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Property tax Smack-Down

A hot retail market comes with a price.

Property taxes on all sorts of retail real estate have jumped substantially in the past four years; today they account for the single largest expense of a property owner's total, outstripping other areas such as insurance, labor costs, maintenance and operations.

Between 2003 and 2007, the median amount of taxes paid by shopping center owners soared 58 percent to $1.60 per square foot from $1.01 per square foot according to a survey by the Chicago-based Institute of Real Estate Management (IREM). It reported the percentage of overall expenses attributed to property taxes increased to 37.5 percent last year from 33 percent in 2003.

IREM surveyed 283 open-air shopping centers across the country in 2007 and found real estate taxes for some account for as much as 44 percent of total expenditures. That creates a problems for tenants as well since often 100 percent of the costs are passed through as part of common area charges.

To be sure, owners are always fighting to get tax officials to lower the assessed values of their properties (and therefore decrease their tax bills), says Tanja Castro, a partner with Washington, D.C. — based Holland & Knight, who advises clients on reducing their commercial real estate taxes. But when the market is booming, the rising taxes are less of a concern because everything else — rents, property values — are also rising.

In addition, some properties changed hands so often owners never had time to worry about the property tax bill. “The hotter the retail market the bigger the jump in taxes because the higher assessments are triggered by centers changing hands,” says Steve Laas, a director with Thomson Property Tax Services in Austin, Texas.

Now, however, the retail real estate market is hitting a lull, and values in some areas are even dropping, meaning that owners will have to make renewed efforts to get the best assessments.

An extra incentive to do that is coming from tenants. With retail sales slowing, tenants have already begun to push back in leasing negotiations. Many have sought caps on paying the pass-through costs. They have also asked for rent relief when renewing leases and, in some cases, are getting it, says Mez Birdie, director of retail investment services for NAI Realvest in Maitland, Fla.

“Here in Orlando I have seen several landlords with vacancies in their shopping center giving rent relief because they don't want to lose tenants because taxes are high,” Birdie says.

An added issue for retailers is that by moving from older enclosed malls and neighborhood and community centers into newer, more high-end locations during the last cycle, tenants unwittingly exposed themselves to fat tax bills. That's because newer properties carry greater assessments, says Bob Henderson, the national director of property tax services for Ernst & Young in Atlanta.

In fact, that means that tenants sometimes are more worried about property taxes than landlords.

“The biggest concern [about higher taxes] is for the tenants because all the taxes are passed down to them and they pass it on to the consumers,” says Laas. Meanwhile, “the concern of the landlords is that their property taxes are higher than the competition's across the street.”

But don't look for tensions to ease at all now that property values aren't rising as quickly. For one, states and local governments too are dealing with new economic pressures. A slowdown means reduced tax receipts across the board. So if governments don't want to cut services, they need to make up shortfalls. For example, in Florida at press time residents were set to vote January 29 on a bill that would double their home exemption to $50,000. That means tax assessors will look in the direction of commercial properties instead.

“The less taxes that are paid by homeowners means government will increase the [tax rate] to make up for that,” Birdie says. “The commercial property owners have no relief.”

Missing tax receipts

Adding even more pressure to the mix are the large numbers of baby boomers retiring in the next few years, who will pay less taxes and increase pressure on legislatures to “decouple” residential property tax rates from commercial. An example of what that could look like comes in Washington, D.C., which taxes commercial property at a rate of $1.85 per $100 in assessed value while taxing homeowners only half as much, $0.88 per $100. Elsewhere, Nevada capped residential increases at 3 percent a year, in contrast with 8 percent for commercial property.

All of this could not be coming at a worse time for commercial real estate given the drop in investment sales volume and property values. Even worse for retail is that because it's so high profile in the community, it becomes an obvious target for raising taxes, Birdie says

Still, the slowdown in the real estate market will eventually help hold down tax increases because there are fewer properties changing hands given the difficulty in getting financing, says Castro. For example, there was only a 2 percent increase in taxes between 2006 and 2007, according to the IREM survey out of the 58 percent total increase in the past four years.

Further, during the 12-month period prior to the survey, the percentage of real estate tax expenses of the overall total fell to 37.5 percent last year from 39.3 percent in 2006.

Lowered expectations

The problem with real estate taxes is that they tend to lag [behind] the market, says Steven Kurtz, senior director of the Valuation Services Group for SMG Schonbraun McCann Group in Roseland, N.J. “They're reactionary.” When the market slows, taxes may not reflect that for a period of time. “So that's a particular concern for landlords,” Kurtz adds.

Property owners, Castro says, should be working with the assessor's staff when they are preparing the values and be assertive and point out if there is a large vacancy because a tenant went bankrupt or a lease expired. Landlords, she says, should file an annual income and expense report, which may or may not be required, to serve as a basis for the assessment.

“One of the things to keep in mind is the nature of assessment,” Castro says. “The assessors are working with old data so in that situation when real estate starts going down, the data does not capture that downturn.”

The assessor may have used the wrong cap rate to arrive at a valuation, Birdie says. Sometimes assessments may be lowered by as much as 20 percent to 30 percent by pointing out mistakes.

“If you were 95 percent occupied in a market that went poor the next year and you were 60 percent occupied, the assessor may not know,” Birdie says. “You need to make them aware.”

A disincentive is property improvements can trigger higher assessments, says Kurtz. Anyone who renovates a property in a poor neighborhood could actually be penalized for trying to improve it.

“Be very proactive about your assessment,” Kurtz says. In aggressive tax districts, try to negotiate a tax rate before a sale closes or the renovation is begun. “They're really trying to make sure the local economy thrives,” he says, so they are open to ways to make that happen. Many jurisdictions, like New York state, will negotiate payment in lieu of taxes agreements.

If you already own the property, your options are more limited. “The assessment is supposed to mirror the real market value of the property.” Compare the assessment to what you believe is the true market value, Kurtz says.

“The best weapon in anyone's arsenal is information,” says Henderson. Get the records and make sure you're being taxed on what you actually have (size of building, age of structure, etc.).

Property taxes are assessed on an income basis for the market, so owners should look at things like the vacancy rate at the property and dark space that could help lower the overall appraisal, he says.

“You can't have too much discussion and you can't start too early,” Henderson says. In most areas, property tax has a rigid deadline. “If you miss it, you're out of luck.”

Laas pointed out how challenging assessments can result in millions of dollars in savings. Without giving a name to protect client confidentiality, he cited one mall in north Texas in which the original value of $775 million was reduced to $500 million. That reduction in the assessment ended up cutting the client's tax bill by a cool $6.9 million.

Assessing assessments

While the first step in seeking a reduction is to meet with the assessor, if that proves unsuccessful, property owners can appeal the assessment to a board that has jurisdiction over setting the property tax.

An owner's success is also heavily dependent on the jurisdiction and the experience of the assessors' staff, according to Castro. For example, in the Washington, D.C., metro area, the goverment is more willing to make adjustments while Virginia's is not because they perceive their assessments as absolute.

Then some states, like New Jersey, don't permit “spot assessments” — selecting an individual property for reassessment. Instead, they are part of an overall revaluation of properties within a jurisdiction.

However, other states like Florida allow for individual assessments; and some, including California, reassess a property when it is bought or sold.

Back around the Capital region, Virginia and D.C. reassess property values every year, whereas Maryland reassesses them every three years. Assessing properties annually can boost taxes quickly when the market is on the way up, while those assessments in Maryland lag behind, Castro says.

And large REITs aren't immune to the higher assessments either.

Indianapolis — based regional mall REIT Simon Property Group, for example, saw its property taxes during the first nine months of 2007 top $236 million, up $10.5 million over the same period in 2006 — a 4.4 percent increase.

“In my experience, I don't think they are treated any differently,” says Castro.


Amount paid per sq. ft. and percentage of overall expenses shown in a survey of 283 shopping centers nationwide.
2007 $1.60 $1.00 $2.60
37.5% 39.2% 44.3%
2006 $1.57 $0.96 $2.25
39.3% 36.1% 40.7%
2005 $1.29 $0.80 $1.96
37% 36.4% 39.4%
2004 $1.14 $0.70 $1.92
34.8% 32.9% 39.3%
2003 $1.01 $0.61 $1.78
32.9% 31% 39.4%
Source: Institute of Real Estate Management
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