The recent economic tsunami has already devastated the commercial real estate sector. But another wave of bad news is about to hit owners of commercial real estate. The economic downturn has drastically reduced state tax revenues, and state officials are responding by significantly cutting state aid to municipalities and school districts. Why is this bad for property owners? Because local governments will be unable to compensate for the cuts in state aid simply by making commensurate cuts in expenses (many of which are fixed costs such as debt service and binding labor agreements) – they will be forced to increase local property taxes to make up for budgetary shortfalls.
Real estate taxes are often overlooked by building owners in their search for budget items that can be reduced in order to soften the blow of vacancies or to lower operating costs as they attempt to attract new tenants and retain existing ones. Tenants, who typically reimburse their landlords for a share of real estate taxes, overlook this potential area for savings even more frequently – by failing to compel their landlords (through enforcement of lease provisions or simple persuasion) to consider a tax appeal. Yet, a review of the local tax assessment process may well reveal that an owner and, in turn, its tenants are paying more than their fair share of the municipal budget. This is especially true in the current depressed real estate market because many municipalities last conducted a revaluation or reassessment in the real estate boom of the last decade, and, as a result, the current assessment of many commercial properties is based on bloated values of yesteryear that no longer reflect market value.
Not only could a successful tax appeal mean tax savings for 2008, it could also mean a smaller tax obligation in future years.
Statutory deadlines for filing a 2008 tax appeal are approaching (in New Jersey, the deadline is April 1, 2009), and most tax assessors have already begun to determine the assessed value to be placed on every block and lot in their municipalities for the coming year. Therefore, building owners who are interested in filing an appeal (and tenants who have the contractual right or clout to force an appeal) should immediately review their current local property tax situations to determine if an appeal is warranted.
Background on Valuation
Real property is assessed at market value for local property tax purposes. The local tax assessor is familiar with market conditions in his or her municipality. Using this knowledge, the tax assessor utilizes three approaches, each of which will be discussed below to determine market value as of a particular date. (For example, in New Jersey, the assessment date is October 1 of the pre-tax year.) Although all three approaches to value are utilized to verify an assessor’s value conclusion, the approach that is ultimately relied upon will depend on the type of property involved, the use of the subject property and the availability of data in each situation:
- Sales comparison approach. In the sales comparison approach, the assessor (or the revaluation company) researches the market and obtains information regarding recent sales transactions. A review is made between the subject property and the various sales transactions to determine comparability. After comparable sales are identified, they are adjusted to reflect any differences between the comparables and the subject property. An analysis is then performed and a determination of value is reached. This approach is used when data on recently sold properties, similar to the subject property, are available. It is also used by assessors for valuing vacant land, residential properties and condominium properties. As previously noted, if a revaluation or reassessment was done in the last decade, the sales data was collected during a high point in the real estate market. Since that time, property values have declined in most tri-state municipalities, especially in the last year. Consequently, if a recent reassessment has not been done and the present assessed value of the subject property is based on data collected during that peak period, the subject property could very well be over-assessed.
- Cost approach. The cost approach entails adding the estimated value of the land (determined by using the sales comparison approach) to the reproduction or replacement cost of the improvements on the land. The current cost of improvements is determined through the use of cost estimating manuals. Depreciation and obsolescence are then deducted from the estimated value of the improvements. This cost approach is used mainly when valuing new improvements or when valuing “special purpose” properties –properties that are unusual and not frequently exchanged in the marketplace. However, despite the fact that most properties are older or general purpose facilities, property record cards on file in an assessor’s office often indicate only the cost approach to value, even when this approach is not appropriate. Therefore, an independent analysis of the subject property must be done by using the other approaches to value in order to determine if the subject property is over-assessed.
- Income capitalization approach. Income producing properties are valued through the use of the income capitalization approach. The present worth of future benefits is what is actually valued in this approach. If possible, an assessor reviews the present and historical actual income and expense information for the subject property. This information is commonly requested by the assessor’s office on a yearly basis. In addition, revaluation companies request this information from owners of income producing property prior to setting the assessed values during a revaluation. While providing the municipality with this information does not guarantee a correct assessment, it does assure that correct data will be applied. The assessor will also look to the market and review leases, expenses and concessions of comparable income producing properties to determine stabilized income and expenses for the subject property. The actual vacancy rates for the subject property and vacancy rate for similar properties in the market are also reviewed. Once this analysis is completed, net operating income is determined and is then capitalized to arrive at a determination of value. In addition to income producing properties, this approach is sometimes applied to owner-occupied commercial and industrial properties.
Given the dramatic changes in the commercial real estate market over the past year and the ongoing trend of lower rents and higher vacancy rates, building owners should carefully evaluate whether these circumstances will result in a significant reduction in the value of individual properties in their portfolio. If such a reduction has occurred, a prudent owner should seriously consider filing a tax appeal.
Knowledge of the data a tax assessor reviews and how he or she arrives at the assessed value of a subject property would certainly assist the building owner in determining whether its property is over-assessed and whether an appeal is warranted. In reviewing a property for this purpose, the owner must recognize that a tax assessor — unlike an owner, who is inclined to estimate the value of its property in a subjective and personal way — will look at a property’s market value in an objective and impersonal fashion. Although the approaches to value mentioned above appear to be somewhat straightforward, numerous issues arise each tax year between assessors and owners regarding such approaches and their application to specific properties.
Challenging a municipality over local property tax assessments requires advance planning, careful attention to detail in gathering facts and data, and knowledgeable appraisal and legal assistance.
Noah Bronkesh is Chair of the Tax Appeal Practice Group and Ted Zangari is Co-Chair of the Redevelopment Law Practice Group at Sills Cummis & Gross in Newark and Princeton, New Jersey.