Property Tax Checklist

Challenging the Tax Man

By: Mike Fickes, Contributing Editor
As published in National Real Estate Investor, January 2002

Are your property taxes too high? Silly question. All property owners think their taxes are too high. But what can an owner do? The property tax system in the United States is expensive, complicated and time consuming. Many owners believe it's cheaper simply to pay their tax bills and move on. Appeals are expensive and the outcome uncertain.

However, recent innovations in property tax administration coupled with the development of new valuation theories suggest that property owners may soon find that challenging their property tax assessments is worthwhile. "Owners will often appeal only the most flagrantly over-assessed properties, while hundreds of thousands of dollars in assessments aren't appealed because the owners don't realize those assessments are out of line," said John Garippa, a senior partner with the Montclair, N.J.-based law firm of Garippa, Lotz and Giannuario.

Property Tax Checklist

Below are some property tax tips for commercial real estate owners compiled by Jim Popp, a lawyer with the Austin, Texas, law firm of Popp & Ikard. The firm is the Texas member of the American Property Tax Counsel.

Know the applicable deadlines for administrative appeals, litigation and payment of taxes. Most jurisdictions have very strict deadlines. A failure to comply may result in forfeiture of rights.

Evaluate whether the purchase price of a property is equal to property tax value. A property owner should not assume that the purchase price is equal to property tax value.

Determine whether your property is being taxed fairly in comparison to the competition. Newly purchased or constructed properties often are taxed at a higher value than the competition.

Consistently review the performance of your property tax consultant.

Evaluate whether new construction costs equal the property tax value. In many instances, they do not.

Determine whether your property has an intangible value component and whether the tax authorities have evaluated it appropriately.

Consider whether your annual operating statement reflects the market as of the valuation date. Most states value property as of a certain date, such as Jan. 1.

How expensive?
First things first: Just how costly are property taxes? The U.S. Department of Commerce recently estimated that corporate profits in the United States totaled approximately $474 billion during 2001. Corporate property owners currently pay approximately $142.5 billion in property taxes per year, a figure just less than one-third of total corporate profits, according to Scottsdale, Ariz.-baxed ePropertyTax Inc., which provides online tax management for commercial real estate companies.

According to ePropertyTax, approximately one-third of all real estate operating expenses go to pay property taxes, making this tax the single-largest expense associated with real estate operations. In addition, property taxes have increased an average of 7% per year in each of the last 10 years.

Property taxes not only cost an arm and a leg, they muddle the brain. ePropertyTax estimates that there are 112 million taxable parcels of property in the United States, including both commercial and residential. Approximately 9,000 jurisdictions assess parcels for property tax collections, and each jurisdiction uses its own unique set of rules and procedures.

For commercial real estate owners, the property tax system carries further complexities. ePropertyTax says that its clients, all of whom are commercial property owners, average 2.5 taxable parcels per property. For example, a retail property owner with 100 shopping centers might receive 250 individual tax bills per year and maybe more, since some jurisdictions send out bills twice a year.

Quiet acceptance
Laboring under the perception that nothing is certain by death and taxes, most property owners simply pay their tax bills without protest. More than 90% of all property tax assessments generate a check from owners who believe that nothing can be done. However, about half of all property tax appeals succeed, estimates Richard Nearhood, CEO of ePropertyTax. "But you're probably dealing with a universe of, say, 10% of all assessments being appealed," he said.

Why so few? Because an appeal can be very complicated and because property owners often believe the effort will cost too much and yield too little.

ePropertyTax is trying to address these problems. The company's Web-based software allows a real estate company to store online a whole host of financial and tax information from its properties. A company also can use the software, which contains the rules and procedures from all of the approximately 9,000 taxing jurisdictions, to pay property taxes, make projections for future property tax expenditures and track appeals.

For an organization that has multiple offices and properties in many tax jurisdictions, having a central repository of tax information accessible through the Internet can be particularly handy. Such a repository also can eliminate a lot of the paperwork associated with appeals by giving the person overseeing the appeal instant access to important data.

"Now it's easy for an owner or tax consultant or appraiser to look at an assessment and say that it is high, low or related to market value," said John Busi, a senior managing partner with Cushman & Wakefield Advisory Services. New York-based Cushman & Wakefield has invested in ePropertyTax and offers the service provider to its customers.

ePropertyTax has stirred interest throughout the property tax arena. The property tax appeal group of accounting giant KPMG has formed a strategic alliance with ePropertyTax, and Indianapolis-based Simon Property Group and Chicago-based Equity Residential Properties Trust are ePropertyTax clients as well.

Competing property values
In recent years, property tax attorneys have developed new arguments about a property's business and investment values and their relationship to assessed value. An assessor theoretically looks only at pure real estate value. In the real world, this often seems to entail tying real estate value to purchase price. But is that right?

Owners pay for properties based on their analysis of factors beyond real estate. As a result, a purchase price may provide no more than a touchstone for an assessor. "The conflict between the real world of what an owner pays for a property and the hypothetical world of property tax assessments is a constant source of tension," said James Popp, a partner with Popp & Ikard in Austin, Texas.

Currently, Popp represents an owner of industrial real estate who purchased a number of warehouses in Austin in 2000. At the time of the purchase, the properties were filled with tenants paying $5 per sq. ft. on triple-net leases. An assessor valued the properties in January 2001, just as the economic slump began. Since January, the owner has been leasing space to tenants paying $3 per sq. ft. on triple-net leases. Popp is negotiating with assessors to convince them that the original purchase price does not relate to the value of the property today.

"When the economy is moving up or down quickly, sales as valuation guides tent to get stale quickly." Popp said. "But sales stay in the minds of the assessors."

Business value vs. assessed value
The relationship between real estate value and business value is one of the biggest property tax issues of the last few years, according to Popp. "In most states, taxable value is the value of the real estate," he said. "Having said that, when an owner buys a hotel, for instance, the owner is buying an income stream. While there is certainly a real estate component to the hotel business, there are many other business components: management, food service, goodwill, brand names."

Popp represents a number of Marriott hotels and has prevailed in appeals on the strength of evidence that the Marriott name adds 10% to 15% more income (or business value) to a piece of real estate than other flags. This value must be backed out of an accurate assessment, Popp contends.

Over time, this principle has become fairly well accepted in the hotel sector, but the debate over how much should be subtracted from a purchase price to arrive at an assessed real estate value remains.

The question of business value vs. assessed value is a particularly significant tax issue in the assisted living industry, according to Kevin Nunnink, chairman of New York-based Integra Realty Resources. For example, an assisted living building may cost $10 million to build, Nunnink said.

"But the assisted living license may represent 80% of the value of the business," Nunnink said. "If an operator loses its license, the building, with its spoke-and-wheel design, is of little use to anyone. While it may have cost $10 million to construct the building, the property without a license might be worth land value, or a fraction of the building's replacement cost."

So how should an assisted living facility be assessed? Nunnink argues that the business value of an assisted living license gives the property its value, not the real estate. Assessors seem to disagree. "Most assessors will look at the profit-and-loss statement and value the property with that in mind, which would include both intangible value as well as the value of the real property," he said.

Nevertheless, the growing distinction between business value and assessed value is providing ammunition for owners that want to appeal property assessments in a variety of real estate categories, from hotels and health care to office and retail.

Investment value vs. assessed value
Investment value is the second issue that has arisen in the property tax arena in recent years. Garippa of Garippa, Lotz, and Giannuario has worked extensively in this area. Investment value typically relates to REITs, he said. Because of the tax structure under which REITs operate, they are primarily interested in cash flow and often pay above-market prices for properties because of the cash flow they generate.

In short, REITs may pay higher prices for a property, but they don't really pay more. How can that be? Think of it this way: A REIT has access to equity capital from its investors. By using that equity capital, a REIT can bid significantly higher prices than non-REIT buyers when competing for properties. Mortgage interest rates around 9% limit the prices that non-REIT owners, who don't have the same access to equity capital, can pay.

While the REIT pays a higher purchase price, the lower cost of capital equalizes its overall costs with what the non-REIT buyer would pay over the course of a mortgage. The REIT gains other profit-producing efficiencies by spreading insurance and other operating costs over the extent of its property portfolio.

Hence the price paid by a REIT for a property represents part of that company's investment strategy for generating cash flow and has nothing to do with the value a tax assessor should apply to the property.

Far-fetched? In late 2000, Garippa prevailed in court on a related issue, arguing that a premium price paid for a property represented an investment value and should not influence assessed value.

In this case, Cranford, N.J.-based Mack-Cali Realty Corp. contested the property tax assessment of an office complex in Morris, N.M. The matter went to trial and ultimately the question of the property's value resulted in a negotiated settlement.

Within this office complex, AT&T had been leasing an office building as the sole tenant for a number of years. The settlement assigned AT&T's building an assessed value of $105 per sq. ft. While the parties to this case drew up the final settlement papers, AT&T purchased the building from Mack-Cali for $150 per sq. ft.

In light of the price connected to this transaction, the property-taxing jurisdiction took up its argument again, demanding that the $105 per sq. ft. settlement be voided.

As the debate raged, AT&T assigned its purchase contract on the building to a third company, a sale-leaseback specialist, as part of a 1031 tax-free exchange, in which AT&T would shelter profits earned on the sale of another of its buildings.

The matter went to property tax court, where the taxing jurisdiction insisted that the $150 per sq. ft. purchase price paid by AT&T replace the $105 per sq. ft. value. If purchase price provides a true guide to assessed value, the taxing jurisdiction should have emerged from this morass with a victory.

However, the judge agreed with Garippa's argument on behalf of AT&T: Since certain business or investment values underpinned the transaction, the price paid by AT&T had nothing to do with assessed value.