose out of the old rail yards like the emerging monolith in the opening scene of "2001: A Space Odyssey" multiplied in a funhouse mirror.

The Metropolitan Government is eager to add new projects to its tax rolls, and its Assessor of Property decides when and how that happens. The assumptions made by the Assessor's office about a project's cost and timing dictate how quickly and how much a new building is taxed. So, as always, taxpayers need to keep an eye on what the assessor is doing.

The assessor's difficult job has become even more complicated in the post-COVID quagmire of supply chain failures. Twelve-month projects have stretched into 24-month projects, and the assessor's assumptions about completion times have been thrown out of whack. To make matters worse, Tennessee's property tax statutes were not designed to give relief for construction delays or lengthy projects, and the clock is ticking.

New Construction Assessed at Material Cost

The last Davidson County reappraisal was in 2021, and the next will be in 2025. Normally, the assessor's values remain unchanged over the four-year cycle, but new construction is an exception to that rule.

Under the statute for assessing projects under construction, if a new improvement is partially complete on Jan. 1, the assessor is to value the property for that year at land value plus the cost of materials used in the improvement as of that date. This materials-only value favors taxpayers because it excludes labor costs.

The construction documents that are generally accepted as evidence of project costs do not typically segregate labor versus material costs, however. Those costs are most often listed as combined totals, making the exact material costs difficult to determine.

One example from a recently reviewed document described work that included a $279,000 line item for "caulking." Unless labor and materials are both included in that number, that's a heck of a lot of white goop! Rather than demand proof of exact material costs, assessors will sometimes allocate material costs based on a pre-established rule of thumb.

Substantially Complete?

Now for the tricky part. The new construction statute allows assessors to pick up new improvements after Jan. 1, so long as the structure is "substantially complete" prior to Sept. 1 that same year. So, for example, if a building is 50 percent complete at Jan. 1 and 100 percent complete at Sept. 1, the assessor will prorate at the 50 percent value for eight months of the year, and at the 100 percent value for four months of the year. If the improvements are not "substantially complete" by Sept. 1, the assessor must wait to pick up the as-complete value in the following year.

Tennessee has no statutory definition of "substantially complete" for purposes of adding the full value to the tax rolls, but cases make it clear that tenant finish-out and certificates of occupancy are not required. In the absence of simple, objective standards for completion, assessors make subjective judgments about completion that may not favor the taxpayer. Taxpayers can challenge those judgments through an administrative appeal.

Adding Insult to Injury

Under Tennessee law, new improvements may not be valued as incomplete for more than one year after construction began. Now, your immediate reaction might be, "That's ridiculous! How can you value an incomplete property as complete just because it took longer than 12 months to construct!?"

The assessor in Davidson County has taken the position that the statute prevents them from using the taxpayer-favorable, materials-only value in the second year a property is incomplete. They will likely still use the cost approach to determine the appraised value but add back the cost of labor that was taken out in the first year, greatly increasing the tax burden before the property is generating income. The legislature has not acted to provide relief from this further insult to developers already injured by increasingly protracted construction timelines.

The Good News

Tennessee assessors are only authorized to reassess a property at specific times, but taxpayers can appeal the assessor's Jan. 1 value of Nashville property to the Metropolitan Board of Equalization every year. If the assessor issues a prorated assessment for a new construction project later in the year, the taxpayer can appeal that value directly to the State Board of Equalization.

In light of the complexity of Tennessee's law on the assessment of new construction, owners of new projects in Nashville should seek counsel as to whether their assessments are fair and legal and avail themselves of the right to appeal if appropriate.

The 'work from home' revolution has devastated office building values.

Of all the property types, office buildings may wrestle with the pandemic's damaging consequences the longest.

The fallout from COVID-19 will clearly have a lasting economic impact. During the government-mandated shutdowns, businesses — including brick-and-mortar retail stores, restaurants, movie theaters and gyms — suffered tremendous losses.

With everyone except first responders and essential workers stuck at home, office occupancy rates plummeted as business districts, commercial developments, roads and public gathering places emptied. Many companies could not survive the shutdowns and were forced to lay off employees or permanently close their doors.

During the throes of the pandemic, companies that remained in business were compelled to adapt and learn how to effectively put their employees to work from home. Virtual meetings eventually became commonplace and routine. Then as the pandemic waned, companies began to demand that employees return to the office. While some workers ventured back to the workplace, many expressed a desire to continue to work from home.

This widespread sentiment has persisted. In fact, nearly 40 percent of workers would rather quit their jobs than return to the office full-time, and more than half would take a pay cut of 5 percent or more to retain their workplace flexibility, according to a recent survey by Owl Labs.

Given the tightening job market and the need to retain workers, many companies complied with employees' demands and either permitted them to work remotely or allowed hybrid arrangements. Little did these employers know that allowing employees to work from home would have a profound effect on the appraisal of office buildings for property tax appeal purposes.

Office valuations suffer

Property taxes are the largest single expense for most office landlords, and most property taxes in the United States are ad valorum, or market-value based. In other words, higher-valued properties have greater property tax levies. Therefore, property owners frequently file tax appeals to reduce this expense.

In the context of a real property tax appeal, the valuation of office buildings can be complex. Typically, an arms-length or comparable sale is the best evidence of value in a tax appeal proceeding. Since there aren't many arms-length purchases of single office buildings today, they are commonly valued by capitalizing the property's rental income stream minus property-based expenses. As a result, the actual rents collected are critical to the building valuation.

And rents have suffered. The mass exodus from office buildings to remote locations significantly lessened the demand for dedicated office space. With employees working remotely, many companies have realized they can function as well as before while occupying much less space. Thus, as leases expire, the tenants that choose to renew their leases are requesting a much smaller footprint with lower overall rents.

Compounding the decreased demand for office space, building expenses have skyrocketed. Rapid inflation has helped to propel insurance and general property maintenance costs, which have surged upward by more than 15 percent since 2020. Furthermore, lingering COVID-19 health concerns have led to enhanced cleaning protocols and upgraded air filtration systems, which have likewise raised building expenses.

Simultaneously, the Federal Reserve has raised interest rates to combat inflation. These higher interest rates, meanwhile, have further reduced property values by increasing the cost of financing. Mortgage interest rates and the risks on the equity side have also increased. This has a negative effect on the market valuation of office buildings as higher capitalization rates generate much lower appraised market values.

Challenge unfair assessments

Altogether, reduced office space demand, weakened cash flows, higher building expenses and rising interest rates do not bode well for the U.S. office sector. Landlords are being forced to offer concessions such as free rent or are paying for extensive interior buildouts to attract tenants.

This large shift in lease renewal rates, occupancies, expenses and capitalization rates have produced the equivalent of the four horsemen of the apocalypse for office building valuations, driving property tax appeals and raising a distinct possibility that many office buildings will become stranded assets. Experience indicates these changes can result in a 10 percent to 30 percent drop in market value from pre-pandemic levels.

A good rule of thumb would be that if a building's net operating income has dropped, the real estate tax levy should go down correspondingly. Most municipalities, however, have not reduced assessments to reflect the economic downturn.

Consequently, now more than ever, property owners must be vigilant to avoid paying excessive property tax bills. Conferring with experienced counsel, questioning assessors' property valuations and challenging tax assessments will help to ensure an office building's current real property taxes are based on this new valuation reality.

Legal covenants often cause excessive property taxation for mall owners that are looking to redevelop.

The repurposing of malls and anchor stores is a popular topic in community development circles, but legal restrictions make redevelopment extremely difficult. Often locked into their original use by covenants, malls and anchor stores are often grossly overvalued for property tax purposes.

In pursuing a redevelopment, taxpayers should ensure the properties are fairly assessed and taxed.

Debilitating obsolescence

It is difficult to overstate the plight of malls and department store anchors. Gone are the halcyon days when the mall was everyone's shopping destination. There is even a website, www.deadmalls.com, devoted to failed malls. Credit ratings of most anchor store operators have fallen below investment grade. Commentators usually blame the retail apocalypse on e-commerce and shifting consumer spending habits.

COVID-19 exacerbated these trends and mall foot traffic has been slow to recover. Some chains, including Neiman Marcus and JCPenney, have filed bankruptcy. E-commerce volume surged in 2020 and 2021 before tapering in 2022. To date, e-commerce and brick-and-mortar sales have not yet reached an equilibrium.

One in five American malls have fully closed and remain "zombies" without a redevelopment plan, estimates Green Street Advisors, a commercial real estate analytics firm. A December 2022 article from The Wall Street Journal that detailed the "long death" of the White Plains Mall noted there is no shortage of dying malls. The article observed that converting enclosed shopping centers to other uses remains a "difficult feat." Repurposing, while much-discussed, has not really happened.

The question is why. The answer relates, at least in part, to legal challenges inherent in changing the property's use.

Tied hands

Any property valuation begins with a "highest and best use" analysis. A basic assumption about real estate directs that the price a buyer will pay reflects that buyer's conclusions about the property's most profitable use. Competitive forces within the local market shape a property's highest and best use, but that use must reflect practical and legal restrictions.

Many people incorrectly assume that governmental requirements pose the only legal restrictions on use. Zoning ordinances may impose barriers, owners of neighboring properties may object to redevelopment proposals, or there may be other hinderances to changing the property's use.

Zoning limitations pale in comparison to restrictions in recorded easements and unrecorded operating agreements between mall owners and anchor department stores. While zoning may permit non-retail uses, private agreements generally do not.

Malls would be economically unfeasible without department stores and inline stores that symbiotically drive traffic to each other. Generally, anchors own their pads and inline tenants lease space from the mall owner. A typical mall is subject to two levels of private restrictions designed in an earlier time period to promote the efficient functioning of the mall for retail stores.

Recorded operating restrictions or restrictive easement agreements (REAs) impact the entire mall and its anchors and are generally binding for 40 years or longer. Typically, substantive amendments to the REA require the consent of all parties, and their economic interests are not always aligned.

Unrecorded operating agreements govern the relationship between individual anchors and the mall owner. Terms typically address tenancy, hours of operation, required years of operation under a specified tradename and the size of each anchor and the mall. Operating agreements also generally restrict the size and construction of improvements on the anchor pad and regulate usage.

A simple example involves anchors using stores as a delivery point for e-commerce, a concept known as buy online, pick up in store (BOPIS). Many REAs and operating agreements severely limit implementation of this concept.

But what if the mall's highest and best use is no longer retail? E-commerce and changed consumer practices undermine the REAs' and operating agreements' ability to ensure the property's success, but those private agreements are understandably focused on preserving retail usage.

The common party to these agreements is the mall owner, making it the logical purchaser when an anchor looks to sell. The potential economic return on any proposed redevelopment must be sufficient to encourage an entrepreneur to take the redevelopment risk for the mall and/or anchors.

Legal risk escalates the economic risk. For example, owners of some anchor properties seek conversions to multifamily or industrial use as salvation from the "retail apocalypse." Even if they overcome zoning objections, attempts to change REAs and unrecorded operating agreement restrictions may require unanimous consent among owners with competing economic interests.

The anchor pad may not even be worth its unimproved land value since its use is restricted to retail under the REAs and operating agreements.

Property tax implications

While mall owners and anchors struggle to remain viable in the changed retail environment, ad valorem property taxes pose an immediate challenge. Most states value property as what a willing buyer would pay to a willing seller, but the glory of malls and anchors before e-commerce generally encourage high property tax valuations.

Assessors performing an income-based assessment seldom recognize how anchor chains' plunging credit ratings affect value. The sales-comparison approach is equally challenging, as anchor property transaction volume has plummeted since 2006.

Most sales involve a change to non-retail use and thereby require unanimous consent. Consent is easier to obtain when the new use increases foot traffic to the remaining inline tenants and anchors, but it is easy to envision anchors holding the process hostage in an attempt to force the purchase of their failing stores.

REAs and unrecorded operating covenants make calculation of an anchor's value extremely difficult. They also call into question the comparability of previous transactions to repurpose anchors in the same mall, since those anchors may have agreed to one specific new use but may object to another.

REAs and operating agreements often hamstring mall and anchor redevelopment. Most were signed before e-commerce and did not envision retail losing its vitality. The parties to these covenants often have divergent economic interests and perspectives, and the natural party to lead redevelopment — the mall owner — must overcome these hurdles.

In the short term, however, owners should address highest and best use with assessors to reduce property tax burdens until their zombies can be brought back to life.

J. Kieran Jennings was quoted in the December 14 digital issue of the Wall Street Journal's Property Report, Page B6, titled, "Falling Building Values Spur Tax Appeals." 

Mr. Jennings is a partner in the law firm Siegel Jennings Co., L.P.A, the Ohio, Illinois and Western Pennsylvania member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. 

Land use changes can subject unwary landowners and developers to massive property tax bills.

For real estate developers in Texas, the purchase and development commencement dates on a land project may have heavy tax implications that could make or break a deal.

Agricultural Exemptions

The Texas Property Tax Code allows some landowners to benefit from special property valuations for wildlife management, agriculture, or open-air uses, commonly referred to as agricultural exemptions. Depending on the valuation and exemption in place, a landowner may be excused from paying large amounts of taxes.

Under an agricultural exemption, tax liability is based on the land's productive agricultural value, as opposed to market value. The agricultural exemption supports and promotes the land's agricultural or wildlife- use by providing a discounted land value for use in calculating property tax liability while the land is being used for approved agricultural purposes.

Securing an agricultural exemption is not necessarily an easy process or a guaranteed result for a landowner in Texas. To qualify, land must have been primarily used for agriculture at least five of the past seven years. Accepted agricultural purposes include crop production, raising livestock, beekeeping, timber production, wildlife management, and similar activities. Additionally, many counties set minimum acreage requirements, and some consider the agricultural activity's degree of intensity.

Triggering Rollback

An agricultural exemption does not attach to the land forever, and some developers may be unaware of the rollback tax. This somewhat vague provision of the state's tax code can impose a heavy tax burden when a piece of agricultural land is purchased for development, and/or when the land use changes. This tax burden may be more onerous than simply losing the exemption moving forward.

Appraisal districts maintain two values on the appraisal roll for agricultural land. Similar to how homestead exemptions are recorded, the appraisal roll lists the land's market value and the lower valuation reflecting its wildlife or agricultural production. When appraising agricultural land, the assessor will determine and record both its market value and the value of its capacity to produce agricultural products.

When an assessor calculates the amount of tax due on the land, he/she will also calculate the amount that would have been required had the land not benefited from an agricultural exemption. The difference in the amount of tax imposed under the exemption and the amount that would have been due without an exemption is called the additional tax for that year.

If land that has been designated for agricultural use in any year is sold or diverted to a nonagricultural use, it triggers a rollback tax. The taxes due under this provision include the total amount of additional taxes for the three years preceding the year in which the land is sold plus interest at the rate provided for delinquent taxes. This rollback tax is in addition to the larger, non-exempt tax burden moving forward from the sale.

The chief appraiser determines whether the land has been diverted to a nonagricultural use. A tax lien attaches to the land on the date the usage change occurs to secure payment of the additional tax imposed, as well as any penalties and interest incurred if the tax becomes delinquent.

The lien favors all taxing entities for which the additional tax is imposed. If the usage change applies to only part of a parcel, the additional tax applies only to that portion of the tract and equals the difference between the taxes imposed on that section of the property and the taxes that would have been imposed had that part been taxed on market value.

Monitor Exemptions 

The county appraisal district may have incomplete or incorrect information about a particular property's change in use. It could be that the use is diverting from agricultural use to wildlife management, and the exemption may still apply. This means that an agricultural exemption could be erroneously removed from a property that would still qualify.

This happens most often when a change of ownership and a deed newly recorded with the county triggers the removal of the special valuation. Owners must be diligent in submitting to the county a new application for agricultural or wildlife management use by April 30 of each year to ensure that their exemption stays in place.

Review Annual Assessments

Landowners should not grow complacent about protesting assessments annually. If agricultural owners don't file protests to keep their assessed land value down year over year, they may be on the hook for more taxes when they sell the land to a developer.

A taxpayer may protest a property valuation each year for the current tax year, but many Texas counties do not increase land values every year unless property transactions prompt them to do so. Few taxpayers protest when their assessments do not increase from the previous year, and the protest process is even more likely to be overlooked when the landowner has an agricultural exemption.

Repercussions for the landowner become apparent when they receive a compelling offer to sell. The landowner may make a sweet deal with a developer, but this will always trigger a change of use and the rollback tax. The buyer and seller will need to reach an agreement about satisfying the tax payment upon closing.

This becomes even more difficult for the landowner to manage if their properties are in counties that do not send a notice of appraised value when the value rolls over unchanged from the prior year. Therefore, it is still important and worth the effort to protest the valuation of agricultural land each year, even when the value is unchanged or minimally increased.

To accurately forecast potential property tax liabilities for development projects, landowners and developers alike must be aware of both the taxable and market values of land under consideration for sale or development. The rollback tax provision can be a bit complicated, but the right property tax team can help to navigate the process and avoid pitfalls that could disrupt the project's profit potential.