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Property Taxes in the Income Approach

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Douglas Kues

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Apr 19, 2002
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Certified General Appraiser
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California
Subject is a 6 plex residential property with 25 year old improvements purchased 1 year ago at $360k and being refinanced. Tax rate is 1.040 assessed at full value, resulting in current actual property taxes of $2973.

Property is currently worth, say, $400k (not yet confirmed through appraisal process). In performing a current income approach, assuming it is possible to extract a market derived cap rate from comparable sales of, say, 9.5%, what is the best method of addressing property taxes?

My thought process is: 1) it is NOT reasonable to include actual taxes when we know the property to have increased in value around 10%, 2) it is NOT reasonable to add a point to the indicated cap rate......since the improvements are not new or proposed, and we have a historic rate applied......... and since it is not possible to determine a market derived cap rate when comparable sales typically report NOI after property taxes.

My question is: 1) on what basis should a property tax amount be calculated and applied to best reflect the impact of taxes on value in this scenario????? :?:
 

airphoto

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Jan 15, 2002
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Retired Appraiser
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Pennsylvania
Dug,

Are you sure you're not straining over/under a gnat on this one? Property taxes of under $3,000 on a $360-400,000 valuation? Would a difference of $1,000 in annualized net income make that large a difference in your capitalized calculation?

Here in the far north taxation is significant .. on the order of $3,000 taxes on a $50-60,000 property in Amsterdam, New York (aka "the Dump" or "AmsterDump.") That'll have a significant impact on valuation! There are those who've remarked that there are bargains to be had in The Dump. I maintain that there are NO bargains in The Dump. In fact, there is no longer a supermarket in The Dump as they've all been driven out. Wanna capitalize the difference in valuation for the necessity to commute just to shop?
 

Douglas Kues

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California
8) Thanks for the prompt response!

The numbers are not critical, but the concept seems to have attracted the attention of MAI reviewers in our area that have conditioned the last three of our appraisals (for the same client) based solely on incorrect application of property taxes. It seems that the technique of "adding a point to the cap rate" in order to reflect a 1% property tax rate is catching on......and I have a real problem with estimating a property tax on appraised value when the appraised value is not yet determined. Gues you would have to be from the other side of the country to find any humor in this one, but on this issue I would rather assess the impact of a shopping commute from the Dump than argue with a reviewer attempting to apply a method that doesn't apply. Thanx.
 

airphoto

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Professional Status
Retired Appraiser
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Pennsylvania
Dug,

Guess I have to quote Rush on this one: "Illustrate the ridiculous by being ridiculous!" It'll take you an extra page or two, but .. do your estimates based on the existing tax, plus an example at an increased tax (say 10% increase, then 20% increase.) They'll NEVER be reduced!

After developing those three numbers, apply a probability percentage to each case and (mathematically) derive your estimate of the likely scenario. IMHO making an adjustment in the cap rate can't work. 'Course, I've never heard of your problem .. and note that no-one else has yet made remarks on it on this forum. But, how can you build in a change in the cap rate, which amounts to a forecast? You have no basis for that forecast .. taxes always increase, and that's already part of the cap rate ..

Finally, if you're being strafed by your local MAI's on this .. require of them their derivation of this technique, so that you may audit their results ..
 

Douglas Kues

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California
Bill in NY:

Thanks for hanging in with this question, and I should have thought of Rush in the first place.......simplicity and common sense at its finest.

OK OK....the subject property is assessed at $100k and under same ownership for 20 years. Now it is worth somewhere around $1M and being appraised for refinance. How would you forecast the property tax for the income approach, and what is the basis for the value on which the tax is based? Remember.....we haven't established a value at this point, only estimated it. Is it reasonable to "estimate" property taxes before a value is calculated? And if so, then we have allowed one "estimate" to determine another "estimate" with neither one being market supported. In addition, it seems that in practice this technique is comparable to using an assumption to establish a fact.....which is clearly a hypothetical situation. It seems that I have entered the forest without seeing a single tree.

Thanks in advance for the next lesson.

Doug
 

airphoto

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Retired Appraiser
State
Pennsylvania
Dug,

This may be complex, but bear with me:

As a former assessor, the courses provided by the state of NY suggested that property taxes not be a component of any income approach due to the unreliability of tax assessments.

Having said that, most assessments are NOT adjusted due to a sale but are continued until the next general re-assessment. In a revaluation, typically one-third of assessments are unchanged, one-third increased and one-third decreased (and by varying amounts, obviously.)

I did one commercial appraisal (using the UCIAR form, btw) for an attorney for an assessment grievance that went to state Supreme Court. In that case, the assessment of $80,000 resulted in a tax burden that made for a negative cash flow, and no capitalized value. Reducing the burden to an assessment of $45,000 (supported by market sales data) resulted in a capitalized value of $45,000. Just luck, but that's how it worked out. D'Judge's final determination was $55,000.

It's possible to set up a DB or Excel worksheet and tinker with various combinations of assessment/tax burden so as to illustrate the effect on your capitalized value.

Now .. some questions. I appreciate the over-time change in valuation of your subject, but how does the current assessment compare with the potential change in assessment? If you're like NY, you're probably at partial value assessments, and will have to adjust by an equalization rate to find what 'full value' the assessor has put on your subject. Next, you need to verify the probability of any near-term assessment change. As mentioned above, might not happen or might not happen for some indeterminate period (and might, even, decrease?) Keep in mind that a change just a few years in the future will minimize immediate impact on a discounted cash flow.

I would suggest that you begin from your probable value as found in your market data sales grid. Now it's time to disclose in your report: the possible and probable changes in assessment, and to what degree those changes may influence your income approach to valuation. After laying out these scenarios you have created the background for arriving at your final opinion of value. Others may disagree with your conclusions or opinions, and it's fair of them to do so as long as they can show a basis for their conclusions. That doesn't make either of you "right" or "wrong" just not in agreement.

Finally, don't lose sight of the fact that you're estimating value as of the date of the appraisal. A change in assessment will happen at least a year in the future. You're not forecasting the value in the future when that change in assessment occurs. Capitalization, despite appearing to be a forecast is not really intended for that purpose!
 

Douglas Kues

Thread Starter
Freshman Member
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California
It was neglectful of me not to set forth all the parameters of my question. Your answer was much appreciated and took more time than you probably had to spare. I would fly out and pick up lunch, but my ex resides somewhere in Long Island, and NY is probably not large enough.

In California we have Proposition 13, 1 a 1987 vote that provides for a flat property tax of 1.000% assessed at full value. Re-assessment is performed periodially, but is ALWAYS a factor of a sale transfer. Thus, if the property transfers at $1,000,000, the property tax effective from data of COE is $10,000 per annum.....subject to local add-ons for fire districts, school taxes, etc.......and subject to annual increases that approximate 1.02% or so.

With regard to appraisal, tax is pretty much cast in stone at the selling price.....assuming the selling price to be at market value. So, if we apply the tax rate to the selling price, and the property does not appraise for the selling price (it does happen) then the tax impact is skewed. The fact that our tax rate and assessed value (100%) does not change is what creates and compounds the appraisal issue.

Valuation practice out west will, therefore, TYPICALLY increase a market derived cap rate by 1.00% to reflect the impact of taxes on new construction or on property that has not been previously taxed. I have, historically, applied the tax rate to the Replacement Cost approach results, since assessors typically no not assess intangibles (outside of a transfer) and intangibles can be easiest removed from the replacement cost approach (assuming a limited impact from age, etc). In ANY event, it is not (in my opinion) mathematically possible to apply a cap rate supposedly derived from a market comparison approach to a property tax in an income approach....when the property tax cannot be determined without first determining a value on which to assess the tax. So, to accept the MAI review opinion I referred to earlier, the appraiser would be forced to use either the replacement cost approach or the selling price per unit of comparison to establish a market value.....in order to estimate the property tax..........in order to apply a meaningful cap rate to it resulting in a value from an income approach........which is typically the most reliable approach for income producing properties.

The plot thickens, but I think when the smoke clears the answer is rather basic. It cannot be acceptable to fabricate a property value in order establish a value from the very approach for which the value has been fabricated.......and there is no way other than fabrication to establish a property tax from within an income approach without first fabricating the value, unless the value is derived from one of the other approaches used in the analysis. In this golden state, there are simply no trees in the forest. We have created an appraisal dilemma with the passage of our Prop 13, and I shall take a position that makes sense. As soon as one is found. It is relatively common in this market for the 1.00% property tax to impact operating expenses by 10% or more, so the trickle down can be quite significant on cap rate valuations.

Bill in NY, thanks for your help and involvement in this forum. I shall watch for your responses to others with interest.

My original question probably now has new meaning, and my apologies are in order for not spelling it out better.
 

Geoff Hatcher

Junior Member
Joined
Jan 23, 2002
Professional Status
Certified General Appraiser
State
Ohio
I don't think it is unreasonable to use a Tax Additor in this case. I utilize it alot when there is a large descrepency in the county appraised value and market value. Should use it much more often.

Following is one I just calculated for an appraisal in Central Ohio, excuse the formatting as it did not copy well. Simply deduct the taxes from the pro forma and add the tax additor to the capitalization rate and it will account for the increase or decrease in taxes based on market value.

Millage Rate - Violet Township -Pickerington Corporation Limits
= 95.25

X (1 - 0.483579507) Reduction Factor = 49.18905196

X .90 = (10% Credit) 44.27014676
Divided by : 1000/.35 or 2,857.142857 (Ohio's assessed value is 35% of the appraised value)
=0.015494551
Tax Additor = 1.55%
 

Douglas Kues

Thread Starter
Freshman Member
Joined
Apr 19, 2002
Professional Status
Certified General Appraiser
State
California
Actually, my problem was grasping the concept of "loading the cap rate" to estimate taxes for the subject property. You may find the dilemma in earlier posts above. The solution came after a conversation with a local MAI that has created a small Lotus program to do the math......only I didn't take the time to pirate or duplicate the program formulas.

The trick is, in a market like California where the tax rate may change from various local add-ons, where the statewide is the same basic 1% of the full value of the property. Although this should work in any market where the tax rate is the same for the subject and all comps.

1.) The cap rate is extracted from the market comparison approach, being careful NOT to include the capitalization of income portion of the market approach (yet). Estimate your value using sales price per unit of comparison or a gross income multiplier, or any technique other than capitalization of net income (because you haven't established your subject net income yet)....... 2.) Determine your "before tax" net operating income for the subject property, 3.) Add your local tax rate to the cap rate you extracted from the market....and apply it to your subject property before tax NOI, 4.) This will estimate the market value from the income approach....then simply multiply your indicated value by the local tax rate to determine what the taxes should be at the appraised value, and enter this indicated tax as the property tax in the income approach. DONE.

Actually, this will never be an exact calculation, because you are using an estimate to formulate another estimate (a circular calculation that can never reach a precise number). It is as close as you will ever get, however, and checks 100% of the time with my local MAI Lotus formula. Much simpler, and indisputable. You must, however, take the time to make an explanation in addenda as to how you arrived at the property tax estimate for the subject property. Print this and give it a try on your next assignment.

Interesting topic. I hope it doesn't end soon.
 
A

Anonymous

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most assessments are NOT adjusted due to a sale but are continued until the next general re-assessment. Quote

Same here, I served on the Board of Equalization. In my state, all appraisals are cost approach, but they will do income on apartments as a gotcha if a landowner protests.
 
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