By Michael B. Rogers
Alliance Tax Advisors, Denver
mrogers@atatax.com

Real estate taxes are going up! That has been common place in the apartment market for quite some time. Now, with values generally going down, at different degrees depending where you are located, shouldn’t property taxes follow suit? No, not necessarily.

For the typical multi-family property the real estate tax can account for as much as 25% of operating expenses and is often the single largest line item expense. To make it worse, unlike triple net leases, an apartment owner is hard pressed to pass along this expense to a tenant that just signed a 6-month lease. For this reason the bill gets paid and we move on.

The Formula
The formula seems simple, Value X Rate = Tax , right? Unfortunately it is not quite that simple. The property tax is a locally driven tax that is administered by a local jurisdiction that varies from state to state. Some states have general laws dictating how property taxes are administered, but many vary from jurisdiction to jurisdiction.

The Value
The formula’s first variable is Value (or typically referred as the assessment – according to value). The method to derive a property‘s assessed value differs from jurisdiction to jurisdiction. Apartments are assessed annually in Texas and Florida while North Carolina has County driven reassessment cycles that can extend as long as eight years. The State of Maryland requires property to be reassessed every three years, but the timing of this triennial reassessment can vary from location to location. California typically reassesses property only when a change of ownership occurs, and during those between years, the value can only increase 2%, and on and on and on.

Once you determine the reassessment cycle, one must understand the valuation methods of each state and local jurisdictions. Does the assessor use mass appraisal techniques, statistical modeling, or the more standard appraisal methods such as the cost, sales comparison, direct capitalization, and discounted cash flow approaches? For example in Colorado, multi-family properties are classed as residential and are valued based on the sales comparison approach or a gross rent multiplier. A direct capitalization approach is not accepted. In Texas, the assessor is charged annually to assess based on market value, however, a property must also be equalized with other similar properties, and the latter method takes precedent.

The Tax Rate
The second variable is the tax rate. Some states have tax rate caps, but many derive the tax rate based on the local jurisdiction’s budget. If the overall tax value base drops a jurisdiction can simply increase the rate to compensate for the lost value. Fortunately this can go in both directions. In Virginia during years from 2004 thru 2007, many jurisdictions lowered their tax rates as values increased dramatically, whereas now rates are increasing as values are starting to trend downward.

The Tax
After the value is multiplied by the tax rate your tax liability is set. But wait, there is more. The timing of when taxes are paid is an often missed step in this burdensome process. Most states have an effective date of valuation of 1/1 each year, but the timing of when the taxes are paid can have a huge impact on a property’s annual operating statement. For example, a 1/1/2009 effective valuation date in Arizona is used to calculate the taxes that are due in 2010. A similar situation occurs in Washington State, where the 2009 taxes paid are based on a value from 1/1/2008. In both of these situations, if you are expecting taxes to go down because your property’s performance is worse than the prior year, you will be quite surprised when you receive your tax bill.

What to do?
What can an owner/operator do about the real estate tax? The first variable, value, can be controllable, while the second variable is somewhat uncontrollable. Make sure you have a complete understanding of how your property taxes are calculated, from the timing of the value to when they are paid. Make adjustments to budgets and accruals as information is received and updated. Because establishing value is not a science and is very property specific, be diligent about your assessed value. The best plan is to make sure someone, either internal or an outside consultant, is keeping the property’s value as low as legally possible.

Mr. Rogers is the western regional vice president with Alliance Tax Advisors. He has over seventeen years of national experience in the real estate appraisal and property taxation fields. His most recent role as Vice President – Property Tax Administration provided him in-depth experience managing all property tax functions for a national multi-family real estate investment trust with over 80,000 units in 24 states and 47 markets with a property tax liability of over $70 million.