Owners of triple-net-leased properties too often conclude that they have no reason to appeal their property tax assessments, since the property taxes pass directly to the tenants. No matter the asset type — single-tenant property, multi-tenant office building or shopping center — the decision to pursue a tax appeal impacts the owner's interest beyond the potential savings to the tenant. Owners of triple-net-leased properties should weigh four economic realities when they consider filing tax appeals.
Avoid taxation of tenant improvements — Of the three approaches to valuation that are available in the appraisal process, assessors commonly choose to use the cost approach. In many instances, they include the cost of improvements made by the tenant in their valuation of the triple-net-leased properties. Examples of these improvements might include wall coverings, carpeting, counters, trade fixtures and decor that is recognizable to the public as being associated with one particular brand or product line.
Trade fixtures are installed in the property at the tenant's cost, for the tenant's use. These trade fixtures are often removable by the tenant at the end of the lease. Even if not removable by the tenant, the fixtures are not likely to be of any use to future tenants or the owner, and their presence on the property has a negative impact on value because the owner has to bear the cost of removal.
While these tenant improvements are costly to install, they in no way contribute to the owner's net operating income. By including in its opinion of value the improvements paid for by the tenant, the assessor arrives at a value substantially in excess of a value justified by the income the property produces.
To the investment community, value is a product of income, not of cost. Investors put up their money based on an expected return on investment. Therefore, owners should not be punished by having to pay taxes on tenant improvements.
Lower the cost of vacant space — As leases mature and tenants do not renew their leases, owners more than likely experience a holding period while the property is advertised for rent. During this non-income producing period, owners of triple-net properties who have been passing the tax bills through to tenants will now acutely feel the tax bite. It is during these times that a landlord's aggressive stance on property tax appeals actually lowers the cost of holding vacant property.
Build goodwill — The successful appeal of property taxes on triple-net properties contributes to nurturing a quality relationship between both the landlord and the tenant. Property owners who “go to bat” for their tenants create a valuable and useful measure of goodwill. Any tenant most certainly appreciates saving money on taxes because these tax reductions flow straight to the tenant's bottom line.
Gain a competitive edge — The benefits of aggressively pursuing property tax reductions can reach the property owner's pocket. By successfully appealing the property taxes that pass through to lessees, owners can increase rental rates while keeping their tenants' total occupancy cost at or below market at lease renewal time. This not only improves the owner's net profit margins, but also maintains his ability to be competitive in the market.
When not to appeal
In determining whether to file a tax appeal, owners may face considerations other than saving tax dollars. If the owner is contemplating using the property as collateral for a loan, a public declaration of low value may have a dampening effect on lenders. Similarly, the owner may wish to optimize its financial statement, particularly in the instance of publicly traded companies. A lower property value would not support such optimization. Lastly, extra care should be taken in deciding to appeal the taxes of a property likely to be taken in the near future by eminent domain proceedings. Low valuations here would be detrimental to the owner's best interests.
With a better understanding of how property tax issues relate to triple-net properties, owners will be better able to analyze their assessments and determine whether to file tax appeals. Because of the technicalities related to the taxation of these properties, working with knowledgeable property tax professionals will prove helpful.
Jerome Wallach is the senior partner at The Wallach Law Firm based in St. Louis. The firm is the Missouri member of American Property Tax Counsel. He can be reached at [email protected].