​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.

​Investors should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class, says attorney Kieran Jennings.

Recently, The New York Times published an article on property taxes imposed on retailers under the headline "As Big Retailers Seek to Cut Their Tax Bills, Towns Bear the Brunt." This and similar articles question the fairness of how retailers have reduced their tax bills by using sales of unoccupied stores as comparable transactions to establish the assessed value for an occupied store.

The local government has cried foul, and the article concentrates on the perceived end result―lost revenue for government coffers.

What is missing from the article is basic tax law, which holds that all taxpayers in a given class must be taxed uniformly. Thus, the series of bad decisions that led local government to overtax retailers made communities dependent on inflated revenue. The initial mistake many assessors made was to seize upon sales prices associated with leased retail stores without critically examining the transactions.

Investors, and taxpayers in general, should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class.

Most state constitutions specify that taxes must be uniformly assessed, which requires assessors to follow the same rules for all taxpayers within a class. At the most simplistic level, the rules of the game must be consistently applied to all and not changed to affect the outcome.

To understand how equally applied rules achieve fair taxation of property, bear in mind this fundamental truth: The assessor's goal is to measure the value of real estate only. Taxing entities then use that value to determine the tax. A lack of well-thought-out rules and procedures created the problem of non-uniform assessment.

Many states don't even have a clear definition of what they are trying to measure. States use terms such as "true value" or "true market value" without any further defining language. For most people, fair value simply means what a home would sell for in an open-market transaction. But commercial real estate is not that simple and requires clear definitions applied uniformly to all taxpayers.

Commercial property values are influenced by many factors unrelated to real estate. Consider how, under various circumstances, the same property might sell for wildly different values: An owner-occupied property will sell based on what the market will pay for the building once it is vacant, either for the new owner to occupy or as an investment for the buyer to lease-out at market terms.

The same property, were it leased at an above-market rental rate or to a highly credit-worthy tenant, functions much like a bond and will sell based on a market capitalization rate and for a greater price than the owner-occupied property.

Finally, the same property leased with long-term, below-market lease terms or a less credit-worthy tenant might sell for less than the owner-occupied price or the above-market-leased example. In each scenario, the same property sells for different amounts. Without a clear set of guidelines, establishing value based on sales price would be inconsistent even for a single property, much less an entire class.

Of the three scenarios, the only method that can be replicated consistently and applied to owners of both leased and owner-occupied real estate alike is that of the owner-occupied property. Owner-occupied interest is the unencumbered, fee-simple interest, which makes it the measuring stick common to all taxpayers. All other interests are influenced by non-real-estate factors such as lease terms or business value.

Adding to the confusion is the ever-changing commercial real estate sector, where market data is full of sales that include non-real-estate influences. The single-tenant market, for example, has evolved from almost exclusively retailer occupancy to include specialty uses and even nursing homes and hospitals.

The assessment goal should be to measure the real estate value alone, ensuring that all taxpayers are taxed with the same measuring stick, but confusion comes in when the sales alone don't indicate real estate value. Leased sales indicate the value of the real estate along with the tenant's credit-worthiness, the life of the lease and a host of other factors that can include enterprise zones and outside influences.

The court cases that are clarifying the methodology and the measuring stick appear to reduce assessments, when they are actually correcting the assessments and requiring assessors to value the same interests for all taxpayers. Defining terms and ensuring rule uniformity protects all taxpayers. There is no foul to be called and the losses affecting some local governments are the result of their own mistakes.

The cure is simple, but the short-term pain for community coffers is significant. States must establish clear definitions and guidelines around property rights so that assessors can value all real estate without encumbrances. Local governments cannot rely on a single taxpayer subset to carry the tax burden.

​True to campaign promises, the new Cook County assessor has proposed sweeping legislation that borrows the most burdensome tax requirements and penalties from jurisdictions across the country. But will this enhance transparency or simply saddle taxpayers with inaccurate assessments and the need for costly appeals?

The 2018 race for Cook County Assessor ended in Fritz Kaegi beating out incumbent and long-time political powerhouse Joseph Berrios. Kaegi's campaign promises targeted the "insider" game of property tax appeals and proposed to bring fairness and transparency to the Illinois property tax appeal system.

The proposed requirements would only be imposed on commercial or income-producing properties worth more than $400,000, or residential properties with seven or more units worth more than $1 million. Residential properties with six units or less, as well as mixed-use commercial/residential buildings with six or fewer apartment units and less than 20,000 square feet of commercial area, are exempt from reporting income data.

In Cook County, these commercial properties will be required to submit income and expense data to the assessor prior to July 1 each year, and attest to the truthfulness of such information. Counties outside of Cook County may adopt the same requirement.

Property owners who fail to file the required information may receive a notice from the assessor demanding its submittal. If the taxpayer fails to report the income pursuant to the notice, the taxpayer will be fined 2 percent of the previous year's total tax bill. If the taxpayer still does not submit evidence within 120 days of the original notice, the proposal adds a second penalty of 2.5 percent of the prior year's tax bill.

As if these financial penalties were not enough, the taxpayer who fails to provide the information within 120 days is precluded from appealing the subject property's tax assessment. Furthermore, the Cook County State's Attorney's office is granted the right to subpoena the income and expense data from the tax payer on an annual basis.

None of the legislation eliminates the right to appeal to the Board of Review, however.

So, will the proposed statute bring fairness and transparency to the appeal process? No.

Round hole, square peg

The requirement to file income and expense data is not revolutionary. In many cases, taxpayers file appeals based directly on the property's income data rather than incur appraisal expenses. On the other hand, income-producing properties that commission an appraisal will provide the income and expense data to the appraiser in order to explain any differences between the actual rents in the subject property and the market rents used to calculate the assessment. Thus, the new rules will not necessarily bring more transparency to the values of multimillion-dollar commercial properties.

For the institutional investor, the greatest concern about the proposal is the validity and application of the collected income and expense data. As the old saying goes "garbage in, garbage out."

The assessor claims that the collection and aggregation of data directly from taxpayers will help identify the true rental market value of specific real estate. The concern is that taxpayers will be reporting a variety of unadjusted rents rather than market rates. Market rates take into account the differences between gross, modified and triple net leases, as well as tenant improvements, concessions, length of lease, sale-leasebacks and a host of other factors. Without adjustment to market rates, the data will be incorrect and the assessments will be inflated. This will produce a higher rate of appeal on an annual basis and impose greater appeal burdens on all involved.

Furthermore, the new requirements will bring the greatest harm to smaller commercial investors who may not be filing property tax appeals at all. Many of these are mom-and-pop organizations that keep handwritten ledgers and have market values between $400,000 and $1 million. The annual reporting requirement and respective penalties would be financially burdensome to taxpayers in this group, many of whom never undertook the expense of filing an appeal. Now those taxpayers may be open to valuation increases on an annual basis and have to spend money on appraisals and attorney representation.

And transparency?

The proposed statue prohibits "non-personal income and expense data" the assessor collects from being accessed through Freedom of Information Act searches. Does this indicate that the data sets the assessor produces cannot be analyzed by the taxpayer for accuracy? Where is the fairness and transparency in that?

If the statute passes, the hurdle for Illinois taxpayers will be to clearly identify the difference between market rents and actual rents for each of their properties, which may result in extremely burdensome requirements and penalties. The mandated steps may require intricate analysis and could result in property owners expending time and money responding to annual notices for documentation, fines for noncompliance, and the inability to challenge illegal assessments as a right.

Much of the income-and-expense statements, rent rolls and other data the assessor seeks are already available in documentation currently being submitted in support of annual appeals. Based upon this readily available data, the assessor should be able to generate guidelines that reflect current rental rates, occupancy levels and capitalization rates.

If Cook County taxes need reform, this is not the reform.

​The FTZ Act prohibits state and local taxes on tangible personal property.  Here's what you should know about the potential for reducing your tax bill.

Foreign-trade zones can offer substantial tax savings for businesses involved in various aspects of manufacturing and international trade. While there are costs involved in setting up and maintaining such a zone, the prospect of escalating trade wars is spurring companies to explore the FTZ designation as a potential cost-control measure.

First, some background. FTZs are the U.S. equivalent of what are known internationally as free trade zones. Authorized under the Foreign Trade Zones Act of 1934, they are usually in or near U.S. Customs and Border Protection ports of entry, and are generally considered outside CBP control. Many communities have integrated these zones into state or local economic development incentive programs.

Broadly speaking, FTZs are designed to stimulate economic growth and development. In an expanding global market, countries increasingly compete for capital, industry, and jobs, and FTZs promote American competitiveness by encouraging companies to maintain and expand their U.S. operations. The zones accomplish this by removing certain disincentives associated with operating in the U.S.

The best-known incentive is designed to level costs among domestic and foreign- manufactured goods. For a product manufactured in a foreign country and imported to the United States, the duty is based on the finished product rather than on its individual parts, materials, or components.

Domestic manufacturers must often pay duties on multiple parts, materials, or components that are imported to be incorporated into a finished product. When those duty payments are added together, the cost of the finished product is higher than for comparable finished goods. FTZs correct this imbalance by assessing duties on products manufactured in an FTZ as if they were manufactured abroad.

Companies operating in FTZs enjoy a number of other benefits:

• No duties or quotas on re-exports

• Deferred customs duties and federal excise taxes on imports

• Streamlined customs procedures

• Exemption from certain state and local taxes

These benefits become increasingly valuable to domestic companies during trade wars, particularly when the disputants impose steep tariffs on manufacturing parts, materials, and components.

STATE AND LOCAL FTZ RULES

FTZs are subject to the laws and regulations of the U.S., as well as those of the states and communities in which they are located, with one significant exception: The Foreign-Trade Zone Act specifically prohibits state and local ad valorem ("on the value") taxation of imported, tangible personal property stored or processed in one of these zones, or of property produced in the United States and held in the zone for export.

Several states, including Arkansas, Kentucky, Louisiana, Maryland, Mississippi, Oklahoma, Texas, Virginia and West Virginia, impose ad valorem tax on business inventory. In a handful of other states, including Alaska, Georgia, Massachusetts, and Michigan, some jurisdictions tax some inventories. But even in these states, most legislatures have carved out "freeport" exemptions from ad valorem taxes on merchandise being shipped through the state.

The problem is, the longer it takes for the merchandise to be shipped out of state, the greater the temptation for an enterprising tax assessor to conclude that the merchandise is no longer actively in transit. In such cases, the exemption may no longer apply and the merchandise could become subject to an inventory ad valorem tax.

FTZs may offer a safe harbor from these taxes. Foreign and domestic merchandise may be moved into a zone for operations, including storage, exhibition, assembly, manufacturing, and processing. Such merchandise may remain in a zone indefinitely, whether or not it is subject to duties. And, while no retail trade of foreign merchandise may be conducted in an FTZ, foreign and domestic merchandise may be stored, examined, sampled, and exhibited in the zone.

Of course, there is a catch. When a proposed FTZ designation could result in a reduction to local tax collections, the zone's governing authority must consider the potential impact on local finances. Specifically, an applicant must identify the local taxes for which collections would be affected, and provide documentation that the affected taxing jurisdictions do not oppose the FTZ designation. Importantly, in jurisdictions that already have "freeport" exemptions to ad valorem taxes, the adverse impact would be limited only to the amount of ad valorem taxes imposed on inventory that is determined by a tax assessor to have come to rest in the state, such that it is no longer subject to the "freeport" exemption.

There are costs associated with FTZs, including application fees and assessments as well as operating fees to maintain the designation. Therefore, individual companies must conduct their own cost/benefit analyses and determine whether these zones are right for them. A competent legal or tax advisor can help to project initial and ongoing costs.

Considering the other trade uncertainties currently buffeting manufacturers, eliminating ad valorem tax exposure alone may warrant using an FTZ.

​Assessors too often value newly constructed apartments as fully occupied, producing excessive assessments.

Developers frequently ask how to estimate property taxes on newly constructed multifamily properties, and tax assessors often provide an easy answer by adding up the value of building permits or by projecting the project's value when fully rented. However, this seemingly simple question grows complex when the assessor's valuation date precedes full occupancy and the ramifications of a wrong answer can linger for years.

Consider these points to value a new multifamily project more accurately.

Valuation Methods

Charged with valuing hundreds or thousands of parcels, assessors often seek a quick way to value a new multifamily project.

The cost approach offers the quickest and easiest route for the assessor, who estimates the current expense to construct an identical structure. One way to do this on a new project is to add the value of the building permits to the land value.

While building costs are clearly a factor in the decision to build, the cost approach ignores the market preference to value income-producing projects based primarily on income.

The assessor's second-easiest option is to rely on an appraisal's stabilization value and ignore the time and cost required to achieve stabilization. In valuing a not-yet-built multifamily project using an income approach, appraisers preparing a financing appraisal should, but don't always, calculate two different values: the "at completion" value and the "stabilized" value.

"At completion" is the project's value when construction is complete but prior to being fully leased. The prospective market value, or "as stabilized," reflects the property's projected market worth when, and if, it achieves stabilized occupancy.

The Dictionary of Real Estate defines stabilized value in terms of the expected occupancy of a property in its particular market, considering current and forecast supply and demand, and assuming it is priced at market rent. To determine a property's fair market value prior to stabilization, one must account for the monetary loss the owner will incur prior to stabilization.

Development Issues

Improvements generally trigger reassessment. The assessor's statutorily mandated valuation date generally ignores the development calendar's key milestones, most importantly the construction commencement, completion and revenue stabilization dates.

The developer makes assumptions during the development process, calculating the cost of building and operating the improvements as well as the rents that can be achieved. This calculation serves as the basis for a pro forma of an income and expense analysis of the project when fully leased.

Construction loans reflect building costs and subsequent time and money needed to achieve full lease-out or stabilization. Banking regulations require the lender to obtain an appraisal. The completed, but not yet stabilized, project incurs costs in the form of income not received during initial leasing, until it reaches stabilization.

Permanent financing depends on the stabilized value, which, in turn, depends on the project's income. Appraisals for permanent loan commitments obtained prior to the project's completion use a prospective valuation date and must contain various assumptions as to the property's financial condition on that prospective date.

The FDIC's Interagency Appraisal and Evaluation Guidelines authorize using a prospective market value in valuing a property interest for a credit decision. The Uniform System of Professional Appraisal Practices requires disclosure of assumptions in an appraisal with a prospective market value, as of an effective date subsequent to the appraisal report's date.

Assumptions regarding the anticipated rent at stabilization and the time required to lease the property are key to calculating stabilized value. Also critical are incentives the owner may offer prospective tenants during lease-up, and the project's projected income once fully leased. The appraisal should clearly disclose these assumptions, but they can still prove incorrect.

Clear disclosure of assumptions is critical. Unfortunately, many appraisers fail to adequately disclose their assumptions, and shortcut to the project's stabilized value.

Valuation Dates

Most state statutes prohibit taxation of improvements while under construction. The project usually comes on line for tax purposes after completion but prior to stabilization.

Being mandated by statute, the valuation date often does not account for where the multifamily project is on the spectrum between completion and stabilization. Unsophisticated assessors charged with valuing these projects often employ mass-appraisal techniques and may value the asset similarly to the market's stabilized properties.

Statutory Caps

Some states cap potential increases in tax value, which may magnify impact of the initial tax valuation. Caps limit increases that would otherwise bring values up to the market. For example, South Carolina properties undergo countywide reassessment every five years, but property values ordinarily cannot increase by more than 15 percent from the previously determined value.

Assessors know that a project's value at completion will nearly always be lower than its stabilized value because stabilization takes time and costs money. Competition may lower the project's achievable income, too. This knowledge can spur assessors to reach for stabilized values regardless of whether the project is yet stabilized. This taxes the unrealized, additional value between completion and stabilized levels.

A Matter of Time

All of the above considerations involve a timing disconnect between the property's actual condition on the statutorily mandated valuation date and its estimated future value based on fallible projections by the lender, developer or assessor. Axiomatically, assumptions don't always hold true. Lease-up may take longer than expected and may require concessions that increase cost. In over-built markets, the stabilized income may be lower than originally anticipated.

Charged with calculating true or fair market value as of a statutorily mandated valuation date, the assessor should examine how the market would value the property as of that date. If the asset has not achieved stabilization, the assessor should discount appropriately for time and financial costs required to achieve stabilization.  That is what the market would do, and is what the assessor is statutorily obligated to do.

And that should be the answer to the seemingly simple question of how to value newly constructed multifamily projects for tax purposes.

​Here's what taxpayers should do if the tax controversy now brewing causes large property tax increases

Recent headlines questioning the taxable values of Atlanta-area commercial properties may threaten taxpayers throughout Fulton County with a heightened risk of increased assessments.

Changes in the Midtown Improvement District, which extends northward from North Avenue and along both sides of West Peachtree and eastward, are rapidly reshaping the Atlanta skyline. Multiple new buildings under construction rise 19 to 32 stories, ushering in more than 2,000 new apartment units as well as hotel and office uses.

Amid this intense construction, Fulton County tax assessors have come under fire in newspaper and broadcast news reports that showed assessed taxable values were well below the acquisition prices paid for many commercial properties. Both Atlanta and Fulton County have ordered audits to determine whether assessors consistently undervalued properties, resulting in lost revenue.

While it may be unsurprising that assessors failed to keep up with rapidly changing market pricing in a development hotspot like Midtown, the news coverage and government scrutiny may pressure assessors to increase commercial assessments across the board. Owners of both newly constructed and older properties should diligently review the county's tax assessment notices, sent out each spring, to determine whether they should appeal their assessed values.

Know the assessment process

Understanding the permissible approaches to valuation is key for the taxpayer to determine whether to appeal an assessment. The two most commonly used methods are the income approach and the market or sales comparison approach, both of which can be problematic if incorrectly applied by the county assessor.

Assessors typically value apartments and office buildings using the income approach. Initially, however, assessors use mass appraisal methods that may not reflect the specific financial realities of the individual property. Taxpayers should examine each of the various components of the county's income model and question whether each element of the formula is appropriately applied to their property.

By utilizing data from the market, has the assessor overestimated the rental rates for the property? Property owners should analyze and discern whether it is beneficial to provide the previous year's rent roll to the assessor in order to argue that the county's model rental rate is inaccurate for their property. An older complex or building may have new competition from a recently built property offering up-to-date amenities. Not only will the older property be at a disadvantage to charge premium rents, but the newer construction is also driving its taxes higher.

Has the assessor used a market occupancy rate that does not correctly indicate the property's occupancy level? In order for the income approach to accurately achieve both physical and economic occupancy, the vacancy and collection loss should take into account both the occupancy rate and concessions that the owner provides to renters to maximize occupancy. Again, in a fluctuating market with new construction competing against old, occupancy rates can be affected.

In using market data, has the assessor underestimated the expenses for the property? Perhaps the expense ratio used is inappropriate for the property. If so, property owners can demonstrate this by providing the previous year's income and expense statement to the assessor, differentiating their property from the mass appraisal model.

A common area of disagreement is the capitalization rate. A capitalization rate is the ratio of net operating income to property asset value. Has the assessor used a cap rate that is derived incorrectly from sales of properties that are not comparable to the taxpayer's property?

Has the assessor properly added in the effective tax rate to the reported base cap rate from the comparable sales because the real estate taxes were not included in his allowable expenses? If the effective tax rate is not added to the base cap rate, and real estate taxes are not included in the expenses, the result is a lower cap rate, and thus, an artificially and incorrectly higher value. An analysis of the accurate application of the sales comparison or market approach is helpful in making the determination of the appropriate cap rate.

Many factors go in to determining if sales are sufficiently similar and can be relied upon. The comparable sales used should be of a similar age as the subject property. Older properties usually command a lower price per unit or lower price per square foot than newly constructed properties.

The comparable sales used should be similar in square footage to the subject property, with similar square footages in the various units within the property, because larger average unit size usually generates higher rents and also results in a quicker lease-up.

Consider the type of purchaser involved in the comparable sale transactions. Private investors typically pay less for properties than institutional purchasers such as real estate investment trusts because REITs are able to obtain lower-cost loans.

Similarly, if below-market-rate financing was already in place and the buyer was able to assume the loan, then the sale price may have been artificially inflated. Another circumstance to examine is, if the seller provided a significant amount of financing in the sale, there may have been unusually favorable financing terms; if so, the sales price must be adjusted.

Another aspect to investigate is the existence or lack of substantial deferred maintenance at the time of sale in comparison to the subject property. The necessity for additional capital expenditures after a purchase can affect the purchase price.

It is helpful to inquire into the effective real estate tax rates of the sold properties in order to determine if they are sufficiently similar to the subject property. Jurisdictions or taxing districts with lower tax rates can cause properties to sell for higher prices. Taxing neighborhoods with higher tax rates tend to generate sales with lower values, and thus, higher cap rates.

All commercial real property owners in Fulton County should carefully examine their tax assessment notices, because higher valuations by county assessors may be on the horizon. Property owners do not want to pay sky-high taxes based on what may be reflexive assessments stemming from the latest headlines.

Tax courts don't always recognize market value in setting property tax assessments.

Most real estate is taxed ad valorem, or according to the value. The theory is that each person is taxed on the value of the real property they own.

The New Jersey Constitution (Article VIII, Section 1, paragraph 1) stipulates that property is to be assessed for taxation by general laws and uniform rules, and that all non-agricultural real property must be assessed according to the same value standard.

Our statutes define the standard of value as the true property value. We call this market value, or the most probable price a property will bring in a competitive and open market under conditions requisite to a fair sale. That assumes the buyer and seller are each acting prudently and knowledgeably, and that the price is unaffected by undue stimulus.

In 2005, the state Tax Court, in a General Motors case, openly admitted it was making a determination that the highest and best use of the property was as an auto assembly facility. By this determination, the court set public policy indicating that this highest and best use fairly and equitably distributed the property tax burden.

In this case the court felt it was necessary to conclude the highest and best use of the property at issue was an auto assembly plant because to do otherwise may allow features of the property to go untaxed and therefore lower the value of the plant. The court also stated that this determination was consistent with and effectuates the public policy of fairly and equitably distributing the property tax burden. All of this was concluded while the market data suggested a different result, given that no auto manufacturing facility had ever before been sold to another automobile manufacturer. Further, by law, the tax court's role is to determine value, not to redistribute the tax burden.

The history of the Tax Court has, in practice if not in theory, interpreted the constitution and statutes of real property taxation to find value in a uniform and stabilized manner. In other words, although the market may vary over a period of years under review, the court would attempt to stabilize the effect of the differences when rendering opinions.

The Tax Court would also set precedent by using methods of valuation not normally used in the marketplace because it deemed the data before it at trial to be lacking. It has, for example, applied a cost approach to determine value when a buyer would purchase a property based on an income approach. This is common in court decisions, but often runs afoul of true market motivations and distorts the conclusion of value. The more the courts reach these types of decisions, the further away they move from concluding market value.

The court's attempt to carry these principles forward has appeared in various ways over the years. As early as 1996, in a case involving a super-regional mall with anchors not separately assessed, the Tax Court deemed the income approach inappropriate to value the stores and instead valued the stores on a cost approach. Today, the legacy of that decision requires plaintiffs to present a cost approach, which is not evidence of market value. This may well distort a property's valuation.

Issues such as capitalization rates are also problematic for certain assets in Tax Courts findings. Over the years, court precedent has set rates that often do not reflect the market. This is especially evident today when valuing regional malls classified as B or C grade. The market capitalization rates are well over those the courts have historically found. Although transactions verify this market data as accurate, the courts fail to recognize it, making it difficult for plaintiffs to prevail with values based on actual, transactional data.

In January 2018, after a number of decisions that rejected plaintiffs' approach, our Tax Court appears to have taken some pause. It recognized that by rejecting proofs from the market and data forwarded by taxpayers, it was ultimately failing to conclude to warranted assessment adjustments.

It stated:

"there has been some criticism of late, that the Tax Court perhaps has raised the bar for meeting the standard of proof too high in property tax appeals, given arguendo, what could be viewed as a growing trend seen in a number of recent decisions, where the court rejected expert opinions and declined to come to value. While such a suggestion may give the Tax Court pause for self-examination and reflection, it must not serve to invite expert appraisers to abrogate their responsibility of providing the court with 'an explanation of the methodology and assumptions used…'"

The quote seems to recognize that the proof bar was getting so high that a plaintiff could never prove its case. A more realistic view of the proofs provided by a taxpayer comes with it the recognition that market data and actions from market participants are the touchstones of value that should establish our assessments.

​What You Need to Know to Successfully Appeal Your Inordinate Property Taxes

For some time, owners and operators of seniors housing properties have been aware of the staggering demographic statistics, such as the Census Bureau's projection that the baby boomer population will exceed 61 million when the youngest boomers reach 65 in 2029. This is truly the Silver Tsunami. Yet, even seniors housing professionals may be surprised by excessive property tax assessments that break otherwise carefully constructed budgets.

Before discussing what seniors housing owners can do to combat an excessive property tax assessment, it will help to review why some taxpayers will receive such unwelcome notifications. Factors include the large and increasing number and variety of seniors housing projects, coupled with the mass-appraisal methods that assessors typically employ.

With tens of thousands of units constructed each year, the country now has over 3 million seniors housing units ranging from independent living to assisted living, memory care and/or nursing care. Appropriate assessment methods depend on whether a property is an all-encompassing, continuing care retirement community; freestanding with only one component (such as independent living only); or comprising several (but not all) of these subtypes.

Unfortunately, assessors with limited resources usually use a cost-based methodology that is cost-effective for valuing a large number of properties. That may work for residential assessments in areas with similar homes, but given the significant differences between seniors housing properties, this approach can create an enormous tax problem for taxpayers who own seniors housing.

An outrageous assessment

In one recent case, the owner of a newly constructed property was shocked to receive an assessment valuing the property about 30 percent above its actual cost.The resulting taxes would have exceeded the owner's budget by over $250,000, not only ruining cash flow, but also destroying more than $2 million of market value.

Fortunately, there are measures taxpayers can take to counter excessive assessments. A critical initial step is to confirm any appeal deadline. Not only do rules differ across the country, but in many states the appeal deadline depends on when the notice is sent.

Further complicating this point is that more than one formal appeal may need to be filed, and taxpayers often have a narrow window within which to file. Generally, if a taxpayer receives a notice and misses a required appeal deadline, there are no second chances for that tax year.

Other important steps are to determine the applicable value standard and the assessment's basis. Usually (but not always) the standard will be market value, or the probable cash-equivalent price the property would fetch if buyer and seller are knowledgeable and acting freely. To determine that value, the assessor usually will have used an incomplete and improper cost approach that only adjusted for physical depreciation.

For these typical cases where the assessor has estimated market value using a flawed cost approach, drilling down deep into the assessor's cost methodology may produce a gusher of tax savings. In the aforementioned case, the assessor had used the costs for constructing a very expensive skilled nursing facility. Correctly using the assessor's cost estimator service for the subject property, which was mostly comprised of independent living units, reduced the cost by about $10 million.

Additionally, an assessor's cost-based valuation often will only account for depreciation from the property's physical condition. A proper cost approach must also account for any functional or external obsolescence.

Functional obsolescence can be substantial, especially for older properties, because consumer preferences change over time. What consumers may have desired years ago may now constitute a poor offering.

External obsolescence, which is often due to adverse economic conditions, can impact a property regardless of its age. For example, there will be external obsolescence if new properties overwhelm market demand in an area, or if the inevitable next economic downturn lowers market values.

Other scenarios

While atypical, sometimes assessors will use an income approach or sales comparison approach to value seniors housing properties. As with the cost approach, those approaches introduce many ways for assessors to reach erroneous and excessive value conclusions. One potentially large error is valuing the entire business and failing to remove the value attributable to services, intangibles or personal property.

In the previously mentioned case, the taxpayer's appraiser used the income approach and concluded that the seniors housing property had a total business value of approximately $22 million. The appraiser then determined that about $1 million of that value was attributable to services and intangibles and about $800,000 was attributable to tangible personal property as shown in the table below.

In a similar vein, the Ohio Supreme Court recently reversed the Ohio Board of Tax Appeals in the case of a nursing home property where a taxpayer's appraiser had determined that only about sixty-two percent of the total paid for all assets was for the real property. The Board of Tax Appeals had summarily rejected the appraiser's analysis as a matter of principle. The Ohio Supreme Court reversed and ordered the Board to reconsider the appraiser's analysis, and determine what amount, if any, should be allocated to items other than real estate.

These cases underscore that an assessor who uses the income or sales comparison approach and mistakenly values the entire business, rather than the real property alone, can improperly inflate a real property assessment by a material amount.

Another step taxpayers can take to achieve tax justice is to involve experienced tax professionals and appraisers. As the above analysis shows, property tax valuation appeals have many procedural nuances as well as legal and factual issues that must be addressed. In addition, in some jurisdictions there may be a basis to obtain relief based on the assessments of comparable properties.

As the inevitable Silver Tsunami inundates markets, there will be more seniors housing properties and more instances of excessive tax assessments. To the extent that the surge in the elderly population depletes local government finances, whether due to government pension plan shortfalls or otherwise, there should be no surprise if property tax bills increase.

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Careful preparation is the key to contesting these unfair property taxes.

It may be paradoxical that big-box retail has lost property value in real estate markets where commercial property values in general are climbing, but that is the message many owners must convey to achieve a lower property tax bill.

For decades, big-box properties generated significant tax revenue for schools and local governments, but that story is changing. Annual valuation gains of 2 percent to 10 percent annual increases may have become a simple rule of thumb at one time for assessed values, but are no longer expected or acceptable to most big-box owners. Instead, there is now a major struggle between the big-box owners and the local property tax assessor.

Many companies have changed their real estate and marketing strategy to adapt to declining big-box property values. Toys R Us, Kmart, Sears and other stores have either closed stores or no longer exist. Others, including Walmart and Target, have adapted to suit customers who are no longer happy shopping in a mega store, or having to walk to a distant corner of a mega store to pick up a toothbrush, a bottle of milk or a pair of shoes.

Many retailers have achieved positive results by reducing store sizes. Target moved away from the superstore format to stores of 25,000-45,000 square feet, emphasizing the "grab and go" concept rather than the full grocery store.

Some experiments have not worked so well. Walmart opened a number of smaller, "neighborhood" Walmarts, only to close many a few years later. Mega stores still exist, but while commercial real estate values in general may be soaring, the value of these mega stores generally is not.

Yet, the local assessors do not see it that way, applying either a simple, across-the-board increase based on the general market, or using the standard cost, income capitalization and market/sales approaches to perpetuate valuation increases that ignore changing retail dynamics.

Points of contention

The cost approach often results in an inflated and unrealistic value that no one would pay in an open-market transaction. The cost approach should only be used on a relatively new building with little depreciation or obsolescence to take into account. The original cost may also include single-purpose features which have little or no value to a second-generation user.

Finally, if the building is to be repurposed, there is enormous added cost to convert a mega store to multi-tenant occupancy or to a different use with a shallower usable depth; it may not be economically feasible.

The income approach is often unavailable since these stores are most often owner-occupied, and this approach should only be applied for a rental property. An owner-occupied property should never be required to produce income and expenses in the context of a valuation of the property for property tax purposes. Such information values the business that is being operated from the property, and not the bricks, mortar and land.

This leaves the third option, the market or sales approach, as the primary appraisal method. Here starts the war.

First, many assessors see a Walmart, Kohl's, Target or a Lowe's store differently than they do a local mom-and-pop store operated from a similar property. Yet this is wrong, because it violates basic principles of property tax valuations.

A taxing entity cannot collect property taxes on the value to the name as an ongoing business, but only on the bricks, mortar and land. Buildings with comparable size, location, age, quality and other real estate characteristics should have the same value, regardless of whether there is a national name on the building.

Second, most big boxes are owner-occupied. If sold, there would be no lease to transfer to the buyer; the building would be vacant and available to the buyer for its own use or subsequent leasing to a user-tenant. The way to apply this sales approach in such cases is to compare the big box to comparable sales of non-leased property that are, or soon will be, vacant and available.

Such sales in the relevant period are often hard to find. Many of these properties linger on the market for years before they are sold or repurposed. As a result of such few sales for comparison, the assessor will gravitate to using sales of leased properties.

A leased property is a totally different animal from an owner-occupied, big box store. The sale is based on the lease itself – the remaining term on the lease, the net income generated, the tenant's credit and the like. Often, the lease predates the sale by years and does not reflect current market rent. Sometimes the property was a build-to-suit project with rent based on the cost resulting from the user's specific requirements, which resulted in an initial inflated cost to build.

Case in point

This played out in one of my recent cases. The assessor valued a big box at $105 per square foot, based on recent sales of leased properties, with the rent in most of them being established 10-20 years earlier. Some were build-to-suit leases.

There was, however, a recent sale at $75 per square foot of a vacant big box store in a neighboring county. The Colorado Board rejected the assessor's valuation, finding that a vacant store represented the true market value, and reduced the taxable value to $10 million from the assessor's $15 million. This $5 million reduction resulted from digging into the assessor's analysis, pointing out the flaw in the cost and income approaches, and eliminating sales of leased properties.

The battle will soon start anew, and it is never too early to start accumulating the necessary data that will determine the victor.

Lack of data makes for more important conversations between advisors and property owners.

Corporate headquarters present unique challenges and opportunities in property valuation discussions with tax assessors. Managing taxes on any real estate property requires an understanding of all three traditional approaches to value, but headquarters are unusual in that good data are hard to find.

This article highlights common sticking points in value discussions for this unique property set. A collaborative discussion between an advisor and property owner on these few areas can lead to a successful tax reduction.

Cost considerations

A headquarters defines an enterprise, but many of its defining improvements lack value to potential buyers.

Especially with newly constructed or renovated projects, or when lacking comparable data, the assessor will often rely heavily on the cost approach to estimate market value. This can result in a high valuation with room for fruitful discussion about ways to support a value decrease.

Under the cost approach, an assessor using reproduction cost will frequently understate depreciation and obsolescence. It is important to also review treatment of the economic age-life method, which is often misapplied. The effective age, rather than the actual age, must be measured against the life expectancy of improvements.

Deferred maintenance also requires deductions. Good appraisal practice mandates that short-lived items should first be costed out by category — items such as windows, HVAC systems, carpet, roofs and restrooms — before determining their remaining useful life and cost of replacement based on capital plans.

If the appraiser resorted to a cost approach due to a lack of data for other approaches, in the case of an older headquarters with functional issues not designed to current standards, a replacement cost approach is preferred.

The replacement method projects the cost to reconstruct the buildings using modern materials, design and layout standards. This eliminates the need to estimate depreciation for superadequacies and poor design. It provides a better indication of the existing improvements' contribution to market value.

With preparation, the taxpayer can tell a powerful story of how to build the functional equivalent of the headquarters.

Income and sales

The income approach to value is seldom helpful, in part because of the difficulty in finding market rents for a single-user property of considerable size. The assessing authority may want to use multi-tenant rent comparables, but an explanation of the costs of the conversion from single- to multi-tenant use will reveal a significantly lower value conclusion.

The sales comparison will be the most relevant approach to value in most cases. Appraisers often use gross building area as a measurement unit of comparison for single users, but comparing by net rentable area (NRA) will go far to account for the reduction in value a building experiences when needs and usage change.

The appraiser must also use NRA for comparable sales. Factors such as remote working, benching and collaborative space needs will make more traditional and formal spaces within the building less valuable. Changes in how the corporate workforce uses office space can render many areas obsolete and deductible from NRA, such as auditoriums or an oversupply of formal conference rooms.

Another argument that helps to manage value in the sales comparison approach is to point out that parcels surrounding improvements should not be valued as fully functional and available building sites. Separating land from a corporate campus can diminish the campus' value.

Determining the economic impact to the comparables' sale prices when excess land might be at issue requires a more thorough analysis than simply looking at a land-to-building ratio and using the ratio as an adjustment criterion. The land-to-building-ratio adjustment alone does not measure the economic productivity of any excess land on the comparables in relation to the economic productivity of the headquarters land. There may be difficulty in developing the site due to terrain, or a corporate user might lose the right to add square footage elsewhere on campus if land is partitioned and sold.

There are good arguments to be made surrounding value adjustments for any renovations in a corporate campus. Often a corporate headquarters is physically complicated and evolving. If renovations add space, there is often an imperfect fit to the existing space. The taxpayer may argue that the new space suffers a discount because of the imperfect efficiency inherent in the blending of new and old.

Discussing conditions of sales comparables with the assessor is useful for appropriate adjustments. Often, the assessor lacks access to detailed offering memoranda or insights into the motivations of the buyer or seller, such as instances where a developer would pay more to acquire an assemblage, or if there is a need for cash, or unusual tax considerations.

Set the stage for a productive discussion with the assessor by first initiating an informative dialogue with the building engineers and manager. Ask them about the changing nature of the campus and their predictions about future changes.

On meeting with the assessor, share capital replacement plans and how the building must be changed due to internal industry needs and external trends. A meeting of the minds with the taxing authority on the cost and market approaches discussed above can lead to a successful value reduction.