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Caruthers Property Tax Letter
Article 5. Why Sale Price Should Not Always Equal Assessable Value
Numerous counties in Tennessee are undergoing a complete revaluation for property tax purposes. Among these are the more populated counties (i.e. Shelby, Davidson, Knox, & Hamilton), which usually contain more properties with higher values.
In these counties, there have been a large number of commercial property sales during 2007-2008 at high prices. This will have a costly effect upon the appraisals for property tax purposes coming up in the 2009 countywide revaluations. While residential prices have suffered, commercial investment properties have fared well during most of this two-year period. The timing of these commercial sales will affect the property taxes of those properties that have sold and will also be used as sale comparisons to appraise other commercial properties. In addition. the prices will be used to derive capitalization rates for valuation of other income producing properties.
Given that the basis for property taxation in Tennessee is market value (actual cash value) paired with all the information the assessors have available, how can a property taxpayer defend against such overwhelming evidence and information?
It is not an easy defense, but there are steps to be taken to keep the value and assessment from going beyond a reasonable level due to these extraordinary sale prices.
Assessors do not accept that a property's sale price always equals assessable value and neither should you. Assessors generally view high sales prices as acceptable evidence of value while low prices are often disregarded (below market sales) as having sold low under duress circumstances.
However, this works both ways. A property’s sale price can exceed the required market value definition for property tax purposes. Consider some of the following circumstances where some sales prices may be opposed as evidence for high appraisals.
- Condominium Conversion Sales:
These sales may not equate to the classic definition of market value for property tax purposes and should not be used by assessors for direct comparison market approach or for capitalization derivation information. Usually premiums are paid for properties to be converted. Income and cap rates were not the primary consideration in the motivation for purchase of these type properties. Oppose the use of any condo conversion sales prices or capitalization rates derived from conversion sales.
- REIT Purchases:
REIT’s are notorious for paying above market prices for their investments. REIT’s have to continually invest because they are forced to pay out most of their income in dividends. They also have lower cost of funds and can pay higher prices for properties. The financial pressure on REIT’s forces them to continually purchase properties in order to grow.
- Uninformed Buyers:
The unusual influx of purchasers from outside of the market area often produces many buyers who are uninformed. We’ve seen it before. Outside buyers purchase a property and then a few years later, it is unloaded at a much lower price. The market value definition requires that the buyers be well informed. Be prepared to research as best you can for this possible argument.
- Terms Affect Price:
We’ve seen times when buyers would pay any price for property so long as the owner would finance the property. Favorable financing structure does affect price while it should not affect market value for property tax purposes. The market value definition requires “actual cash value” for property tax purposes. Properties sold under favorable financing should be discounted to a cash equivalent value and, therefore, a lower value resulting in lower taxes. A taxpayer is well advised to research as much as possible in his property area regarding sales of properties which may affect the taxes on the taxpayer’s property.
- Speculative Sales:
Tennessee assessment law forbids consideration by the assessors of any sales that may be shown to be speculative. Speculative sales do exist and if it can be shown, it is a legitimate defense to an assessor’s reliance upon certain sale transactions.
- 1031 Exchanges:
The prices paid in these types of transactions may well be above the typical prices for such properties due to the pressures to obtain properties to participate in such transactions. Premiums are being paid in order to avoid tax penalties.
- Sale / Leasebacks:
These types of transactions have been in existence for many years. Unfortunately, the high prices paid for these transactions have caused the purchasers of such properties to pay higher taxes. This can happen to taxpayers who own similar properties to pay excessive property taxes as well when the sales are used for comparisons or cap rate analysi. The prices paid for such properties are not typically related to the market prices for the properties, but to the credit strength of the Lessee/Seller. If the Lessee’s credit is strong enough, almost any price is possible to achieve.
- Build to Suit:
Cost does not always equal value. That’s a maxim well known in the real estate world. The property may have been sold in a pre-arranged agreement based upon what it costs the builder or developer to construct and may not have relevance to the market value of the property. Special construction interest, extraordinary entrepreneurial profit, and other items may have had an effect on the price. Build to Suit arrangements also affect rental rates if built for a tenant. For the same reasons sales prices are affected, these types of sales should not be used by the assessors as comparables for estimating market rentals.
- Sales of Large Single Tenant Properties:
Such properties are typically leased to a high quality tenant for a longer term than most commercial and industrial properties. Premium prices are paid for reason such as the credit strength of the tenant, its anticipated durability and freedom from management of expenses. Oppose such sales if used by the assessors in valuing typical commercial and industrial properties. It must be argued that the quality of the tenants in the typical commercial investment property does not rise to the level of the single tenant property and incurs more management burden. Be particularly alert for the assessors using such sales in cap rate studies to derive rates to apply to properties within their jurisdiction.
- Improper Analysis of Sales:
In valuing a taxpayer’s property, the assessors are notorious for discounting the taxpayer’s actual tenant list and income as being below economic rent levels. This may be because the leases are old and may expire shortly or in a few years. If this is true, the assessors are on good footing here in their initial step because most laws require a market value or a value based upon current free market rentals. First, a taxpayer should check rental comparables to determine if the assessors’ economic rent estimates are realistic.
Next, when comparable sales are used in the assessors’ cap rate studies, or in direct comparisons with the taxpayer’s property, the taxpayer must also check to determine if the assessors are consistent. The assessors often fail to adjust the actual rentals to market rentals in the sold properties and, therefore, a large error in the assessment can result against the taxpayer. The rent levels of these sales should be adjusted to economic levels for the same reasons the taxpayer’s property rent levels were adjusted. It is easy to see that a low cap rate would result from failing to make the proper adjustments. Examine all comparables for this adjustment in cap rate studies or when used as direct comparisons for derivation of cap rates in a valuation by an assessor of a single property.
- Rapid Decline in Value:
The taxpayer should also impress upon the taxing authorities that the market slowed during the last quarter of 2008 and despite so much damaging evidence during 2007-2008, this argument may gain some significant results. Therefore it is recommended that the taxpayer vigorously pursue this position because of the exact assessment date being January 1, 2009. It also may be many months before commercial property tax appeals are actually heard and the atmosphere for acceptance of economic decline arguments at that time may be very good at that time.
- Sale Price is Not Always Pure Realty:
By this, we mean the recorded sale price on real property typically includes only the real estate. However, for numerous reasons, a sale is sometimes recorded at a price including other types of property. One type of non-realty included in the price could be tangible personal property (furniture, fixtures, equipment not defined as realty). This type property is assessed separately from the real estate and should not be assessed again to the taxpayer as realty. This property should also be excluded from any sale used for cap rate derivation analysis. Another type of property sometimes included in the sale price is the intangible value of the business entity operating within the real estate. This type of intangible property is not subject to assessment and should be removed along with the personal property above.
Properties that sell containing any property other than real estate consist of hotels, restaurants, nursing homes, hospitals, shopping malls, et al. These type properties are often called labor intensive or operational properties because more than the typical management and labor cost is necessary to operate the property as compared to real estate investments such as office buildings and apartments.
If your property falls within this category of properties and has sold, be certain that the assessors are aware of the true price for the real property alone. If the assessors are using comparables of similar properties for direct comparison or income comparables and capitalization rate derivation, also be certain to examine the comparables and see if tangible personal or intangible property were included in the prices the assessors are using. If so, these must be adjusted to reflect only real property. Otherwise, large errors adverse to the taxpayer will result. Challenge any such sales comparable sales used by the assessors.
- Location / Taxes:
Of course, location is always a factor. However, be sure that all the location differences are taken into consideration. The tax burden factors (effective tax rates) are sometimes overlooked. Are the tax burden factors more or less than in your property’s location. If the tax burden in the location of the comparables is less than the tax burden for your property, then it requires another adjustment when used in direct comparison and in cap rate derivations. Lower taxes yield higher NOI’s, and, therefore higher values.
Now you have some of the ways to defend against excessive influence of high sales and low cap rates being thrown at you from the assessors in order to justify the high value placed upon your property.
It is in a taxpayer’s interest to closely examine the motivations and terms behind a property’s sale price. Even though a taxpayer may have paid a high price or perhaps high sale prices of comparable properties appear to justify the value of a property that has not sold, it does mean means you should accept the assessors’ position without close analysis. A protest may be rewarding.
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