Varied Valuations: Is It Time To Appeal Your Property Tax Assessment?
by Jerry LaMartina
Higher property tax bills can deliver a body block to self-storage facility owners’ budgets and business models, and the appeal process can be cumbersome.
But facility owners should always build a cushion into their budgets to handle possible tax valuation increases and costs for appeals whether incurred in-house or through third parties, experts say.
Methods of property tax valuations can vary widely depending how local assessors estimate value, says Kenneth Nitzberg, chairman and CEO of Devon Self Storage, based in Emeryville, California, which owns 42 self-storage facilities in 10 states. The standard valuation methods are based on comparable sales, income, and replacement cost.
Assessors usually don’t combine these three methods, and the specific approach “varies dramatically with the district.”
“Some assessors do assessments every year or every three, five, or 10 years,” Nitzberg says. “It’s all over the board. The longer the period, the greater the odds it’ll be a different assessor.”
Ad valorem real estate tax valuations are calculated differently than when the owner is selling the property, Nitzberg adds. In that case, market valuations are sometimes used and can include a consideration of future potential income discounted to match present value.
Having a high value for tax purposes doesn’t necessarily translate to the market, because if a tax bill is high, it works against income, says Nitzberg. This is detrimental for the buyer, who will then pay less for the property.
Nitzberg cites California’s Proposition 13, which limits assessed value for taxes to the price paid for the asset. That value’s increase is capped in future years by the lesser of two percent or the current consumer price index. But in Texas, for example, assessors have free reign to calculate a property’s value, as most other states do. In most states—California is an exception—Devon Self Storage typically gets a bill from the school district and the county where the property is located. Appeals are sometimes allowed to go to a state’s tax board, “but it’s expensive and unconventional.”
Devon Self Storage appeals all assessments as a matter of policy, because property tax assessments are usually the first- or second-biggest expense. There is typically no fee to file an appeal, but third-party companies do charge service fees. Staffers with Devon do appeals, and therefore that cost to the company is their salaries.
“The thing that’s really unfortunate is if you can’t negotiate settlement and have to appeal, the board is typically made up of people who aren’t real estate knowledgeable,” Nitzberg says. “In more cases than not, they’re good and honest people but they don’t know the market. And they’re all political.”
Chris Sonne, executive vice president for valuation, and advisory and specialty practice co-leader for self-storage for New York City-based Newmark Knight Frank, says the ideal approach for a self-storage owner is to hire a tax-appeal specialist to act as an advocate and negotiate with assessors. Many of these specialists charge a fee based on a ratio of the amount they save the facility owner.
If a facility owner decides to prepare an appeal internally, the owner should start by trying to get an idea of the property’s value based on income after expenses to determine operating income.
“I think a lot of people probably have a reasonable idea,” Sonne says. “[They should] gather comp sales with analysis, so they’ll have documentation to support the reasoning behind their opinion. If it’s a cost-based analysis, get some estimates of cost to replace, less depreciation.”
Facility owners should wait and see how the valuation comes in, and then take appropriate action.
“Tax assessments are going up across the country significantly,” says Sonne. “Given the trends across the country, it’s important to pay really close attention to your tax assessment. Be prepared. You don’t want to get caught unaware with a tax increase that could really crush your bottom line.”
Earmarking money in your budget in case valuations increase, which prompts the need for appeals, is crucial, Sonne says. About half the budgets he has seen for 2020 have that line item built it in.
When someone buys a facility, there is arbitrage because, in many areas, valuations are based on the selling price. Once the sale is recorded, the taxing district is electronically notified “and takes a close look at it.”
“It’s something for people to pay close attention to because it can really hurt you,” says Sonne.
According to Nitzberg, every appeal Devon Self Storage conducts succeeds to a degree. Out of 100,000 properties, probably 20 percent of owners will appeal a tax valuation. Assessors reject 98 percent of appeals as a matter of course. For that reason, Devon digs deep to prepare appeals.
“We put together a study that’s 100 pages to back up our position,” says Nitzberg. “You may have a huge percentage increase in residential property [for example], but a drop in the mill rate [which represents the valuation dollar amount per $1,000 of assessed property value and is used to calculate the tax].” So, assessing a property’s value is not simple.
“It’s very complex and different in every county, except in California because of its limits,” Nitzberg adds.
Whatever combinations of methods a property owner uses to estimate a property’s value, finding comparable properties that are valued at significantly lower amounts is the foundation of an appeal, Nitzberg says, “and sometimes, the lack of knowledge of board members can play in our favor if we can demonstrate that assessor was way out of bounds. Lock it in for multiple years and save more money.”
Devon often does its own assessment of a property before it receives the taxing entity’s assessment. An appeal is a public hearing, whereas a preemptive appeal is not.
“Guess who else goes [to the formal appeal]?” Nitzberg says. “The newspaper. If we [submit our own assessment] before [the taxing jurisdiction’s] assessments are announced, it’s not public information. You can go online where you live in your county, plug in an address, and see what the property’s assessed at. When something is that big a part of your profit and loss, you must be proactive. You can’t be reactive. And you won’t embarrass the assessor publicly.”
Bill DuBois, president of Dallas-based Marvin F. Poer and Co., says recent sales and the income approach tend to be the most common measures for assessing existing properties. The cost approach is typically used for new construction with no operating history, and it is also typically used in less-sophisticated assessment jurisdictions.
An income-based appeal usually requires a current rent roll as of the lien date, an operating profit, and loss statement for at least the most current year and the cap-rate development basis. Marvin F. Poer and Co. is seeing that jurisdictions are frequently using cap rates in the five percent to seven percent range.
“Recent comparable sales analyses are required if your appeal is based on market sales data,” DuBois says. “For newly constructed facilities, construction costs are required to support your value claim. There are many jurisdictions that allow equity [uniform and equal] as an appeal basis. Texas is most notable. An equity appeal involves an assessed value analysis of similar properties.”
Rarely do property owners fail to regularly review their assessments to decide whether to appeal, DuBois says. He advises facility owners to look back three to five years at their assessed values and tax rates in order to estimate likely increases and stay aware of reappraisal cycles, which often result in more significant increases. Maryland, for example, uses a three-year cycle. Colorado uses a two-year cycle, and several others use a six-year to eight-year cycles. In California and Florida, appraisal increases are capped, as long as property ownership is not transferred.
“If there is a sale, the sale will be used as evidence of market value by the jurisdiction,” says DuBois, “and the increases can be very significant depending upon the length of time between the sales.”
The value of knowing the local practices can’t be overstated. The self-storage market segment has shown vigorous new construction and increased value, which generally results in higher assessments. DuBois expects that trend to continue.
Mike Burnam, CEO of TKG-Storagemart Partners L.P., which operates 195 self-storage facilities with more than 15 million square feet of storage space in the United States, Canada, and the United Kingdom, says facility owners should ask themselves a key question: Would they sell the property for the assessed amount?
“If the answer is no, then do not appeal, as that might be the first question the assessor will ask you,” Burnam says.
In markets such as Chicago and San Antonio, what you think the property is worth does not matter.
“The assessor may or may not place a value so high on the store that the taxes actually exceed the [net operating income] of the property,” Burnam says. “You appeal and it might take two to three years of you paying high taxes to get in front of the tax appeal authority and, by then, if you win, you might get your money back, but in between time the city gets to keep the taxes paid, free of interest. Not a bad deal for the city, but horrible for the owner.”
The reality is that some taxing jurisdictions “have no rhyme or reason why your taxes are so high,” adds Burnam, so a facility owner needs to hire an independent tax appraiser who specializes in estimating property values specifically for tax appeals. This kind of appraisal typically costs between $2,500 and $5,000, and he considers it “a necessity to have in your pocket when you go to the taxing authority with your appeal.”
Budgeting For Increases
The wisdom of budgeting for possible valuation increases and appeal costs largely depends on the market where the property is located. For example, California will have a statewide ballot initiative (the California Schools and Local Communities Funding Act of 2018 ) in the November 2020 election that would substantially change the way Proposition 13 applies to commercial real estate, according to the National Association of Industrial and Office Properties (https://www.naiop.org/en/Issues-and-Advocacy/State-Local-Issues/Prop-13). This initiative would separate the tax treatments of residential properties from those for commercial properties by reassessing commercial properties to 2020 values and making 2020 the new base year.
“The two percent cap would then be in place until the commercial property was assessed again, which would happen at least once every three years,” according to NAIOP. “That would create a ‘split roll’ structure, with commercial property treated differently from residential housing.”
In California, self-storage facility owners should not build a cushion into their budgets for possible increases in property valuations unless the new Proposition 13 initiative passes, Burnam says. If it does pass, “then build in a big one.”
In other markets, assessment periods differ. That most markets are required by law to reassess properties in their jurisdictions every two to three years leads to a logical response of budgeting for at least a five percent yearly increase, “just to be safe.”
“In a business where your largest annual expense is real estate taxes, make sure you hire the best tax appeal group you can find, and make sure you ask them if they have experience in self-storage, as it is different in every market,” says Burnam.
The basis for reviewing and possibly appealing self-storage facilities’ tax valuations is tied directly to the appraisal methodology used, says Nicholas Hunter, national director of commercial property and strategic accounts for Dallas-based Paradigm Tax Group. Because the properties are income-producing assets, the valuation process typically is based on an income approach to value, sales comparisons, and an equity analysis that compares the property in question to its competitive properties based on fair market value per unit and tax per unit or based on square footage.
According to Hunter, when a facility owner decides to appeal a valuation, “information is king.”
“The data that is to be provided to the taxing jurisdiction really depends on where the asset is located,” says Hunter. “There are approximately 3,000 counties in the country, and they all have their own unique characteristics. The onus is on the taxpayer to prove the value is lower or different than the value placed on the asset by the local assessor. In order to accomplish this task, you need to have a preponderance of evidence.”
Paradigm Tax Group has “carved out a niche” in the industry, Hunter says, by specializing in helping self-storage owners or operators with their taxes, and the company is one of the biggest self-storage tax representatives in the United States. He recommends that professional self-storage operators have their properties reviewed yearly for possible appeals.
“Property tax is unique in that it can be challenged,” Hunter says. “The process of challenging assessments is vitally important, as property taxes are typically the largest line-item expense on the profit and loss statement. The process is not just about reducing the tax liability. It is really about value creation. If an operator is able to reduce their property tax, that money flows directly to net operating income, enhancing their bottom line.”
Hunter uses as an example of a self-storage portfolio owner who reduces the portfolio’s aggregate tax liability by $150,000. The resulting increased net operating income creates value. With a six percent cap rate at disposition, for example, the incremental net operating income of $150,000 would add $2.5 million in the purchase price.
With the complexities and potential costs involved in property tax valuations and appeals, carefully budgeting to cover expenses is important, and tax professionals can help with the process.