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Jul
22

Use Vigilance To Lower Tax Assessments

A firm understanding of how assessors apply market data locally comes in handy for savvy owners.

The real estate market is flourishing, as articles in Heartland Real Estate Business seem to confirm. Recent headlines such as “General Contractors are off to a Running Start,” and “Speculative Industrial Construction is Making a Come Back in St. Louis Market,” certainly are encouraging to readers.

But investors must remain diligent in keeping their assessed property values in check, or risk paying for their complacency later.

By monitoring assessments and challenging them when necessary, taxpayers can maximize profit and stay competitive when the cycle inevitably reaches its peak and the market begins to slide.

To minimize taxes, every taxpayer should understand the property tax system. That requires a grasp of local market dynamics and how assessors apply market data in establishing assessments.

Real estate taxes are merely a function of the tax rate multiplied by the assessment. The assessment is the measure that, if applied equally, and based solely upon bare real estate, that measure will yield uniform taxation for you.

Assessments tend to follow Newton’s law of inertia. Sales often set assessments in motion, but that doesn’t mean that sale prices always lead to assessments.

Price Versus Value

Too often, assessors confuse price with taxable value. Assessed or taxable value should be based on real estate alone. Sale prices, on the other hand, often reflect other factors that greatly affect the sale.

For instance, the business acumen of tenants and property managers often influence commercial property prices.

The lodging industry has an abundance of business and personal property value that is often difficult to distinguish from real estate value.

Hotel buyers are often purchasing in-place contracts, a workforce, personal property, reservation systems, the reputation of food and beverage providers, and other intangible items. As a result, the business value of a hotel tends to fluctuate more rapidly than the actual value of the “bricks and sticks.”

Because these intangible elements are factored into the sale, an assessment that is later based on the sale price will reflect more than the real estate value, unless the taxpayer takes the right steps to prevent that from happening.

What to look for

It is possible to strip away non-taxable components and turn a sale into a useful indicator of market value. An assessor can rely on a properly adjusted sale in the assessment of the subject property, and when valuing comparable properties. But what is the proper method of adjustment?

Excluding intangibles from taxable value can be an elusive goal. Investors often place tremendous value on the credit-worthiness of tenants, length of lease terms and other non-real-estate items. Those components depend on the occupant’s business rather than upon the location or condition of property improvements.

For assessment purposes, sales must be adjusted to reflect what the price would be if the tenant were a typical market tenant, paying market rent under current market lease terms.

State nuances

Taxpayers should consider not only the sale itself when evaluating for assessment, but also the particular state’s laws concerning assessments. For instance, Ohio recently amended its statutes to preserve it in assessments. Prior to the amendment, an assessor “must” have considered a recent sale price to be the new assessment of the property, regardless of any non-real-estate factors that might have affected the sale price.

Under the amended statute, assessors “may” use the sale, assuming that the sale reflects the “fee simple as if unencumbered value.” Thus, Ohio now takes a more nuanced approach, assessing properties based on market rents rather than in-place contract rents, along with the intention that assessors use market occupancy and market creditworthiness in assessments.

Taxpayers in other states have challenged assessment statutes to achieve more equal and taxation. Courts in Michigan addressed the concept of build-to-suit leases and contract rents, which the initial tenant pays in part to repay the developer’s costs, making contract rents incomparable with market rents.

Michigan now requires assessors to utilize market rents and other market indices to determine market value. Likewise, courts in Kansas and Wisconsin have established case law recently that requires more equal and assessment practices.

While there may be similarities between some states regarding their assessment laws, and a general trend of states moving toward more assessment, all states apply their laws differently.

Taxpayers must give due care to their state’s distinct approach.

KJennings90J. Kieran Jennings is a partner in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jul
13

The Logical and Proper Determination of The True Cash Value of Big Box Stores

I. The Valuation Problem
 
In Michigan, the property tax valuation standard is true cash value (“TCV”), statutorily defined as “usual selling price” (MCL 211.27). There are no exceptions. The valuation standard applies to all taxable property including, for example, apartment complexes, office buildings, shopping centers, single family homes and the subject of this article: “big box retail stores.” As used in this article, big box retail store means the real property comprising an existing free standing retail store with a building area of approximately 80,000 square feet or more.

It is imperative that value to the owner not be substituted for TCV (i.e. usual selling price or market value). In Rose Bldg Co. v. Independence Twp. 436 Mich. 620; 462 N.W.2d 25 (1990), the Michigan Supreme Court held:

The Constitution requires assessments to be made on property at its cash value. This means not only what may be put to valuable uses, but what has a recognizable pecuniary value inherent in itself, and not enhanced or diminished according to the person who owns or uses it. [Emphasis in original.]

Before a big box store’s usual selling price can be concluded, the identity of the interest in the property being appraised must be identified. Different interests in any given property can have significantly different values. Paraphrasing well-known author and real property appraiser David Lennhoff, “you can’t get the right value unless you value the right rights.”

This article focuses specifically on owner-occupied big box stores. Because the properties are owner-occupied, there is no lease in place and no leased fee interest. TCV for owner-occupied property is based on the fee simple interest in the property. Fee simple interest is defined as follows:

Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat. The Dictionary of Real Estate Appraisal (5th ed., 2010).

Thus, this article discusses the usual selling price of the fee simple interest in an owner-occupied large free standing store real property, unaffected by the person who owns or uses the property.

II.    Big Box Stores Are All Built To Suit And Not Built To Thereafter Be Sold Or Leased.

The above section of this article addressed the legal principles governing the TCV of big box stores and other types of property. This section addresses ways in which big box stores are factually unlike most property types. Big boxes are all built to suit or custom built for a specific retailer’s business. They are either constructed by (1) a retailer or (2) for a retailer pursuant to a pre-construction contract whereby the retailer agrees to lease the property after construction under terms that allow the contractor to recover its costs and profit. Unlike many property types (apartment complexes, shopping centers, warehouses, office buildings, houses, etc.), big box stores are never built for the purpose of selling or leasing after construction is completed.

Although this gets us ahead of the story, the question should be asked why, unlike many other property types, are big box stores not built to thereafter be sold or leased. The answer is quite simple. Big box retail stores are custom built to accommodate a particular user’s image and marketing strategies. For reasons discussed below, no one could reasonably expect to profit from custom construction of a big box store and thereafter selling or leasing it in the market.

Although an existing big box store is most often clearly suitable for retail use by another retailer, the market tells us a buyer of the fee simple interest in an existing big box store, at a minimum, is going to make substantial modifications to the property. One not familiar with sales of fee simple interests in big box stores will ask why after sale of the fee simple interest in a big box store are big box store buildings either demolished or substantially modified when the building was suitable, as is, for retail use. The answer is that each big box store retailer has its own business image and desired store layout and design - façade, flooring, lighting, location of restrooms, etc. Each big box retailer wants all its stores to look alike and not like another retailer’s stores.

In short, the market tells us that when the fee simple interest in an existing big box store is sold or leased, one of two things almost always happens - (1) the building is demolished or (2) the building is substantially modified.

III. Valuation Of The Fee Simple Interest

Borrowing a quotation from the late William Kinnard, a professor, author, and well-known real property appraiser, “An appraisal is the logical application of available data to reach a value conclusion.” It is useful to keep this truism in mind when valuing property, including the fee simple interest in a big box store property.

A.    Sales Comparison Approach.

In valuing the fee simple interest of a big box store by the sales comparison approach, ideal comparable sales are fee simple sales of similar properties, i.e. sales of the same interest in property as the interest in the big box store being valued.

The Michigan Tax Tribunal has consistently used comparable fee simple sales of properties that were vacant and available when valuing a subject big box store. See Home Depot USA, Inc. v. Twp. of Breitung, MTT Docket No 366428 (2012), affirmed by the Michigan Court of Appeals in an unpublished opinion, Home Depot USA, Inc., v. Twp. of Breitung, Michigan Court of Appeals Docket No. 314301, (April 22, 2014) (“Petitioner’s selected comparables were vacant and available at the time of sale. The Tribunal finds that these sales best represent the fee simple interest in the subject property. Vacant and available at the time of sale is not an alien term: an appraiser’s analysis of exchange value must account for this eventuality. Not all properties transition instantaneously from seller to buyer like a light switch. Moreover, vacant and available for sale does not automatically present a negative connotation.”) (Emphasis added.)

As the Michigan Court of Appeals further explained:

The tribunal properly valued the properties by valuing the fee simple interest of the properties as if they were vacant and available. By comparing the subject properties to similar big box retail properties that were vacant and available, with various adjustments made to compensate for differences between the properties, Allen [taxpayer’s appraiser] was able to determine what the fair market value would be of the subject properties, if they were to be sold in a private sale, as required by MCL 211.27(1). Therefore, Allen’s sales-comparison approach properly valued the TCV of the fee simple interest of the subject properties.

Home Depot USA, Inc., v. Twp. of Breitung, unpublished opinion per curiam of the Court of Appeals, issued April 22, 2014 (Docket No. 314301).

Below are some common issues and errors in concluding to the TCV of the fee simple interest in big box stores using the sales comparison approach:

1.     Leased Fee Sales. A leased fee comparable may not be a valid indicator of a fee simple interest. Income producing real estate is often subject to an existing lease or leases encumbering the title. By definition, the owner of real property that is subject to a lease no longer controls the complete bundle of rights, i.e., the fee simple estate. The price paid for a leased fee sale is a function of the contract rent, the credit worthiness of the tenant, and the remaining years on the lease. If the sale of a leased property is to be used as a comparable sale in the valuation of the fee simple interest in another property, the comparable sale can only be used if reasonable and supportable market adjustments for the differences in rights can be made. The Appraisal of Real Estate, p. 323 (13th ed.); p. 406 (14th ed).

2.     Sale - Leasebacks. Sale/Leasebacks are typically financing transactions and always transactions between related parties, i.e. in addition to seller and buyer, the parties are tenant and landlord to each other. Thus, a price paid for a sale/leaseback comparable sale is typically based upon a financial transaction not reflective of the fee simple interest value and is always a transaction between related parties.

3.     Expenditures after sale. Misapplication of reimaging costs as “expenditures made immediately after purchase” results from failure to make a logical application of available data.

a.     It is appropriate to adjust a comparable sale price for expenditures that “have to be made” when such expenditures do not have to be made for the subject property

b.     It is not appropriate to adjust for expenditures made after the sale to “reimage” or customize the big box store for the buyer’s specific business purposes. An adjustment for a buyer’s expenditures after sale are erroneously included when the subject has the same or similar physical features and condition because both the comparable sale and the subject would typically be modified to satisfy the buyer’s business plan and image.

4.     Zoning and Deed Restrictions. Real property in Michigan is restricted in use by zoning. Other means of restricting a property’s use also exist. One is deed restrictions. A deed restriction, like a zoning restriction, may have a negative effect on a property’s value. However, like a zoning restriction, a deed restriction may not affect a property’s value. Where a deed restriction exists on a comparable sale property, it is appropriate to determine if the restriction caused a diminution in price when considering using the sale as a comparable sale to value a subject big box store property. However, typically when big box stores sell with a deed restriction, the restriction is negotiated as part of the sale so as to not affect the buyer’s intended use of the property and does not affect the sale price for the property.

5.     Highest and Best Use Issues. The highest and best use (“HBU”) of an existing owner-occupied big box store is likely going to be for retail use. In valuing big box store real property by the sales comparison approach, ideally each improved comparable sale would have the same or a similar HBU as the improved subject property. The Appraisal of Real Estate, p. 43 (14th ed. 2013). A big box store comparable sale not purchased for the subject’s same or similar HBU (retail) should be investigated to determine what evidence it provides about the value of the subject big box store property.

For example, if the improved comparable sale is physically comparable and suitable for retail use but the property sells for a use other than retail, the sold property’s HBU (as reflected by the sale) may not be even similar to subject’s HBU - retail. When that sale is used as a comparable sale without adjustment for this fact (but appropriate other adjustments), its use may result in overvaluation (but not an undervaluation) of the subject. If the comparable sale property suitable for retail use was offered for sale in the market and not bought for retail use, then the comparable property’s selling price for retail use (the subject property’s HBU) would have been equal to or less than its selling price for some other use - this is simply a logical application of available data.

B.    The Income Approach.

The most contested issue involving the valuation of the fee simple interest in big box stores by the income approach is typically the determination of market rent. To the extent the Tribunal has relied on the income approach to value these properties, it has considered only arms length transactions between unrelated parties resulting in agreed upon rent for an existing building not rent for a non-existent store to be built to a tenant’s specifications. The subject of this article is existing big box stores and not stores to be built. Rental terms from build-to-suit leases and sale/leaseback transactions would not reflect market rent (except by accident). Similarly, landlord provided tenant improvements or tenant improvement allowances so the tenant can reimage or reconstruct space for its business purposes must be adjusted from stated rent for a rent comparable so that the concluded market rent is for the subject property as is (without additional rent that may be realizable by the landlord for providing for more than the subject property, e.g. a landlord provided tenant improvement allowance).

C.    The Cost Approach.

1.             The Cost Approach to value big box store properties is generally agreed to by appraisers to be inapplicable due to the fact that it is not used by buyers and sellers and because of issues relating to the quantification of total depreciation. If used, then replacement cost is the basis from which all depreciation must be deducted. Quantifying this depreciation including, proper functional obsolescence and external (economic) obsolescence determinations, typically must be done through information obtained through comparable sales and/or income approach:

2.             Comparable Sales can be used to derive market extracted depreciation.

3.             Income deficiency or capitalization of rent loss (the difference between rent at market and the rent required to justify investment based on cost new) can also be used.

Big box store real property TCVs are adversely impacted by substantial obsolescence. The question has been asked why do the fee simple interests in big box store properties sell for so little as a % of cost new? There are multiple explanations for this market fact which are generally applicable regardless of the property’s age:

a.         All freestanding big box stores are custom built for the original owner’s business purposes and business model and the modified cost for a buyer’s business model/image is expensive.

b.         Upon sale, at a minimum, there is modification for reimaging (when the building is not demolished). (Sometimes the modification is for a use other than retail.)

c.         Fast growing e-commerce sales - In general, even big box retailers are not building new stores and when they are building, they are generally constructing smaller stores.

Significantly, the loss in value attributable to these obsolescence factors further explains why build-to-suit lease rental rates will typically be at rental rates above the market rental rate for an existing big box store property.

IV. Summary

In conclusion, the logical application of available data is required to answer the question: As of the valuation date, what is the usual selling price that would be paid for the fee simple interest in the subject existing big box store property?

The usual selling price is most appropriately determined from fee simple interest sales of similar existing properties and through market rent based on rents agreed to for other similar existing properties. The cost approach is generally not used. But when it is used, it would not likely provide a reliable result unless sales and/or income approaches to value are used to account for total depreciation.

districts in Ohio and Pennsylvania can come in and file their own tax appeal to raise the value of a given property." Landlords must diligently review property taxes yearly, looking at assessments based on current marketplace ' conditions, Shapiro says. "My clients are fighting assessments," he said, "because assessors were ignoring the function obsolescence of their properties, which in some cases meant a 50 percent reduction in value."

 

 

 

 

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Michael Shapiro is of counsel at the Michigan law firm Honigman Miller Schwartz and Cohn LLP. The firm is the Michigan member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

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Jul
08

Custom-Built Carrots: Attracting Growth Firms Calls for Smart Incentives

In the wake of the Great Recession, government initiatives to promote economic growth have varied widely across the nation. Some states targeted manufacturers, while others focused on technology companies and other high-impact, knowledge-based firms. A spirited debate has emerged on the role of economic incentives in these efforts.

Historically, Southern states have targeted manufacturers rather than knowledge-based companies as the engines of economic growth by offering tax incentives aimed at reducing costs. Manufacturers typically make substantial upfront capital investments and create large numbers of jobs. These companies quickly generate property tax revenue for the public coffers.

Knowledge-based technology companies and startups, however, seldom make hefty initial capital investments, nor do they create large numbers of jobs right away. Rather, these employers tend to offer fewer, but higher-paying, jobs that have a greater impact on the economy than an equivalent number of manufacturing positions. As a result, traditional tax breaks linked to job numbers and capital investment don’t appeal to knowledge-based companies, particularly startups that are not yet generating revenue.

The real target should be a category that is best characterized as "growth" companies. Regardless of sector, these companies include startups as well as more established companies that are increasing revenue at a high rate.

Most companies measure success by revenue and profit growth, not by numbers of employees, capital investment outlays or numbers of patents. One study notes that growth firms tend to be eight years old or less and most economists agree that startups will create the vast majority of future U.S. jobs.

Recent statistics suggest a one-size-fits-all approach to economic incentives may not be best. In May, the nation’s unemployment rate fell to a seven-year low of 5.4 percent; however, job growth during the past few years has been remarkably uneven. Fourteen states have rebounded strongly, with employment increasing 10 percent or more from Great Recession lows. Top performers include Texas and Utah, where unemployment has risen more than 15 percent, and California and Colorado, where employment is up more than 13 percent. Knowledge-based jobs are a critical component to employment growth in these states.

In contrast, total employment in 10 primarily industrial states has grown just 5 percent or less from Great Recession lows.

Cutting Costs, Growing Jobs

Nevertheless, manufacturing jobs have been an important component of the recovery. Some states that have enticed manufacturers by offering lower production costs have been among the leaders in the comeback. For example, employment increased about 11 percent in South Carolina, 10.5 percent in Georgia, and 9.9 percent in North Carolina. These states all created an attractive business environment in part by taking steps to cut costs, such as taxes on capital investment.

One of South Carolina’s main incentives has been a fee-in-lieu-of-taxes agreement (FILOT), which targets property taxes. A participating company negotiates the agreement with the county where the company is locating or expanding its facility.

Generally, a FILOT agreement enables companies investing at least $2.5 million in a new facility or an expansion over a five-year period to cut their property taxes by about 40 percent annually. A FILOT typically lasts for a set term of 20 to 30 years.

To calculate property taxes, South Carolina calculates uses according to the following formula: property value x assessment ratio x millage (or tax rate) = tax. A FILOT can reduce the assessment ratio of a manufacturing facility from 10.5 percent to 6 percent, and sometimes to as low as 4 percent.

FILOTs may also set the millage rate for the duration of the agreement or modify millage every five years. Any personal property subject to the FILOT depreciates. The approach to assessment is similarly variable. The FILOT agreement either sets the property’s value at cost for the agreement’s entire term or permits an appraisal every five years. That provision offers an opportunity to revisit the property’s value even during the life of the FILOT.

While clearly attractive to a manufacturer, a FILOT is less appealing to knowledge-based and technology firms, since these companies are unlikely to make substantial initial capital investments.

Structuring incentives for knowledge-based firms poses unique challenges. These employers invest significantly in non-tangible intellectual property and hire highly skilled, highly paid employees. Income tax credits can be attractive if those companies are making a profit, but those credits have little appeal for a startup that is losing money while the market determines whether the company’s product is attractive.

Economic development cannot focus on manufacturing to the exclusion of knowledge based jobs. In his book The New Geography of Jobs, Enrico Moretti notes that each new high-tech job creates five additional jobs out-side the high-tech sector. He argues that the “innovation” sector has a disproportionately larger multiplier effect than manufacturing. That means one of the best ways for a state to generate jobs for less-skilled workers is to attract technology companies that hire highly skilled employees.

Attracting knowledge-based companies requires creation of the critical mass of firms and workers needed to sustain a truly competitive, often self-sustaining, high-tech ecosystem. That ecosystem, in turn, re-quires a landscape that is culturally vibrant, economically robust and entrepreneurial. These qualities are essential to attracting, engaging and retaining the young talent that contributes so heavily to the knowledge-based economy.

Innovative Manufacturing

In the 21st century, innovation isn’t restricted to knowledge-based companies. Manufacturers must also innovate to expand revenues and profits and to respond to changing opportunities. The recovery from the Great Recession has shown that states must look beyond conventional incentives and tailor their strategies to the competitive needs of the companies that are investing capital and creating jobs.

Smart companies, economic development officials and policymakers should focus on growing revenues and profits, not incentives. Despite the differences between the manufacturing and knowledge-based sectors, their workforces are central to both. With that in mind, employers should strive to build the innovative, flexible and adaptable workforce that is a key to growth.

All too often, however, conventional incentives and development strategies fail to address these concerns. Physical infrastructure does not attract and retain employees; opportunity does. Smart economic development is about increasing income for both companies and workers and encouraging innovation. Smart incentives should do the same.

ellison mMorris Ellison is a partner in the Charleston, S.C., office of the law firm Womble Carlyle Sandridge & Rice LLP. The firm is the South Carolina member of American Property Tax Counsel, the national affiliation of property tax attorneys. Morris Ellison can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jun
30

Retail Property Tax Valuation Debate Heats Up in Hoosier State

Indiana has become the latest battleground in the debate over how assessors should value retail real estate and other commercial properties for property tax purposes. The debate’s conclusion will likely affect owners of retail, office and even industrial properties in Indiana, and may affect taxpayers grappling with similar issues in other states.

At the heart of the debate is the question of what assessors should value under Indiana’s market value-in-use standard. Though that term can seem somewhat puzzling, the Indiana Supreme Court has stated that any valuation standard must be based on objective data while also protecting Indiana taxpayers who choose to use their properties at something less than full market potential.

How is market value in-use different from market value? In many if not most situations, they are identical. Where a property is being used for its highest and best use, the property’s market value-in-use will be the same as its market value.

Because a property can be used for something less than its highest and best use, however, its market value-in-use may be lower than its market value. This is the case in the example of agricultural land surrounded by commercial development.

A property cannot be used for something greater than its highest and best use, however; by definition, nothing is higher or better than the highest and best use. Accordingly, a property’s market value-in-use cannot exceed its market value.

Importantly, market value-in-use does not mean the value to the individual user. This distinction may seem like mere semantics, but how the state defines market value-in-use affects many commercial taxpayers. A series of Indiana cases show why.

Since at least 2010, when the Indiana Tax Court issued a pair of decisions addressing the meaning of market value-in-use, Indiana has recognized that market value-in-use as determined by objectively verifiable market data, is the value of a property for its use, not the value of its use to the particular user.

Indiana courts also recognize that in markets where both buyers and sellers frequently exchange and use properties for the same general purpose, a sale often indicates value. The Indiana Board of Tax Review has affirmed and applied these rulings in subsequent cases, including a pair of decisions issued in December 2014 involving big-box retail stores.

These decisions followed longstanding precedent from the Indiana’s Tax Court and kept Indiana in line with the overwhelming majority of other states that have considered the question. Had the board instead agreed with the assessors’ interpretation of market value-in-use as being the value of the use, it would potentially have created a number of anomalous outcomes, including similar properties being assessed differently based on the property owners’ characteristics and not on the properties’ characteristics.

Following the board’s decisions, local governments petitioned the Indiana legislature to change the valuation standard for commercial properties. After a heated debate, legislators left the market value-in-use standard unchanged but amended the property tax statute to modify the evidence available to prove a property’s value, based on the facts of the case.

It is too early to know the full ramifications of the new statute. Assessors’ repeated attacks on the market value-in-use standard, however, will produce one certain result, Taxpayers that own property in Indiana or are considering doing business there will face increasing uncertainty. For that reason, taxpayers must monitor their assessments to ensure fairness as the debate continues.

paul Ben Blair jpgStephen Paul is a partner and Benjamin Blair is an associate in the Indianapolis office of the law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of American Property Tax Counsel. They can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. or This email address is being protected from spambots. You need JavaScript enabled to view it..  The views expressed here are the authors' own.

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Jun
30

Weigh Anchor Inducements To Sink Property Tax Bills

Anchors weigh heavily in tax decisions

As the post-recession recovery for retail properties continues, local assessors are eager to increase shopping center tax assessments to their pre-recession highs or beyond. But regional and super-regional shopping centers are among the most complex types of real estate that assessors regularly value, and that complexity yields errors.

By failing to remove the value of an often-overlooked intangible asset, assessors are improperly attributing excess income to the real property, resulting in excessive tax assessments. This error stems from assessors incorrectly answering one of the most fundamental questions in property assessment: What property is being valued?

Too many assessors look at the income generated by a shopping center and conclude that the income is entirely attributable to the real estate. But the value of a shopping center's going concern is not equal to the market value of its real property. Unless the assessor makes an effort to extract the non-real-estate components, the value indications under the income and sales comparison approaches to value will capture not just the value of the real property, but also non-taxable personal and intangible property.

AGREEMENTS ARE INTANGIBLE

One major non-realty component of a shopping center's value is its operating agreements with anchor tenants.

Shopping centers depend on their anchor tenants for more than rent, Anchors typically make major advertising expenditures to draw customers to the property. As a result, customers ordinarily visit the mall with the initial purpose of shopping at the anchor retailer, and only then venturing out into the rest of the mall, which is typically the domain of more specialized retailers.

Shopping centers with better-quality anchors are able to draw more customers and charge higher rents to inline tenants. The presence of high-quality anchors also conveys stability, which attracts potential inline tenants. Conversely, when a mall loses one or more of its anchor tenants, inline tenants almost always follow the anchor, and the landlord must offer larger concessions to attract replacement tenants.

Beyond helping to attract and retain inline tenants, high-quality anchor tenants contribute indirectly to higher income generation for the shopping center. Because shopping centers often collect percentage rent, or rental income based in part on an inline tenant's retail sales, the long-term presence of an anchor that draws customers is vital to a mall's long-term financial success.

Shopping center developers typically ·offer significant inducements to attract and retain anchor tenants, and to convince those tenants to sign favorable long-term operating agreements. These inducements may take the form of cash, a preferred site, site improvements, or reduced expense recoveries, and may occur both upon the initial development of the shopping center and during redevelopment ·

Whatever the form and timing, shopping centers have to subsidize the anchor's costs. The shopping center gets a return on this investment over the lifetime of the tenancy in the form of higher in-line rents.

Because the higher rental income from in-line tenants is, in part, a byproduct of the anchor operating agreements rather than a reflection of the real estate value alone, it is inappropriate to attribute the entire income stream to the real property. But when assessors use the total income of the shopping center's business in their calculations, they implicitly value the total assets of the business, rather than the real property alone.

PROPER ASSESSMENT TECHNIQUE

To properly value just the shopping center’s real property, the income attributable to the favorable anchor operating agreements must be subtracted from the ' shopping center's total income prior to capitalization.

The calculation of the income attributable to anchor inducements is a two-step process. First, the appraiser must determine the value of the anchor inducements, accounting for both a return of the initial investment and a return on that investment that would be expected by developers in the market. There is no one-size-fits-all method of determining the amount needed to induce a particular anchor tenant. Every shopping center owner has its own method of determining how much it should pay in inducements to potential anchors given the location, size, age, design, and tenant distribution of the shopping center.

Whatever method is used to determine the value of the favorable contracts, it is important that appraisers select values that reflect inducements actually provided by market participants. For that reason, it is important that taxpayers contesting assessments select appraisers who have experience with shopping centers and who understand the dynamics of that industry.

ANCHOR INDUCEMENTS

Once the assessor calculates the total return of and on the inducements, the second step in this process is to determine the income attributable to those inducements. To do this, the appraiser must amortize the total return over the term of a typical anchor agreement – generally 10 to 15 years – at a yield rate high enough to account for the fact that intangibles are the highest-risk components of a business enterprise.

The appraiser will then subtract the resulting figure from the going concern's net operating income, along with return of and on personal property and other non-real-estate expenses, such as start-up costs. The result will be the net income from the real property alone, which is the correct base for the income approach for property tax purposes.

For most retail properties, the largest expense after debt service is the property tax bill. Any reduction in the tax burden can drastically impact a property's profitability, and a reduction in property taxes passed through to tenants can itself be a method of attracting and retaining better-quality tenants. So as the retail market continues its slow recovery, proper treatment of anchor agreements may be a way to keep from drowning in excessive property taxes.

paul Ben Blair jpg

Stephen Paul is a partner and Benjamin Blair is an associate in the Indianapolis office of the law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of America Property Tax Counsel.  They can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it. or This email address is being protected from spambots. You need JavaScript enabled to view it.. The views expressed here are the authors' own.

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Jun
26

Big-Box Retail Offers Property Tax Lessons for Industrial Owners

Taxing jurisdictions have struggled to properly value big-box retail buildings for many years, and the potential for improperly assessing the real estate value of these buildings remains high. Yet the ongoing dance between big-box owners and assessors provide useful insights for property owners in other commercial property types, particularly industrial.

A big box of confusion

Assessing the taxable value of a big-box retail property touches on many of the hot-button issues in property tax law. Some of the circumstances that often lead to incorrect tax assessments include development of big-box retail under build-to-suit arrangements, in which the tenant’s rent is a contractual repayment of the developer’s costs, rather than a market-rate rent. Big-box tenants are often creditworthy national companies under absolute net leases, valuable to a potential investor as a guaranteed income stream, but irrelevant to taxable value of the real estate.

The sale/leaseback transactions that big-box retailers often enter to free up capital for business operations, and the strong investor demand to buy buildings leased on a net basis to a single user that handles all property expenses, can all lead to incorrect tax assessments. Many assessors value the wrong interest, confused over whether to reflect investment value, leased-fee interest, fee simple interest, or value in use versus value in exchange.

The potential for improperly capturing non-taxable items in the property tax assessment is high. Often assessors and appraisers lack sufficient education about the nuances of valuing these types of properties. Depending on whether a tax assessor adopts the correct methodology, the difference in both value and tax liability can be significant. And for cash-strapped governmental entities, there is a strong inclination to try to capture as much taxable value as possible.

Implications beyond retail

Owners of non-retail property types shouldn’t dismiss these valuation issues as pertaining only to big-box retailers. Consider the potential for similar valuation errors with other single-tenant properties developed and exchanged in a similar way. A corporate headquarters building with “superadequacies” - or features only valuable to that particular tenant - is particularly vulnerable to overvaluation, for example.

In Ohio, the state tax appeal board recently dealt with that scenario, related to a large industrial building. The property was constructed to a national bank tenant’s unique specifications for its use as a data center, with gated entrances, impact-resistant windows, raised floors with subfloor cooling, battery backup rooms, and fire-suppression systems. The tenant had specific security needs based on its use, and had the building constructed to protect servers from weather events.

The two expert appraisers involved in the case concluded to drastically different overall values. One appraiser viewed the building as used for general office or warehouse space, and did not perform a cost -approach analysis because of the large degree of economic obsolescence related to a single-tenant industrial building used as an operations center.

The other appraiser posited that the building was unique, rather than tailored to the use of that particular tenant. That conclusion led the appraiser to use out-of-state sales for comparison in his analysis and to develop a cost approach. The resulting difference in the conclusions of value was $8.38 million, and the appeals board adopted the higher value.

According to the current appeal pending at the Ohio Supreme Court, more than half of the property was basic office and warehouse space; and the tenant only used a small portion of the remaining space for its specific purpose: a data center.

A recent Pennsylvania case involved a large, industrial, single-occupant, mixed-use property that consisted of an office building, a conference center, and a third building used for offices, research and development, and manufacturing, all constructed at different times. Again, the value conclusions and appraisal methodologies of the experts differed significantly.

Similar to the Ohio case, one appraiser viewed the property as a special-purpose facility with a limited market. Both appraisers developed cost and sales comparable approaches to value, but the appraiser who viewed the property as special-purpose put more weight into a cost-based conclusion, while the other put more weight on his sales-comparison approach.

Unlike the Ohio case, however, neither appraiser included the replacement costs of specific features that an entity replacing the facility would consider unnecessary, such as acoustic rooms, vibration floor slabs, special piping and chilling equipment.

As in assessments of big-box properties, this divergence in appraisal methodology and the definitions of the interest to be valued led to significant gulfs in the final tax assessments. Assessors are more likely to value properties deemed to be special-purpose with primary reliance on the cost approach, with its inherent difficulties in accurately measuring all forms of depreciation and obsolescence, both functional and economic.

Traditionally, appraisers applied this special-purpose classification to properties that did not readily transfer in the open market-houses of worship, sports arenas, schools. Additionally, primary reliance on the cost approach lacks the built-in market “check” that is present when using data from actual sales and rent transactions that have occurred in the marketplace. Even if not considered as special use, improvements only valuable to the current user can be improperly included in the assessment. Rather, the assessor should measure the value-in-exchange, and avoid cherry picking data for comparables.

Avoid complacency in industrial

The U.S. industrial real estate market is booming, with Los Angeles and the Inland Empire standing out as particularly hot markets, according to Diana Golob, managing director at Hanna Commercial Real Estate in Cleveland, Ohio, who represents both U.S. and European multinational firms. Speculative development has even started to reappear in multiple markets.

Do not let the good news of a thriving market create a blind spot when it comes to reviewing property tax assessments.

In the retail context, jurisdictions are still identifying the correct interest to be valued for real estate tax purposes, and the best appraisal methods to do so. Courts, legislatures, tax assessors and independent appraisers are all grappling with these nuanced issues.

It appears that owners of single-tenant, net-leased or owner-occupied industrial properties will be dealing with similar assessment issues. The applicable assessment law is in flux and sometimes is the polar opposite from one jurisdiction to the next.

It is vital to consult with professionals, familiar with both the legal and appraisal complexities of the jurisdiction, to determine whether a property tax assessment is fair. With a few changes, an expression from psychologist Abraham Maslow is appropriate here: Do not view every assessment challenge as a nail because you only have a hammer in your belt; make sure you have the right tool - for the right assessment approach - for the job.

Cecilia Hyun 2015

Cecilia Hyun is an associate attorney at the law firm Siegel Jennings  Co, L.P.A., which has offices in Cleveland and Pittsburgh.  The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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May
30

A Valuable Lesson

Look beyond value to ensure correct property tax assessment.

Many taxpayers pay close attention to property tax values, and rightfully so. Property owners can realize significant tax savings by successfully challenging excessive assessed values.

Yet taxpayers often overlook equally important assessment issues that can be costly if ignored. A prudent real estate investor always confirms that its real property is assessed correctly, meeting the local assessment authority's requirements and deadlines. That prudent investor also makes a point to understand the tax assessment consequences of any purchase, sale or improvement of real property.

Know Your Responsibilities

What can go wrong with an assessment, aside from the valuation? In one common scenario, a new property owner may miss the deadline to protest a property tax assessment because tax notices went to the previous owner. Having the property correctly assessed in the owner's name is usually necessary to receive copies of tax bills and valuation notices, so a buyer should confirm whether the first property tax bill and valuation notices after closing will be sent to the buyer or to the previous owner. A missed protest or payment deadline will not be excused because the new owner did not receive such notices, especially if the taxpayer failed to properly have the property assessed in its name.

In some jurisdictions, the buyer may need the seller's written authorization to file a value protest if the applicable valuation or lien date preceded closing of the sale. If that is the case, the buyer should obtain the necessary authorization, at closing if possible. The document should authorize the new owner to file the protest in the name of the seller if required.

As part of due diligence, the purchaser should understand how the property has been assessed in the past and what effect the purchase will have on its future assessment. Don't assume the assessment will be unaffected by the sale.

Here are several other property tax issues to consider when purchasing or developing real property:

  • Is the sales price likely to affect the tax value?
  • When does the tax authority send valuation notices, and when is the deadline to file a protest?
  • Will the purchaser's use of the property constitute a usage change that will trigger a higher assessment?
  • Is the property subject to exemptions or abatements? Will the new owner qualify for exemptions, and what are the required steps to secure them?
  • Is the property tax proration calculated correctly? If based on an estimate, will the taxes be re-prorated to reflect the final tax bill?
  • If part of a larger parcel, when will a new tax parcel be created? Who will pay the taxes until separate parcels are created?
  • Are all of the existing improvements properly assessed, and if not, what is the risk of an escape assessment, or a retroactive correction in assessed value that may require the payment of back taxes?
  • Does the state assess and tax construction work in progress?

A well-drafted contract can address some of these issues. For example, the contract may determine the party responsible for paying any rollback taxes based on the change in use, such as a change from agricultural use to retail.

If new construction occurs, the taxpayer should know of any legal requirements to have the improvements assessed. For instance, Alabama law requires the owner to assess any new improvements constructed during the preceding tax year. Failing to do so can add a 10 percent penalty to the tax value of the improvements. Further, the county assessor can go back up to five years and issue an escape assessment for the unassessed improvements, plus additional penalties and interest.

Personal Property

Real estate investors must also investigate the personal property assessment procedures in each state where they do business. Taxpayers should review personal property returns for accurate information, such as the acquisition date and cost. Regularly review the taxpayer's list of personal property to remove items sold or discarded before the valuation date. Timely file all exemptions, and review tax bills annually to confirm the benefit of any such exemption.

A prudent real estate investor must pay close attention to assessment requirements and procedures or risk unexpected taxes, penalties and interest, or missed opportunities to protest excessive property tax values. By consulting knowledgeable local professionals, an investor can ensure that its real and personal property are being correctly assessed and that the assessor has applied all exemptions or value adjustments.

  adv headshot resize Aaron D. Vansant is a partner in the law firm of DonovanFingar LLC, the Alabama member of American Property Tax Counsel (APTC) the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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May
29

What's The Basis For Your Assessment?

Assessors must value only the 'sticks and bricks,' not the business enterprise.

What can Indiana assessors value for property tax purposes? The answer is simple – the fee simple interest and nothing more. Yet assessors stray from that straightforward rule with alarming frequency.

In valuing land and improvements, assessors are not permitted to assign value to personal property; that is assessed separately. They also must refrain from assessing intangible assets – which are non-taxable – or the business operations conducted on or within a property. Profits may be subject to corporate income tax, but not property tax.

The fee simple interest is the absolute, unencumbered ownership of the real property, the sticks and bricks, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.

A fee simple interest means the owner retains the right to sell, lease or occupy the property. If the assessor values more than the fee simple interest, he or she has gone too far. Such assessments are not only erroneous as a matter of law, but also bad public policy because they result in double or otherwise illegal taxation.

Establishing Precedent

The Indiana Board of Tax Review, which oversees property tax appeals at the state level, has recognized that the market value and market value-in-use standards do not permit “assessors to assess things other than real property rights for ad valorem taxation.” In fact, the Indiana Tax Court has dismissed assessors’ efforts to value more than a property’s fee simple interest.

In 2013, the court rejected an assessor’s reliance on above-market contract rents to establish a commercial property’s value. The taxpayer based its rents on sale-leaseback transactions, which included an investment component, and thus sold more than ownership rights in property.

In an earlier ruling, the court agreed that “one should approach the rental data from [sale-leaseback] transactions with caution, taking care to ascertain whether the sales prices/contract rents reflect real property value alone, or whether they include the value of certain other economic interests.”

Indiana law requires assessors to determine a property’s true tax value, which for property other than agricultural land means the “market value-in-use of a property for its current use, as reflected by the utility received by the owner or by a similar user, from the property.”

Too often assessors misunderstand and misapply this standard by seeking to value the taxpayer’s specific, on-site business operations.

Profitability is Irrelevant

Even if the taxpayer’s business is successful, the building in which its business is regularly conducted must be valued no differently than a similar, vacant building. Consider this ex-ample:

In an industrial park, two 10-year-old buildings sit side-by-side, identical in size, shape, condition, construction materials and workmanship. The same external or economic factors impact both properties’ values.

On the assessment date, an extremely profitable business uses Building A at full capacity and around the clock. In contrast, Building B is vacant, though it had previously served the same general purpose as Building A. Despite the owner’s best efforts, no business is conducted on the property.

Objective, reliable market evidence undisputedly indicates that the true tax value of the fee simple interest of Building B is $1 million as of the date of value.

What is the indicated value of the fee simple interest of Building A? It’s (fee) simple: $1 million.

How can that be, especially when business is going gangbusters inside Building A? The answer is that we are not valuing that business activity. In an arm’s length transaction, assuming a fair sale occurs, a reasonable and prudent third party looking to acquire either building would pay no more than the value of the sticks and bricks – $1 million – regardless of the profitability or lack thereof of business operations conducted there.

Let’s further assume that the owner of Building A was instead the third-party buyer, faced with the same choice of two identical buildings, one vacant and the other occupied for profitable uses.

Even knowing with near certainty that its business operations would be remarkably lucrative, the buyer would not pay $1 more for either property than the market would bear. According to the market, both properties are valued at $1 million.

The buyer is not acquiring a trade name or workforce, or the seller’s trademarks, trade secrets, machinery and equipment, customer lists, licenses or contracts. It is acquiring land, a building, and yard improvements, and the value of those for both buildings is the same.

Nobody said determining the fair value of property is always easy. But in Indiana it should always be fee simple.

Brent Auberry

Brent A. Auberry is a Partner in the Indianapolis law firm of Faegre Baker Daniels LLP, the Indiana member of the American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..  

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May
21

Texas Extends Lucrative Tax Incentive

Program is designed to help entice companies and developers to the state.

Economists anticipate unprecedented capital investment in Texas over the next few decades, and tax jurisdictions in Texas are no doubt eager to take advantage of this influx of capital. Increasing property tax rates and limited manufacturing and construction resources have hampered Texas' economic development efforts on the ever-competitive national stage, however.

So, in the spirit of the Texas Economic Development Corp.'s "Texas Wide Open for Business" marketing program, lawmakers have extended two of the state's most popular and lucrative tax incentives programs in order to entice companies and developers here. Those incentives are property tax abatements and a program to temporarily limit increases on the appraised value of capital investments at properties taxed by school districts. Many companies have already discovered that the best way to reduce the property tax burden during early project investment years is through local property tax incentives. But what do these programs offer, and who should  use them?

The recently renewed Chapter 312 of the Texas Property Tax Code, also known as the Property Redevelopment and Tax Abatement Act, allows the taxpayer and local taxing unit to create agreements exempting all or part of an appraised property value increase from taxation for up to 10 years.

This incentive promotes economic development in the state through major capital investment, job creation, job retention and the utilization of existing local vendors. Property owners often seek abatement incentives for projects ranging from retail shopping centers and distribution warehouses to natural gas processing plants and wind farms. Local taxing units that wish to provide property tax abatements must state their intent to provide the incentive, and then adopt abatement guidelines and criteria. Typically, abatement guidelines and criteria reflect the specific needs of the taxing unit. Therefore, abatement guidelines and criteria, such as minimum investment amounts and/or the number of jobs to be created, often vary from county to county. A company considering investment in Texas should research proposed sites in advance to confirm that the potential project meets local abatement guidelines and criteria.

The Texas Legislature reauthorized the use of property tax abatements until Sept. 1, 2019. In 2001, the 77th Texas Legislature  enacted House Bill 1200 Creating Texas Tax Code Chapter 313, the Texas Economic Development Act. Under Chapter 313, a qualified applicant may apply to a school district for a limitation on the appraised value of their new capital investment project for 10 years. The limitation on the appraised value applies specifically to the school district's maintenance-and-operations tax rate, while its interest and sinking tax rate; or bond rate, applies to the full taxable value of the property. This program allows Texas school districts to increase their ad valorem tax bases by attracting large-scale capital investments, and creates desirable, well-paying jobs in the process. Recently, the 83rd Legislature extended the Chapter 313 Act through 2022 and added various rule changes, including the extension of the value limitation from eight to 10 years, and the inclusion of contractor jobs as counting toward job creation requirements for a project.

The Texas Comptroller's Economic Development & Analysis Division, however, is now required to verify that an eligible project will generate sufficient tax revenues over a 25-year period to offset the school district's maintenance-and-operations tax revenues lost as a result of entering into the value limitation agreement. Additionally, the Comptroller must also find that the value limitation incentive is a determining factor in the applicant's decision to invest capital and construct the project in Texas. Reviewing any potential incentive project with an experienced tax professional; offers the best opportunity to create an effective property tax strategy.

Blas Ortiz jpgBlas Ortiz is a tax consultant with Texas law firm of Popp Hutcheson PLLC. The firm devotes its practice to the representation of taxpayers in property tax disputes and is the Texas member of the American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. Ortiz can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

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May
05

Property Tax Assessments Spiral Out Of Control In New York

Massive assessment hikes in New York City confirm that Mayor Bill de Blasio intends to extract as much revenue as possible from real estate, one of the city’s most important industries. This will kill the golden goose underlying the city’s economic recovery.

The city released its tentative assessment roll for the 2015-2016 tax year on Jan. 15, 2015, revealing painful and substantial increases in market value for both residential and commercial properties. The city pumped up the value of residential properties by almost 11 percent, while driving up commercial assessments by 12 percent over the prior tax year.

These increases are nearly double the rate of increase effected by last year’s final assessment roll, where residential market values increased by 6.6 percent and commercial market values increased by 7 percent over the 2013­-2014 roll.

The compound effect of year-after-year increases is a crushing burden to owners and tenants, but the higher end of the commercial property spectrum was particularly hard hit in the latest assessment roll. Owners of trophy office buildings saw their market values spike by more than 31 percent over the prior year’s values.

Even worse, owners saw the market value of luxury hotels soar almost 65 percent over the previous year’s values for assessment purposes. The city is rough-handling these properties with mounting harshness on both sides of the income and expense equation.

As a result of the new citywide assessments, real estate taxes in the city continue to substantially erode owners’ and developers’ bottom lines. Based on an analysis of the most re­cent assessment roll, the percentage of income now dedicated to paying real estate taxes is so high that the city has essentially become a silent partner in these properties — without the inher­ent risks of ownership, of course.

Consider the example of a non-exempt Manhattan residential property, with annual net operating income of $1 million before real estate taxes. Factoring in the current municipal residential tax rate and the prevailing capitalization rates used by the City Department of Finance, our hypothetical property yields a taxable assessed value of approximately $3.6 million and a property tax bill of about $463,000.

That burden means the property owner in this example is paying 46 percent of his or her net income in real estate taxes alone. Even analyzing the numbers based on a gross income of $1.4 million (based on the Department of Finance’s most recent expense guidelines), city property taxes account for more than one-third of the property’s overall expenses.

The situation is similarly oppressive for commercial properties, although they currently enjoy a lower property tax rate and higher capitalization rates than their residential counterparts — at least according to the most recent New York City Department of Finance Assessment Guidelines. Utilizing a similar analysis to the residential example above, the owner of a midtown Manhattan office building with a net operating income of $1 million would be paying just under 40 percent of its net operating income and almost 30 percent of its gross income in real estate taxes.

Based on the de Blasio administration’s ever-increasing crusade for revenue, owners and developers can expect this trend to continue. However, there are a number of avenues for them to pursue in order to ameliorate the effects of this rapid and seemingly endless rise.

While the release of the 2015-2016 assessment roll may have upset many taxpayers, it also marks an opportunity. That’s because the roll’s release begins the process under which owners and developers can initiate challenges to their property tax assessments. Based on the situation described above, it is likely that most of them will be doing exactly that.

Owners must challenge their assessments by filing applications and supporting documentation to the New York City Tax Commission. The owner’s representative must prepare a detailed analysis of conditions at the property, an analysis of leasing and vacancy, and a carefully prepared set of comparable properties to support the relief sought.

The Tax Commission is the administrative agency charged with annually hearing owners’ real estate tax challenges. The agency has the power to offer a reduction in the challenged assessment. Owners who are dissatisfied with the results of this Tax Commission review are entitled to challenge their assessments in New York State Supreme Court.

JoelMarcusJoel R. Marcus is a partner in the New York City law firm of Marcus & Pollack LLP, the New York City member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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