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By Darrell V. Koehlinger, Appraiser; & Derek R. Pederson, Valuation Analyst
In the cyclical world of the commercial real estate market, property tax assessments often receive little to no attention in years in which property values are increasing. In these years, as the market values are on the rise, the property tax assessments often lag the growth in the market. The flip side of this phenomenon is that when property values are stagnant or declining, the assessments may overstate a property's current market value. In general, commercial real estate firms are busier, with assessment issues, in bad economic times than they are in good economic times. In the Year 2003, with both public and private entities under financial constraints, property taxes and, by implication, the assessed real estate market values are receiving closer scrutiny.
Our firm has looked at a variety of real estate assessment issues over the years. Most of our work is based in the State of Minnesota, but occasionally we are engaged for tax appeals in the Upper Midwest and beyond. The Minnesota assessment system, in and of itself, is relatively simple and fairly straightforward. Each year, on the 2nd of January, county and city assessors are required to issue an opinion of estimated market value for each residential and commercial property. The assessor's estimated market value is used as the basis for property taxation. The assessment is supposed to be at 100% of fair market value. Minnesota's real estate tax currently includes additional levies from the city, county, school district, and other special taxing districts. The typical real estate tax, on a commercial property, runs between 4% and 5% of the assessor's estimated market value. Taxes paid on commercial properties are traditionally amongst the highest in the nation. Because the assessor's yearly opinion determines the taxes which the owner will pay, it is essential that this opinion be an accurate reflection of what the market supports. This article describes some of the problems inherent in the assessment process. We also suggest some ways to mitigate or minimize the problems for the assessor, the taxpayer and other professionals involved.
Problems Inherent in the Assessment Process
The assessor is trying to do a difficult, if not impossible, task. In theory, he/she must re-appraise every property in the jurisdiction each year. Commercial real estate valuation is an involved process. Any number of factors may prevent a fair analysis of a particular property.
1. Lack of Time
A thorough appraisal of any single commercial property can take days, or even weeks. Due to the sheer number of properties that must be re-appraised by the assessor, individual properties cannot be appraised on an annual basis. As a result, assessors end up relying on general market data from the "bigger picture" when assigning the fair market value from which the property tax is generated. A good example of this is the assessment of a typical downtown office building. The assessor's tax value is based solely on how a particular building compares to similar office buildings in the immediate area. A full appraisal of that same property, however, includes attention to the specific details of the building, its operating costs, leases, vacancy rates, the appraised value of comparable office buildings, economic conditions, etc.
2. Premise of Value
Properties must be assessed on a fee simple basis rather than on a leased fee basis. Every valuation assumption must be "market-derived", not based on the leases in place. The reason for this is relatively straight-forward in that it does not allow a completely vacant building to be assessed differently from an identical building which is fully leased. Theoretically, owners who have done a good job leasing their properties are not penalized on behalf of those who have neglected to find, or who were unsuccessful in finding, tenants. When appraising for real estate tax purposes, this subtle requirement can lead to questions with unclear answers. For example, how does one appraise, at market level, a multi-tenant office building which could be used by either one large tenant or by 20 smaller tenants? When do you use the actual expenses rather than using the broader market level expenses? These are difficult questions and are best answered on a case by case basis.
3. Unique Properties
Special use properties present a challenge because the assessor's jurisdiction is limited by geography, rather than property type. Unique properties frequently require the application of a special valuation methodology in order to accurately reflect their market values. For example, if an assessor is charged with assessing a property such as a malting plant or a semiconductor facility, he or she is likely to have limited experience with this unusual type of property. A lack of understanding of the proper methodology can lead to value estimates that do not accurately reflect the market.
Even when the assessor does have a firm grasp on the methodology, value estimates can be flawed from a lack of understanding of the individual variables which go into the appropriate model. In the valuation of land used for gravel mining, for example, market value is influenced by factors such as the value of developable land, gravel lease rates (based on the quality of the gravel), reclamation costs, and special assessments to develop the property. A lack of knowledge in any one of these areas can lead to inaccurate value estimates. Again, time constraints play a key role; it is unreasonable to assume that each assessor could learn the intricacies involved in the valuation of every special use property type that is contained within his/her jurisdiction.
This does not mean that city or county assessors cannot become experienced in the valuation of special use properties. A prime example is found in the City of Bloomington, whose assessors are especially well versed in the valuation of hotel properties. This is due, in part, to the many hotel properties located in their jurisdiction.
4. Interest Being Appraised
Assessors may have to distinguish between business, real estate, and personal property interests in the assessment process. This distinction can sometimes be a difficult one because of the various interpretations of what is considered real estate and what is not. This issue frequently arises in the valuation of special use properties, particularly if the property owner has various trade fixtures. The claim can be made that these are not part of the real property.
Suggestions For Reconciling Differences
Both the appraisal process and the assessment process are somewhat subjective. We recognize that working with the assessor to reach an understanding is sometimes better than fighting for a specific value. The following is a general list of suggestions which have worked well for us and our clients over the years.
Provide More Information
Assessors usually operate without the owner's proprietary information. Typically, property owners are reluctant to share proprietary operating data with assessors when times are good. Assessors often comment that they only see operating data when times are more difficult.
As stated earlier, market levels of income and expenses, rather than contract terms and actual expenses must be used to arrive at fee simple value estimates. Notwithstanding this, and assuming sound management, the actual performance of an income producing property is typically more indicative of the property's submarket. Without the owner's proprietary information, however, assessors have a diminished ability to account for differences within market sectors. Property owners, appraisers and attorneys who give the assessor as much information as they themselves would require will likely see a reasonable valuation. No one, including assessors, likes to be blindsided by previously withheld information in the assessment process.
Understand the Assessor's Point of View in Reaching a Settlement
In tax appeal proceedings, assessed value adjustments can be sought for any tax year in which a Real Estate Tax Petition has been filed. Real Estate Tax Petitions must be filed on or before April 30th of the year in which the tax becomes payable. Considering that taxes are payable in the year following any given assessment date, the January 2, 2003 assessed values, for example, can be petitioned on or before April 30, 2004.
When an appraiser finds that the market value of a property is below the assessed value in any year in which a tax petition has been filed, the ultimate goal of the property owner, or attorney who is using this information, is to have the assessed value of the property adjusted to the market value of the property as reported in the appraisal. Although assessors will occasionally agree to adjust assessed values to the concluded market value estimates, during fiscally restrictive times assessors are hesitant to reduce assessments in past years. Thus, court proceedings may be necessary to realize assessed value adjustments for years in which corresponding tax revenues have already been collected. If the potential cost of court proceedings exceeds the potential tax savings that can be realized through these proceedings, property owners and attorneys may wish to consider other alternatives. One such alternative is to resolve assessment issues for years to come on a multi-year basis rather than for a specific year in which taxes have already been paid.
Reach as Many Areas of Agreement as Possible
Although assessors and appraisers may ultimately disagree on the market value conclusion in some instances, both parties normally agree on some or most of the assumptions and variables that were used to arrive at the value conclusion. If it can be established that both parties are in agreement on most issues, it becomes easier to pinpoint areas in which differences exist that can be resolved. For example, a review of the assumptions and variables used by an appraiser and an assessor may reveal a significant difference in market rent conclusions. If both sides share all of the information that they used to arrive at their respective conclusions for market rent, it is possible that the additional information will result in one or both sides determining that a change in the market rent conclusion is warranted. If other issues did not exist, this could result in a fair settlement.
When reaching areas of agreement it is important not to dwell on details that are not important. For example, it is pointless to argue about issues such as minute differences in a property's gross building or net rentable area.
Make the Dealings With the Assessor a Shared Learning Exercise
While due diligence must always be conducted on the appraiser's side to ensure that sound methodology is used to value a property, assessors do not usually have the luxury of adequate time to spend on the valuation of individual properties. As a result, it may be necessary for the appraisers to educate the assessors on the appropriate methodology for the valuation of special use property types that are not frequently valued in their jurisdiction.
Occasionally, differences in value can also stem from a difference in sale or lease comparables, either in terms of the comparables used or the depth of knowledge on the details of individual sales or lease agreements. Both the appraiser and the assessor should consider any new information and its impact, if any, on the value conclusion.
Conclusions
In order to reach a settlement with the assessor in a timely and cost-effective manner, we advise the following steps:
Shenehon Company
88 South 10th Street, Suite 400
Minneapolis, Minnesota 55403
Phone: 612.333.6533 / Fax: 612.344.1635
ValuationSpecialist@shenehon.com
