Kieran Jennings of Siegel Jennings Co. explains how taxpayers and assessors ensure a fair system, with tremendous swings in assessment and taxes.

A fundamental problem plaguing the property tax system is its reliance on the government's opinion of a property's taxable value. Taxes on income or retail sales reflect hard numbers; real estate assessment produces the only tax in which the government guesses at a fair amount for the taxpayer to pay.

Assessors' estimates of taxable property value create ambiguity and public scrutiny not found in other taxes, and incorrect assessments can lead to fiscal shortfalls that viciously pit taxing authorities against taxpayers seeking to correct those valuations. Worse yet, the longer a tax appeal takes to reach its conclusion, the worse the outcome for both the taxpayer and government. Paradoxically, swift correction of assessment roll protects the tax authority as well as the taxpayer.

As an example, Utah daily newspaper Desert News reported in December 2019 that, due to a clerical error, Wasatch County tax rolls recorded a market-rate value of $987 million for a 1,570-square-foot home built in 1978. The value should have been $302,000. The Wasatch County assessor said the error caused a countywide overvaluation of more than $6 million and created a deficit in five various county taxing jurisdictions, according to the county assessor. The Wasatch County School District had already budgeted nearly $4.4 million, which it was unable to collect.

How does an overvaluation error cause taxing districts to lose money? In many, if not most jurisdictions, the tax rate is determined in part by the overall assessment in the district as well as the budget and levies passed. Typically, there is a somewhat complex formula that turns on the various taxing districts, safeguards and anti-windfall provisions.

Simply stated, tax rates are a result of the budget divided by the overall assessment in the district. A $1 million budget based on a $100 million assessment would require a 1 percent tax rate to collect the budgeted revenue. If the assessment is corrected after the tax rate is set, however, then not all the revenue will be collected and the district will incur a fiscal shortfall.

The sooner a commercial property assessment is corrected the healthier it is for all involved. In the Utah example, had the error been corrected prior to the tax rate being set there would have been no impact on the taxpayer, the school or any of the taxing authorities.

FAIRNESS FOR THE COMMON GOOD

Most state tax systems are flawed and provide inadequate safeguards for taxpayers—if the tax systems were designed better, there would be less need for tax counsel. By understanding the workings of the property tax system, however, taxpayers can help maintain their own fiscal health as well as help to maintain the community's fiscal well being.

As with all negotiations, it is important to understand the opponent's motivations. Although residential tax assessment typically is the largest pool of overall assessment, taxing authorities know that commercial properties individually can have the greatest impact on a system when they are improperly assessed, to the detriment of schools and taxpayers. That makes it important to act as quickly as possible in the event of an improper assessment. And, importantly, resolutions that minimize impacts to the government can maximize the benefit to the taxpayer.

A lack of clear statutory definitions, political tax shifting or a simple error can cause a breakdown in the tax system. In Johnson County, Kan., the assessor raised the assessments on all big box retail stores, in some cases by over 100 percent. Recently, the Kansas State Board of Tax Appeals found those assessments to be excessive. The board reduced taxable values in several of the lead cases back to original levels, and the excessive assessment caused a shortfall.

The Cook County, Ill., assessor has been in the news for raising assessments on commercial real estate in many cases by more than 100 percent. If those assessments are found to be excessive, it could be detrimental for the tax authorities and taxpayers alike. In Cook County, the assessor has stated that the increase is in response to prior underassessment.

SEEK UNIFORMITY, CLARITY

With tremendous swings in assessment and taxes, how can taxpayers and assessors ensure a fair system? Uniform standards and measurements are the answer.

Like the income tax code, the property tax code is criticized for being confusing and overly wordy. To achieve greater equity and predictability, clarity is key. Defined measures of assessed value and standards to ensure uniform assessment results will help create transparency and ensure fundamental fairness between neighbors and competitors, so that no one has an advantage nor a disadvantage.

All taxpayers must be subject to the same measurement. For instance, a government cannot apply an income tax as a tax on gross income for one taxpayer and on net income for another. Likewise, one taxpayer should not be taxed on the value of a property that is available for sale or lease, and another owner taxed based on the value of its property with a tenant in place. Because tax law under most state constitutions must be applied uniformly, one set of rules must be established for all, and what is being taxed should be clearly defined.

Tax laws often include phrases like "true cash value" and "fair value." To be clear, the only measure of taxable value common to all property types is the fee simple, unencumbered value. The value of a property that is measured notwithstanding the current occupant or tenant is not necessarily the price that was paid for the property; it could be higher or lower. And because this concept is difficult for many taxpayers and assessors to understand, there needs to be a second check on the system; that safeguard is taxpayers' right to challenge their assessment based on their neighbors' and competitors' assessments.

To protect themselves on complex matters, it is often helpful for taxpayers to hire counsel that is intimately familiar with the law, real estate valuation and the local individuals with whom the taxpayer will be negotiating. To reduce the need for counsel, get involved with trade groups and state chambers of commerce, which can aid in correcting the tax system.

Uniform measurements of assessment, the ability to challenge the uniformity of results, and swift resolutions combine to create fairness and stability, which in turn enhance the fiscal health of both taxpayers and tax districts.

​Many states are attempting to change established law, causing commercial property taxes to skyrocket.

No one wants to be blindsided with additional tax liability. This is why many businesses belong to industry groups that closely monitor liability for income taxes. Unfortunately, these same companies rarely stay on top of legislation that may have a significant impact on their property tax liability.

It is often too late when a taxpayer learns that their tax liability for real estate has increased under a new statute or assessment practice. Property owners that fail to keep up with proposed rule changes are at risk of incurring unexpectedly high tax bills at a time when they may be least-prepared to pay them.

Property owners may take for granted that key precepts assessors use in determining taxable value are so widely held and accepted as to be immutable. Almost every state's tax law holds that a property owner pays property taxes on the asset's "real market value.," Real market value is the price a willing buyer and willing seller would agree upon in an open-market transaction

In a retail real estate sector that is still reeling from widespread store closures and mounting competition from e-commerce, the lease rate for a lease in place may not reflect market rent. Thus, it is the "fee simple" estate that is being valued for tax purposes: What rent does the market data support as of the tax assessment's date?

Valuing the fee simple estate at market rent is a significant taxpayer protection in the changing landscape of today's marketplace for retail spaces. Sales of brick-and-mortar stores have plummeted due to changing consumer spending habits, a decline in international tourism spending and a lack of investor demand for many big boxes. It is no secret that internet sales have battered the department store sector. The resulting closures of large department stores have further dampened investors' appetite for large-box spaces, and these effects have trickled down to impair the value of smaller retail spaces.

Assessors question assumptions

In the past several years, some assessing authorities have pushed to change the definition of real market value to disregard the perspective of a willing buyer in an open market, and to instead create a false value as if the property were fully leased at market rates as of the assessment date.

In Oregon, recent rules are being proposed (and the theory tested in court) with the assumption that a property can always receive a stabilized rent in the market place. Thus, an assessor would use a property's expected occupancy and market rent in using the income approach to determine the fee simple interest. The costs to get to a stabilized rent, according to the new rules, cannot be applied to discount the stabilized rent. Thus, a vacated department store, or a brand new vacant building, will be assessed as if it is receiving full market rent, without reflecting any of the costs associated to get there.

For example, the proposed rule states that it is implied in the cost approach that valuation reflect not only construction and materials but also all indirect costs, such as the cost of carrying the investment in the property after construction is complete but before stabilization is achieved, as well as all marketing costs, sales commission and any applicable holding costs to achieve a stabilized occupancy in a normal market. Thus, even though the taxpayer has not yet incurred all these expenses, they can be added to the taxable value and the taxpayer may not subtract them in arriving at market value for property tax assessment purposes.

The result is that not only will a new vacant space be valued as if it is fully rented, but a second-generation retail space may be assessed under the cost approach as if it is fully leased. The reality of lease-up costs, including holding costs and tenant improvement costs, are simply to be ignored.

The International Association of Assessing Officers (IAAO) recently published a paper titled Commercial Big-Box Retail: A Guide to Market-Based Valuation. This paper appeared to ignore generally accepted appraisal methods for valuing these types of properties and to advocate for the changes in accepted definitions of property rights that taxing entities in many states are now seeking. Importantly, when American Property Tax Counsel reviewed the IAAO's paper, its lawyers found that many of the propositions cited in the paper were based on cases or laws that had been overturned and were clearly inconsistent with established case law and law.

These attempts by the assessing authorities to change the definition of real market valuation for property taxation purposes should worry commercial property owners, and particularly owners of retail properties, given the continuing potential for prolonged vacancy. For these properties to remain viable, the owners need to mitigate all costs, including property taxes.

A reduction in property taxes can benefit a property owner significantly. Oregon has the benefit of a five-year statutory hold, with some exceptions, on a successful appeal to property taxes. Thus, a $100,000 reduction in property taxes through the appeal process could result in a $500,000 savings.

With the assessing authorities' proposed changes to the tax rules, however, market realities and real market value are compromised.

Take advantage of the following opportunities for tax savings in the booming multifamily market.

With healthy multifamily market fundamentals and increasing demand from investors, apartment property values are on the rise. For owners concerned about property tax liability, however, there are still opportunities to mitigate assessments and ensure multifamily assets are taxed fairly.

Here are key considerations for common scenarios.

Property Acquisition

Whether an investor is buying a single property or a portfolio, it is wise to understand how the transaction will affect property taxes going forward. In some taxing districts, the assessors will move the value to 80%-90% of the sale price in the assessment year following an acquisition. If the sale is an arm's length, open market transaction with no unusual investment drivers, there remain few arguments against increasing taxable value to equal the sale price, less personal property.

When running income and expense projections on a potential acquisition, look to how the sale will affect taxable value. To pencil in reasonable budgets, consult with local experts who can zero in on a likely tax rate. Those who know the market can forecast local rate increases with some accuracy.

When there are non-open-market factors in a sale – such as unusual financing, tax shelter exchange considerations or a portfolio value allocation based on forecasts – there is more room to make arguments for a value based on an income approach. In discussing this approach with assessors, the greatest source of disagreement is the capitalization or cap rate used to extrapolate value from the income stream.

For apartments in the Midwest, initial cap rates can range from 4.5% to 6.5%, and assessors will often choose rates from the lower end of the range or use an average. Taxpayers who can demonstrate or work with the assessor to derive the correct cap by using appropriate comparable sales will enjoy a more reasonable value discussion.

Opportunity Zones

An opportunity zone stimulates investment within its perimeter by enabling investors to reap tax benefits on deferred capital gains and spur growth. This vehicle has been of special interest to developers of student and low-income housing. To get the full benefit of the new program, investors must decide to invest in a qualified opportunity fund (QOF) by the end of 2019.

Investors in QOFs which were formed to meet a June deadline must invest these funds into qualified property by year end. Investors that miss the deadline will be subject to IRS penalties. After 10 years of investment, 100% of the gain will be free of capital gains. This can enhance returns considerably.

The race to the year-end finish line could lead investors to initiate apartment deals that fail to meet market development yields. When looking at the values for property tax purposes, the costs of such projects driven by tax advantages can be discounted in a valuation analysis.

Procedural Concerns

Property owners' increased sophistication in challenging assessed values has led many taxing jurisdictions to use procedural arguments to shut down a petitioner's case, citing failure to comply with minute details of technical rules such as income disclosure requirements.

• In some jurisdictions, petitioners must disclose certain information for an appeal to go forward. For example, in Minnesota a petitioner that contests the assessed value of income-producing property must provide a slew of information to the county assessor by Aug. 1 of the taxes-payable year. These include: year-end financial statements for both the year of the assessment date and the prior year;
• a rent roll on or near the assessment date listing tenant names, lease start and end dates, base rent, square footage leased and vacant space;
• identification of all lease agreements not disclosed on the above rent roll, listing the tenant name, lease start and end dates, base rent and square footage leased;
• net rentable square footage of the building or buildings; and
• anticipated income and expenses in the form of a proposed budget for the year subsequent to the year of the assessment date.

The duty to disclose is strictly enforced, even if there is no prejudice to the taxing authority. In the case of an appeal for an apartment project, it would be prudent for a petitioner to clarify with the assessor in advance what data is required. Particularly if there is a commercial component to the project, where license agreements can be considered leases, a prior agreement with the assessor on what is required will remove the risk of a case ending on procedural grounds.

Seniors Housing

Many seniors housing complexes include independent living sections; assisted living areas, usually with smaller unit sizes and limited or no kitchen facilities; and memory care areas with even more limited furnishings, locked access and egress and full-time staffing by case professionals.

No matter what type of living area is involved, the monthly rental payment covers services provided to residents over and above rental of an apartment unit. These services are most intensive and comprehensive for residents in memory care, who require the most direct staff attention and receive all meals and services through the facility.

Even assisted living and independent living residents enjoy significant non-realty services, including wellness classes and other programming, spiritual services, medication dispensing, field trips for shopping or other events, onsite dining facilities and operation, and access to full-time staffing at the facility. These services are part of what residents pay, and it's important when trying to determine the real estate value for tax purposes that the service income component is excluded from the valuation analysis.

Although the market is robust for both multifamily investment sales and construction, taxpayers who apply a data-based approach with knowledge of local market conditions, procedures and opportunities can achieve a reasonable property tax bill.

Investment value is not market value for property tax purposes because the excess value transfers elsewhere, according to attorney Benjamin Blair. But where does the value go?

When a new building enters the market with a headline-grabbing development budget, the local tax assessor is often happy to use the value stated on the construction permit as a blueprint for a high initial tax burden. After all, would a property owner fight an assessment equal to construction cost? The answer is yes, and here is why the taxpayer should file a protest.

Consider this all-too-common scenario: A new building's publicized development cost is, say, $50 million. The first year after the completion of construction, the assessor assigns the property a market value of $50 million. The owner, now a taxpayer, protests the assessment, relying on an appraisal that shows the property's value to be only $40 million.

The initial reaction of virtually every assessor that faces this common pattern is skepticism—skepticism sometimes shared by the judges deciding the tax appeal. How can it be that the property "lost" $10 million in value so quickly? Why would the owner have even constructed the building if it was an economic loser?

An owner who can explain this value loss—or, more accurately, this value transfer—will be better prepared to ensure a property's tax assessments are based solely on the value of the real estate in question. And, when appropriate, that owner will be prepared to challenge inaccurate assessments.

COST IS NOT MARKET VALUE

Anyone who has ever purchased a new car or made-to-order clothing understands that cost may not equal value. Regardless of the price the buyer paid, those items are worth less to the market after the initial sale. The same factors that immediately depreciate a new car or custom suit affect some types of real estate.

A property can have an off-the-rack market value and then minutes later have a resale value that is different. This does not mean that the owner overpaid for the asset. Rather, the owner paid what the asset was worth to that owner, but a second buyer will not necessarily pay the same price at a later sale.

Real estate buyers will not pay for branding elements, design elements or items of personal preference. When a building is built to the specifications of a specific user, the design, layout and components make it unlikely that cost will equal market value. These buildings exist because they are worth the cost to the first user, not because they inherently have an increased market value.

Investment value is not market value for property tax purposes because the excess value transfers elsewhere. The key question is, where does the value go?

WHERE THE VALUE GOES

Circumstances vary and different properties will transfer value in different ways. Here are some common ways it can occur.

The examples of a custom suit or built-to-suit building illustrate how value can transfer to a person or organization, but value can also transfer to another property. For example, a golf course surrounded by homes is unlikely to have a market value equal to its development cost. The golf course's value is not in the golf course alone; much of its value is reflected in the increased sales prices garnered for the surrounding homes. Likewise, amenities in a subdivision or common spaces in a condominium tower have little value on their own because their value is transferred to the adjacent properties.

Value can also transfer within a property. For example, a parking garage or conference center in a suburban office development is unlikely to generate sufficient rent to make those assets independently feasible, but the increase in rents achievable to the adjoining tenant spaces can make those amenities valuable to the whole. Were the parking garage to sell in the open market, it would almost certainly garner a sale price below its development cost.

Finally, value can transfer to the community. A highway interchange will never have a market value equal to its multimillion-dollar price tag, and public transit systems and arenas would never be justified based on ticket sales alone. Communities deem these projects worthwhile, however. The value of such properties transfers to the community.

Similarly, in many markets the cost of "green" building features, such as a green roof or permeable parking surfaces, is rarely recovered upon the property's sale. Developers still incur those development expenses, even when they will not contribute to the property's profitability. The value of those features is transferred to the community, which receives air purification and water retention benefits.

FIGHT FOR TRANSFERRED VALUE

Understanding the concept of transferred value is important, both because it explains the motivations of those who build and own properties that are worth less than cost to the open market, and because it can help to avoid overvaluing the property. Property can be overvalued in many situations—for example, for insurance or financing purposes—but the pain of overvaluation is most acute in property taxation, since overvaluation generates a higher tax bill and corresponding lower profitability for the life of the asset.

Understanding transferred value can also assist enterprising owners in generating additional revenue streams. If part of the property's value transfers to another person, property or the community at large, then the owner may be able to build a case for monetizing the value transferred to others.

In times of stagnant growth and personnel cutbacks, assessors are eager to capitalize on published construction costs. But by explaining how cost relates to market value, and being able to show where the value went, diligent owners and property managers can reduce fixed expenses, lower tenant occupancy costs and ultimately improve profitability.

Protest any tax assessment that doesn't reflect the cost to remediate any existing environmental contamination.

Owners of properties with environmental contamination already carry the financial burden of removal or remediation costs, whether they cure the problem themselves or sell to a buyer who is sure to deduct anticipated remediation expenses from the sale price. Fortunately, New York law allows those property owners to reduce their property tax burden to reflect their asset's compromised value.

Tax types

Most local governments in the United States impose a property tax on real estate as a primary source of revenue, levied and calculated by either ad valorem or specific means. Latin for "according to value," ad valorem taxes are imposed proportionately based upon the market value of the property. Thus, the higher the market value, the higher the real estate tax.

Specific taxes, on the other hand, are fixed sums without regard to underlying real estate value. School, county and town governments nearly always compute real property taxes using the ad valorem method, whereas lighting, garbage or sewer districts typically apply specific taxes. Because school and county/town taxes account for the overwhelming majority of a property tax bill, property owners frequently use assessment litigation concerning the market value of the subject property to reduce assessments and, as a result, lower the real property tax burden.

The cardinal principle of property valuation for tax purposes is that assessments cannot exceed full market value. Many states including New York codify this in their constitutions. The concept of full value is regularly equated with market value, which is the highest price a willing buyer would pay and a willing seller accept, both being fully informed.

Disagreements often arise if the subject property is afflicted with environmental contamination. The treatment of environmental contamination and remediation costs is of particular concern to both owners and municipalities. Owners seeking to depress taxable values and thereby reduce their tax burden claim these expenses dollar-for-dollar off the market value under the principle of substitution. In other words, a proposed buyer would not pay more than $8,000 for a parcel worth $10,000 which needs $2,000 of remediation.

On the other hand, municipalities would prefer the adoption of a rule (either via legislation or court decision) barring any assessment reduction for environmental contamination. Otherwise, they claim, polluters would succeed in shifting the cost of environmental cleanup to the innocent taxpaying public, in contravention of the public policy of imposing remediation costs on polluting property owners and their successors in title.

Pivotal case

Fortunately for property owners, a seminal 1996 court decision guides the treatment of environmental costs to cure taxable value in New York. In Commerce Holding Corp. vs. Town of Babylon, the petitioner purchased 2.7 acres of land in the Town of Babylon, Suffolk County. A former tenant of the property had performed metal plating on the premises and discharged wastewater containing multiple heavy metals into on-site leaching pools, ultimately resulting in the severe contamination of the parcel. The owner filed tax appeals and argued the value of the property should be reduced by the considerable costs needed to clean up the parcel.

As expected, the town's position relied on a public policy approach and urged the court to reject any argument for a reduced assessment. Ultimately, the case traveled to New York's highest court, which summarily rejected the public policy arguments that polluters should not be rewarded with lower assessments.

Instead, the court applied the constitutional and statutory requirements of full market value assessments, holding that the full value requirement is a "constitutional" mandate which cannot be swept aside in favor of public policy. Thus, property must be valued as clean, with the value reduced by the costs to cure the remediation per year. Challenges seeking the limitation or outright reversal of the Commerce Holding case have been continually rejected.

A recent clarification

The New York State Court of Appeals did not address remediation again in a property tax litigation context for almost 20 years after Commerce Holding. In a 2013 case, Roth vs. City of Syracuse, a property owner sought to have the assessment on certain rented properties reduced because of the presence of lead-based paint.

The court declined to expand the application of Commerce Holding in this case for two significant reasons. First, the owner continued to rent the buildings and collect income. Second, the owner had not taken any steps to remove or remediate the lead paint and restore the properties. Thus, to successfully claim an assessment reduction, a property owner should not stand idle but take definitive actions to remediate the property. 

​Savvy commercial owners are employing use restrictions as a means to reduce taxable property values.

Most property managers and owners can easily speak about their property's most productive use, in addition to speculating on a list of potential uses. Not all of them, however, are as keenly aware of their property's specific use restrictions; even fewer realize how those limitations affect the property's value for tax assessment purposes. 

Government-Imposed Restrictions

Local zoning laws impose the most common use restrictions. Their impact on property uses and potential values is commonly understood. A property zoned for development as a retail power center, for example, will generally have a higher market value than a property that is limited to uses, such as auto repair or animal kenneling. Market values are often used to set tax assessment values, so a use restriction that increases or reduces market value will also increase or reduce a property's tax assessment value. 

Less common restrictions that can impair a property's value include covenants or agreements entered into with a municipality. Whether this pertains to the future development of a parking structure, to meet open-space standards, or to fire department ingress and egress lanes these covenants typically limit the owner's ability to fully develop the property and, thereby, reduce its market value. Historical designations by local government also generally reduce a property's market value. This is because they limit the owner's ability to configure the property to produce maximum rental income. 

Even fire suppression requirements reduced market value for one commercial property. This multi-building campus was constructed to suit a technology company, with all fire suppression controls located in a single building. When the technology firm moved out, regulations enforced by the local fire department prohibited the new owner from leasing or selling individual buildings because all but one of the structures lacked onsite control of the existing sprinkler system, those being in another building. 

Semi-private Restrictions 

The complexities of government imposed restrictions pale in comparison with semi-private restrictions that are often created during a property's development. Consider the covenants, conditions and restrictions (CC&Rs) on use imposed when property is subdivided for development. 

CC&Rs are not typically classified as "government-imposed," as they are based on an agreement between the developer and property owners within a development. Yet, these covenants do limit how the property may be used. While CC&Rs often govern planned residential developments, they also regulate property usage in some industrial parks and retail centers. Because CC&Rs lack the uniformity of government-imposed zoning laws which, theoretically, would apply equally to competing commercial properties, the restrictions in CC&Rs usually impact property market values negatively by limiting potential uses. 

Another complex area involves easements between adjacent property owners or among multiple owners within a larger development. Like CC&Rs, easements limit property uses and can reduce market value.

Private Restrictions 

The most common private usage constraint is the deed restriction, which prevents the buyer of a property from using it for certain purposes. The treatment of deed restrictions and other limitations imposed by property owners varies by state. In some states like California, property tax assessors must ignore private use restrictions, while in other states, such restrictions are taken into consideration when assessing properties. 

Deed restrictions and other privately imposed usage limitations can significantly affect real estate values. A property restricted to residential use where neighboring properties are allowed retail or industrial uses will have a lower market value. However, if the local tax assessor is prohibited from considering such private restrictions, the property's assessed value may be much higher than the market would otherwise indicate. 

State, Local Laws Often Prevail 

Clearly, use restrictions — whether government-imposed or privately imposed — will usually impact a property's market value. From a property tax perspective, however, an assessor may or may not consider use restrictions in determining taxable value. 

Whether and how an assessor considers use restrictions in an assessment usually depends on state and local tax laws. In California, property tax regulations, court decisions and guidance documents issued by the State Board of Equalization assist property owners in understanding how use restrictions may or may not affect their property's taxable value. 

In some cases, the treatment of use restrictions is based on local tax assessment policies that are not set forth in any particular statute, regulation or court decision. Tax or legal advisers who interact regularly with local tax assessors can be invaluable resources in those jurisdictions. 

Use restrictions play a significant role in property tax assessments. Knowing a property's use restrictions and how those restrictions affect value is crucial to obtaining a fair property tax assessment. Armed with information about their particular use restrictions, savvy property managers and owners will find out how the local assessor uses those restrictions to determine taxable value. In most cases, that will involve collaborating with a professional experienced in handling local property taxes. 

​Cris K. O'Neall is a shareholder with the law firm of Greenberg Traurig LLP in Irvine, California. The firm is the California member of American Property Tax Counsel, the national affiliation of property tax attorneys.

June 13, 2019

Board of Directors IAAO
IAAO Headquarters 314 West 10th Street
Kansas City, Missouri 64105

Re: IAAO May 2019 Exposure Draft: Setting the Record Straight on Fee Simple

Dear Board Members:

American Property Tax Counsel is the preeminent organization of real estate tax attorneys in North America.Please accept this letter as our official comments in response to the May 2019 Exposure Draft entitled Setting the Record Straight on Fee Simple promulgated by the IAAO Fee Simple Task Force.Consistent with our professional focus, these comments will address property tax policy and the legal implications of the Exposure Draft. As attorneys, our concern is the accuracy of the legal arguments advanced in the paper. The starting point is to ask the question, "why would the assessor's organization attempt to write a paper addressing legal theory and not one on appraisal methodology?"The paper appears to be nothing more than an attempt to support new legal/appraisal theories to gain an advantage in pending litigation and to shape public opinion to support a new way of valuing and taxing commercial properties.

This Exposure Draft reads like a solution in search of a problem.The Fee Simple Task Force has done little to disguise the Exposure Draft as anything but an attempt to tax certain commercial taxpayers differently than all other taxpayers.While perhaps intended as primarily a public relations vehicle, the Exposure Draft undermines the credibility of the IAAO as an organization purportedly dedicated to education and research, and its official adoption would do a disservice to the IAAO's respected assessors.[1]

Sound tax policy requires common ground and uniformity.As recognized in the Exposure Draft, fee simple estate is the foundation of what assessors are often asked to measure.However, while the Draft's authors posit a false premise that "it is essential to clarify fee simple in order to maintain accuracy, consistency, and uniformity in assessment practices," the truth is fee simple requires no further clarification.The most glaring flaw in the Exposure Draft is the unchecked presumption there is some conflict or digression between how the legal and appraisal professions define fee simple.There isn't.[2]

Context matters, and many terms can differ from the legal to the technical or industrial uses.Liabilities in accounting, for instance, can mean short-term or long-term payables.Within the law, a liability in an income tax dispute is understood to mean something different than a liability in a tort case.Similarly, title companies will speak of a fee simple estate or fee simple title and understand that it describes how title will pass to heirs.Appraisers, being in the profession of valuation, must define and communicate how fee simple impacts an asset's value.[3] Even within the legal environment, fee simple can mean that property passes as an inheritable estate in the context of a will, or that a fee simple interest in property is to be valued in the context of assessment or eminent domain.While the phrase "fee simple" can have different implications depending upon the setting in which it is invoked, there is no conflict between the legal and appraisal definitions—in any setting, it is understood to describe the "largest possible estate," "absolute ownership," "broadest interest," and so on.No experienced lawyer or judge is confused by whether "fee simple" in the assessment context invokes questions of inheritability.

States vary somewhat in the terminology used to describe the measure of assessed property, using phrases like "true value," "fair cash value," "actual value," etc., but such phrases are generally understood to mean fair market value.As to what must be assessed, states overwhelmingly agree that the taxable estate should be fee simple.Fee simple is important as a base because the fundamental aspect of assessment in most states is uniform treatment of taxpayers within a class.Some states treat residential, agricultural, and commercial/industrial property as different classes.In other states, all real estate is considered one class.Regardless, the measure of the tax must be the same across the class, and the object being measured must also be the same across the class.Where uniformity is required, one taxpayer cannot be assessed on a fee simple with no lease while a neighbor pays taxes on the fee simple subject to a lease.[4]And in law, the unencumbered fee simple is the only standard that returns uniform assessments.

2.The Definition of Fee Simple Is Already Clear

The Exposure Draft's authors make much ado about the historical evolution of the definition of fee simple but fail to consider the modern evolution of real estate as a tradeable asset.Again, it is worth noting why context is important.Real estate was not a particularly sophisticated investment until the advent of modern financing arrangements, sale-leaseback transactions, and the trading of leases as investment vehicles.As the real estate industry grew increasingly complex, it became necessary for its definitions to get specific.Similarly, the accountants among APTC's membership have observed that the accounting profession and the federal courts interpreting the Internal Revenue Code were also compelled in the early-1980s to address the growing prevalence of sale-leaseback transactions.

The Task Force argues that practitioners are confused by the word "unencumbered," yet the only cases it cites are not even on point.As a matter of law, the Ohio cases in the Exposure Draft have been superseded by the enactment of that state's amended assessment code.Contrary to the Task Force's interpretation, those cases stood for the fact that the prior statute required valuation based on a property's recent sale price even when the sale price reflected atypical circumstances or included the value of non-realty assets.The change in the statute eliminated that issue, as Ohio now mandates that assessors value the fair market value of "the fee simple estate as if unencumbered." R.C. 5713.03, as amended by 2012 Am. Sub. H.B. No. 487 (emphasis supplied to indicate new words added).[5] As for the 9^th Circuit case cited in the Exposure Draft, it is unclear what the Task Force means to suggest by its partial quotations.[6] The rest of the cited paragraph actually recognizes that a freehold estate can be "encumbered or unencumbered," and nothing in the full text of that case indicates the court is confused by that premise or by the definitions it discusses.City of Los Angeles v. San Pedro Boat Works, 635 F.3d 440, 450 (9th Cir. 2011).

As a practical matter, several states have approvingly cited (and sometimes even adopted [7]) the Appraisal Institute's definitions of fee simple and leased fee.In those jurisdictions which have explicitly relied on the recent editions of The Appraisal of Real Estate and/or The Dictionary of Real Estate Appraisal to explain these concepts, this Exposure Draft would directly conflict with applicable law.And even in states which have not adopted those definitions, most appraisers have been using the Appraisal Institute's definition of fee simple for over 35 years at minimum.No industry or professional association can force upon a state a definition which conflicts with existing laws, and the IAAO should take care not to encourage its members to violate the rules of their jurisdictions.

3.The Bundle of Sticks Endures Because It Is a Useful Metaphor

The example of the bundle of sticks is almost sacrosanct.As a technical matter, the statement, "The bundle of rights or bundle of sticks metaphor originated as a description of real estate, not a fee simple absolute estate" is incorrect.While legal historians debate the origin and evolution of the bundle metaphor there is consensus it came into common usage around the turn of the 19th century to describe ideas of ownership and rights in property, both real and personal.The fact that the bundle metaphor may be misused or misunderstood by some does not necessitate its abandonment or overhaul.As a descriptive tool, it helps most students and practitioners to visualize the interplay between the interests and the encumbrances that impact property rights and affect value.

4. Fee Simple Unencumbered Is the Basis for All Property Tax Liens

It should go without saying, but the value on which the property tax is determined should match the basis for the property tax lien to which it is attached.In every jurisdiction, property tax is a liability of the property, not the owner.When any property is valued for tax purposes, the resulting assessment gives rise to a tax lien that attaches to that property.This in rem obligation means that if the tax is not paid, the lien can be sold for the unpaid taxes.If the owner fails to take steps to satisfy the lien, the purchaser of the tax lien can become the owner of the property.These basic principles underlie every assessment of property tax.

However, the position in the Exposure Draft would cause a valuation of assets that the tax lien does not attach to.When a tax lien is sold, it is sold free and clear of all other liens and encumbrances.The buyer receives title known as "fee simple absolute."That title does not include any liability on a mortgage or any liability (or benefit) arising from a lease. None of those private, contractual rights are part of the lien.Leases and encumbrances are expressly made subordinate to the tax lien. This is because the entire premise of the property tax is that the government can seize and sell "the property" to satisfy the tax lien.

How then, can the value on which the property tax is computed include assets that the tax lien does not attach to?The answer is obvious – it cannot.Respectfully, the position in the Exposure Draft contravenes this basic principle of ad valorem taxation, further demonstrating why that position is incorrect as a matter of property tax law.

5.The paper raises ethical issues that need to be properly addressed.

The IAAO Code of Ethics raises many concerns relative to the paper.For instance, the Code provides:

"It is unethical for members to conduct their professional duties in a manner that could reasonably be expected to create the appearance of impropriety …

It is unethical to perform any appraisal, assessment, or consulting service that is not in compliance with the IAAO governing documents or the Uniform Standards of Professional Appraisal Practice …

It is unethical for members to accept an appraisal or assessment-related assignment that can reasonably be construed as being in conflict with their responsibility to their jurisdiction, employer, or client, or in which they have an unrevealed personal interest or bias …

It is unethical to accept an assignment or responsibility in which there is a personal interest without full disclosure of that interest …

It is unethical to accept an assignment or participate in an activity where a conflict of interest exists and could be perceived as a bias, or impair objectivity …

It is unethical to knowingly fail to observe the requirements of the Uniform Standards of Professional Appraisal Practice …"

There are pending cases across the country on this very issue, including many in the home states of the authors of this report and members of the Board of Directors.This paper imbeds the IAAO into pending litigation with no acknowledgment of that in the report.The report is silent on the pending matters where one or more authors are a party or are expert witnesses.The paper should not be silent on the conflicts of interest of the authors, the Board of Directors and the organization.

Given its significant authoritative status in the appraisal industry, all appraisers are encouraged to follow the standards in the Appraisal Institute's treatise, The Appraisal of Real Estate. Advocating to specifically reject the definitions in the Appraisal of Real Estate, 14^th edition, the Dictionary of Real Estate Appraisal, 6^th ed., and local law is antithetical to the IAAO's mission and responsibilities to their membership.

6. Conclusion

As with the IAAO's 2017 white paper on Commercial Big Box Retail, the Fee Simple Task Force is attempting to legislate through its latest paper, without regard to the nuances in each jurisdiction. Fortunately, under the constitutions of nearly all states, the fundamental aspect of assessment is uniformity and the ideas expressed in the Exposure Draft are legally untenable.

The constitutional mandate of uniformity requires that real estate be assessed upon the fee simple, unencumbered, because that is the only definition applicable to all real estate.Office buildings that are leased can be assessed based on fee simple, unencumbered.Single-family homes that are owned can be assessed upon that same standard.Properties held as tenants-in-common can be assessed upon that same standard.Without this "white canvas" standard, assessors would be left with no basis on which to comply with uniformity requirements.

The paper raises issues of ethics, USPAP compliance and creates confusion even within the publications of the IAAO[8].

We urge the IAAO reject the adoption of the May 2019 Exposure Draft Setting the Record Straight on Fee Simple.

Respectfully submitted,

American Property Tax Counsel
BY: Linda Terrill, President

[1] The Exposure Draft's authors are all involved in litigation concerning this issue. Indeed, several are serving as expert witnesses for taxing authorities advocating for the position set forth in the Exposure Draft. Given USPAP's clear prohibition against "Advocacy" by appraisers, the IAAO should not be taking sides in this manner.The paper gives the appearance of "creating" supporting authority because none exists.

[2] Unfortunately, the Exposure Draft's authors fail to cite any authoritative legal definitions of fee simple, relying instead on references to secondary sources.While seemingly obvious, we feel it is necessary to point out that Black's Law Dictionary is binding nowhere.Similarly, although the Restatements are generally more respected, they are likewise nonbinding except in the limited jurisdictions where limited sections have been adopted.Moreover, it is unclear why the Task Force cites to an outdated Restatement.

[3] Brokers and agents may use the term loosely or even incorrectly, but that is not a reason for the appraisal or assessment professions to change a long-accepted definition.

[4] Beyond the problem of non-uniformity, because most states recognize contracts as personal property, such a framework seems doubly unworkable in states where personal property is not taxable.

[5] Importantly, the Ohio cases cited were in large part the basis for the legislative clarification.

[6] The Task Force fails to discuss California's property tax regulations pertaining to fee simple, such as the inclusion of "unencumbered or unrestricted fee simple interest" in the definition of fair market value, the adjustment of the sale price for a property encumbered with a lease to its unencumbered-fee price, and the capitalization of unencumbered net income in the application of the income approach.(18 Calif. Code of Regs., §§ 2(a), 4(b)(2) and 8(d).)The City of San Pedro case does not discuss any of these property tax regulations.

[7] See, for example, In re Equalization Appeal of Prieb Properties, 47 Kan. App. 122, 275 P. 3d 56 (2012).The IAAO cannot advocate for its members to adopt a definition and value real property in violation of their law.

[8] The positions set forth by the taskforce are inconsistent with other IAAO publications below:

Page 12, Property Assessment Valuation 3 ed., starts with a paragraph titled Fee Simple Interest. "The owner of a fee simple absolute interest holds the title to the property free and clear of all encumbrances. The assessor typically values property as an estate in fee simple, unless statutes or administrative rules dictate otherwise. The bundle of sticks example, as well as the acronym SLUGGER stating how the rights in the bundle can be bargained away, is located at page 10, Property Assessment Valuation 3 ed.

At page 11 leases are described as being private encumbrances able to affect fee simple ownership of property. Property Assessment Valuation, 3 ed.

Again, at page 11 both Leased Fee and Fee Simple interests are discussed and the caution that "before a property is valued, the appraiser must know which interests are to be valued." Absolute Ownership—Ownership of all real property rights and interests in a real estate parcel. See fee simple. P. 1, IAAO Glossary for Appraisal and Assessment, 2d ed. Fee Simple—In land ownership, complete interest in a property, subject only to governmental powers such as eminent domain. Also fee simple absolute. See estate in fee simple; fee; and absolute ownership. Page 67, IAAO Glossary for Appraisal and Assessment, 2d ed.

Statutory law continues to require that assessors value only the real estate, not the success or lack thereof, by the owner of the real estate.

Assessors and their minions frequently take the position that an occupied store is more valuable than an unoccupied store, a conclusion commonly referred to as the "Dark Store: theory. Owners of big-box retail properties and their tax advisers bristle at this erroneous contention, because real property taxes are just that– a tax on the value of the real estate.

It is the assessor's function to value the property's real estate components, which consist primarily of land, bricks and mortar; or in the cases of most big boxes, land, concrete, pop-up concrete or metal slabs. It is a common but mistaken practice of assessors to place a greater taxable value on a big box occupied by a major retailer than on a vacant building of equal design, construction and utility.

This errant valuation methodology has given rise to controversy played out through expert testimony and sophisticated argument before administrative agencies and the courts. It is in this context that the term "Dark Store theory" has come into play.

A call to action

Owners of big-box real estate need to deliver a consistent response in the face of this increasingly pervasive and costly misconception. And because informal meetings between the owner's representative and the assessor are limited in time and scope, providing little opportunity for sophisticated argument, these owners must take a position that can be expressed in laymen's terms and understood by the average taxpayer.

That message is that the dark store theory is not a theory at all. It is a reality. The real estate components of occupied buildings have the same value as the real estate components of vacant buildings.

Dark Store theory has become part of the dialogue when valuing commercial properties for taxation. It's vilified as though it were a new concept with dark connotations, like the revelation of a new and insidious scheme by Darth Vader. In fact, its underlying concept is as old as the exercise of determining value for any purpose.

Unless a particular property has actually sold on a particular date, any opinion of its market value is hypothetical. Any such opinion is subject to informed disagreement within the boundaries of accepted valuation methodology. The standards of that methodology, as expressed, for example, in the Uniform Standards of Appraisal Practices, require that the value of a property is based on the willing-buyer, willing-seller concept. The assumption is that a willing buyer wants to buy and use the property.

Logic, not to mention all standards of appraisal practice, dictates that the hypothetical buyer is buying the property for some purpose. Whatever that purpose, it precludes the seller's continuing to use the property. This discussion is independent of a sale-leaseback transaction, which is a financing strategy.

The reality is that the buyer wants to use the property, as is the case across the spectrum of property purchases.

A residential parallel

The same concept applies to the sale of a suburban bungalow. When the Smiths buy a home from the Joneses, they expect the Jones family to vacate the property by the closing date. The Smith family bought the property expecting it to be available for occupancy on the closing date. Nothing about the selling family's success or possible dysfunction affects the purchase price.

In valuing single-family homes, assessors do not discuss the resident families' success (all the children became neurosurgeons). Yet assessors effectively do so in valuing big boxes, which by all valuation standards must be deemed available for occupancy as of the date of closing.

One does not hear the expression "dark house theory," because the assumption of availability of the property for use by the buyer at closing is intrinsic to the transaction. In appraisal parlance, the concept has been and remains that the exchanged property is "free and clear of all encumbrances," ergo vacant, or in current usage, "dark."

Many big boxes, typically measuring in the neighborhood of 100,000 square feet, have come on the market in recent years due in part to changing consumer buying patterns and reduced store counts by retailers. There is a tendency among assessors to over-value properties occupied by the surviving big-box retailers, in effect imposing a form of income tax that they justify by citing retailers' over-all company sales, while turning a blind eye to the availability of big boxes standing dark in the same market.

The sales volume and profits produced by a big-box store are as unrelated to the real estate's value as apple pie is to a computer. Thus, two side-by-side buildings of the same size and specifications, with one housing a high-profit retailer and the other an empty or dark box, have the same real estate value.

​Managing expenses is one of the best ways to ensure the long-term profitability of investment properties, and prudent developers know the importance of carefully monitoring and challenging property tax assessments. But student housing, as a subsector populated largely by tax-exempt educational institutions, presents unique opportunities to minimize taxes for some projects.

Excepting abatements and other local incentives, there are two principal ways to minimize property taxes: The property can be entitled to a statutory tax exemption, or the property can be deemed to have a value of zero dollars. In certain instances, creative structuring can take advantage of these options to improve the developer's cash flow and returns.

Beneficial vs. actual ownership

One of the most potent ways to minimize property taxes is a statutory exemption. For university-owned housing, exemptions will almost always eliminate the tax bill before it arrives in the mail. But what if the property is owned by a private developer, not the university?

Although private ownership by a for-profit entity often sentences real estate to a lifetime of property tax liability, some states disregard formal ownership for property tax purposes, focusing instead on who benefits from the asset. In states adopting this "beneficial ownership" doctrine, the law may treat privately owned properties the same as university-owned real estate, entitling them to exemptions otherwise limited to properties used for educational purposes.

Consider the example of a small private college that wants to develop new on-campus housing, but lacks the resources to borrow the necessary funds to construct the building. Instead, the school contracts with a private developer, which builds the student housing and leases it to the college. The school then operates and maintains the property as student housing, just as it would any other dormitory.

Even though a private developer owns the structure, the benefits of the building go to the college, which may be deemed the beneficial owner of the property. Because the college's intent is not to earn a profit, but rather to support its educational mission by providing housing for its students, the property is exempt.

This structure still allows the developer/owner the right to earn a reasonable return on its investment in the property. This result is logical when one considers that the college's intent is to finance the construction of on-campus housing. If the college financed the construction of a dormitory with a bank loan, the school would not be disqualified from claiming an exemption just because the bank earned a return on its loan.

Precluding profit in this manner would effectively prevent any educational institution from borrowing funds at market rates to finance any construction. Just as the bank is entitled to a reasonable return on its loan, the student housing developer is entitled to a reasonable return on the lease.

Of course, beneficial ownership works in both directions, potentially making an otherwise-exempt property taxable. If university-owned property is leased to a private party who uses it to make a profit, then the property would likely not be entitled to an exemption. Even though the true owner is an exempt educational entity, the beneficial owner is not exempt.

Leaseholds without market value

Even when a property lacks a statutory exemption, however, it will not incur property tax liability if it is deemed to have a negligible market value. An assessed value of zero dollars will always result in zero taxes owed.

A recent case from the West Virginia Supreme Court shows how a new student housing development – or, at least, the developer's leasehold interest in the development – could properly be assessed as having no market value.

In that case, a university leased land to a developer for the purpose of developing student housing with a retail component. The developer constructed the improvements on the leased land at its own expense and transferred title of the new building to the university, which executed a sublease to use the student housing. As the subtenant, the university offered the on-campus housing to students, collecting rent and turning it over to the developer, who then returned 50 percent of the net cash back to the university as a payment on its lease.

The university operated the residential facilities, therefore, while the developer was compensated for constructing the improvements and retained the right to sublease the retail space. The developer's interest in the property was a leasehold.

Because university-owned property is exempt, the university's interest in the property was not taxable. But in West Virginia, leaseholds are taxable real property interests, meaning the developer's interest needed to be assessed. The county assessor concluded that the developer's interest in the property had a value independent from the university's exempt interest, and assessed that interest. The developer challenged the assessment, arguing for a zero value.

The case eventually came before the state Supreme Court, which held that the value, if any, of a leasehold interest is based on whether the leasehold is economically advantageous to the lessee and freely assignable, so that the lessee can realize the benefit of the lease in the marketplace. After all, market value is measured by what the interest could garner if sold on the open market.

If the lease could not be freely assigned to another party, it would have no value in the marketplace. Because the lease was drafted in a way that the assessor conceded was not freely assignable, the Court affirmed that the value of the developer's leasehold interest was zero.

Beware potential pitfalls

The applicability of these strategies to a particular project is fact-dependent. For example, some states, especially those with large amounts of public lands, tax possessory interests. In those states, a government-owned property leased to a private entity can be taxed if the private entity has a "possessory interest" in the real estate. Likewise, privately owned improvements on exempt land can be taxable because the tax is being imposed on the improvement, rather than on the whole property. And assessors eager to increase the tax base can still challenge even the best structuring.

Not all development deals will be ripe for these types of exemption-planning opportunities, nor will all student housing developers find these strategies compatible with their business objectives. Competent tax counsel can help developers weigh the myriad factors that may determine what strategy can deliver the best returns.

But property taxes are one of the largest ongoing expenses of property ownership, so opportunities to minimize their impact on a project's financial results deserve full consideration. With some creativity, developers can improve their own profitability while also helping their academic partners achieve their goals. 

​The American Property Tax Counsel argues that if a property tax assessment is premised on a uniform per-square-foot value, rental rate or vacancy rate for all office properties in a metro area, the assessor is likely going to overlook distinguishing factors in submarkets that could benefit building owners.

Managing fixed expenses is the best way to ensure the long-term profitability of investment properties, especially in a flat market. The largest continuing expense for most commercial properties is the property tax bill, and in a market with skyline-defining properties and headline-grabbing sales prices, tax assessors have multi-tenant office properties in the crosshairs.

Any reduction in tax burden can drastically improve an investment's profitability, competitiveness and tenant retention. As another assessment season begins across the Midwest, understanding tax assessors' common errors can equip property managers and owners with the tools necessary to review the accuracy and reasonableness of the assessments on their office properties and, when appropriate, challenge those assessments.

Know the relevant market

To an outsider, the office market can appear monolithic. To such people, rent, occupancy and other income characteristics of office properties are consistent throughout the market. But pulling data from the wrong market can lead assessors to an incorrect result.

For example, assessors may assume that Class A downtown office towers are the best-performing assets in the market, and value them accordingly. Contrary to this perception, though, Class A properties may not outperform all Class B or Class C properties, and downtown may not be the strongest office submarket in a certain metro area.

Nowhere is the distinction between office submarkets clearer than in the downtown-suburban divide. In many Midwestern markets, suburban office properties tend to be newer, have better occupancy, and in some cases, command higher rents than their downtown competition.

The factors influencing the relative performance of downtown and suburban office properties vary, but they include employees' desire to work closer to their homes, and comparatively low land prices, which allow office building construction with the larger floorplates many tenants prefer. Suburban office markets also typically are able to offer free parking, while paid parking — which is common in the central business district — increases occupancy costs for tenants and their employees. Downtown towers though may appeal to large law firms, accounting firms and banks seeking a prestigious address.

If an assessment is premised on a uniform per-square-foot value, rental rate or vacancy rate for all office properties in a metro area, the assessor is likely failing to consider distinguishing factors in submarkets. Finding those distinctions can benefit owners on either side of the downtown-suburban divide.

Don't blindly trust sales

Assessors are often too reliant on sales data. Although some properties may be valued by considering sales prices for comparable properties, office properties do not neatly lend themselves to such an analysis. Applying the recent sales price of a downtown office tower to all other office towers in the downtown area may seem reasonable on its face, but fails to recognize how buyers and sellers interact in the office market.

For many real estate types, an assessor can identify comparable sales and adjust those transactions to reflect differences between the comparable and subject properties. Unlike owner-occupied buildings, investment properties that are otherwise similar are not easily adjusted for real estate-related factors. This is because market participants do not settle on sales prices based on attributes of the real property, but on attributes of the income stream.

Buyers of multi-tenant office buildings are motivated by the durability of the income stream, reflecting either potential for growth or existing leases with creditworthy, in-place tenants. Knowing a target's income characteristics, buyers apply their own capitalization rate thresholds and back into the sales price. But that price necessarily reflects the particular income stream being purchased, which may have limited applicability to another property. This approach is opposite to the way many assessors believe sales prices are set.

This is not to say that sales of comparable properties are entirely irrelevant in valuing an office property for tax purposes. For example, because capitalization rates reflect the behavior of investors in the market, sales of properties that are comparable as investments can inform the selection of a capitalization rate in a particular analysis. But if an assessor has used a recent sale as the sole basis to set the assessments of the competitive set, whether their assessments truly reflect the market is questionable.

When income isn't income

As income-generating assets, office properties are most commonly valued using the income approach. But even though office rents are not as attributable to personal or intangible property as is, for example, a hotel's income, the rents paid by office tenants are not entirely attributable to the real estate. Simply capitalizing a building's existing income stream mistakenly assumes it is.

The market for office properties in many areas is extremely competitive, and nearly all leases in some markets reflect tenant incentives like improvement allowances. Even long-standing tenants expect such incentives when their leases are up for renewal, and tenants are accustomed to using those allowances to refresh their space. Landlords, in turn, collect marginally higher rent that amortizes those costs over the lease period. But the impact of above-market allowances must be removed from the lease rate in determining the market level of rent. An assessor cannot say that a lease is $15 per square foot if the landlord paid the tenant $5 per square foot upfront.

Assessors also often misunderstand reimbursement income. Triple-net leases are uncommon in the office market; instead, landlords build an assumed level of expenses into their base rent and if the expense exceeds that base-level in future years, the tenant reimburses the landlord for the excess. Some assessors mistakenly view reimbursement income as additional profit. But, as the word "reimbursement" suggests, landlords only collect reimbursement income when, and to the extent, expenses exceed the base amount. Assessors should be reminded that reimbursement income is not a profit center.

As the office market continues its slow expansion, assessors are eager to capitalize on the most visible parts of the city skyline. But by grounding the assessor in the economic realities of the office market, diligent owners and property managers can reduce fixed expenses, lower tenant occupancy costs and ultimately improve profitability.