Public forums have painted a picture of Cook County residential owners carrying an unfair property tax burden, but the truth is that property taxes have increased for everyone. The culprit is not the institutional taxpayer, nor is it the valuation process; today’s oppressive property taxes are a symptom of a diseased system for funding municipal pensions.
Clarity on inequity
To understand where the inequity lies, it is important to first understand how Cook County values residential versus commercial real estate. Outside of Cook County, every property is assessed at a third of its market value, regardless of property type. Therefore, every $1 million property — residential and commercial alike — will have a taxable assessed value of $333,333. Multiplying that by the local tax rate (let’s use 7 percent) creates a $23,333 tax bill.
Molly Phelan, Siegel Jennings Co.
By contrast, Cook County assesses every residential property for taxation at 10 percent of its market value, whether it be a single-family home, apartment building, condominium, co-op or the residential component of a mixed-use development.
If the market value of a single-family home is $1 million, its assessed value is $100,000. Taxing entities multiply this by the state equalization factor, which hovers around 3.0 for an equalized taxable value of $300,000. Again, using a 7 percent tax rate produces a $21,000 tax burden. That is a 2 percent effective tax rate, and some residential owners qualify for further reduction.
The deck is stacked against commercial property owners in Cook County, which assess all non-residential property at 25 percent of market value (barring government-granted incentives). Thus, assessors value a $1 million property as taxable at $250,000. The 3.0 equalization factor and 7 percent tax rate yield a $52,500 tax burden.
That is $31,500 more than a taxpayer would pay for a residential property of equal market value in Cook County and equates to an effective tax rate of 5 percent. It’s clear the burden is already on commercial/industrial property owners.
Faulty method?
Some advocates for residential taxpayer relief levy criticism on the valuation methodology for income-producing properties, pointing the finger at commercial/industrial investors while claiming insider shenanigans. Although there are indictments and investigations into some tax practitioners, local media has failed to understand one very important issue — the Illinois Property Tax Code and surrounding case law.
Some news organizations claim that assessments give commercial real estate a break because a property will sell for $2 billion but only have a base market value of $1 billion for property tax purposes. However, real estate valuation is based in the Illinois statute, which states the valuation of real estate should be at “the fair cash value.” Courts have further interpreted this to mean a “fee simple, as if unencumbered” estate. The aforementioned critics shy away from understanding this term, but the statute essentially asks: What are the “bricks and sticks” of the real estate worth?
Nuances ignored
Adding to the confusion is a misapplication of the banking industry’s understanding of valuation, which is based on leased-fee estates, or value determined by rental income. Assuming rental rates are equal, a building that has 20 percent occupancy will have a lower market value than a fully occupied property.
For example, Building A and Building B are both single-tenant, single-story, concrete retail buildings measuring 14,000 square feet, identically constructed in relatively the same suburban location. Building A is encumbered by a 75-year lease signed last year with a high-credit, national pharmacy chain. Building A sold for $13 million on Jan. 2, 2020.
Building B has been owned and occupied by a mom-and-pop retailer for seven years. What taxable values should Building A and Building B have?
The assessor, many reporters and the general public claim that Building A must be valued for taxation at its $13 million sale price. Furthermore, they will claim that the physically identical Building B must be worth the same. Is that fair? Is that equitable? No.
For a fair and equitable value of Building A, the assessor must unravel the sale to separate what the buyer paid for the bricks and sticks and what they paid for the income stream from a 75-year lease with a creditable national tenant. If the lease was worth $10 million, this would indicate the buyer paid $3 million for the real estate. This type of analysis is a significant nuance in valuation that has been highly disregarded in the media.
Similarly, industrial properties often include business or machinery value in the purchase price. Therefore, it is unfair to assimilate data for valuation purposes without a careful dissection of purchase terms.
So, where does the inequity — the disease — lie? With local municipalities, pensions and tax levies. Chicago’s tax rate consistently rose to 7.266 percent in 2017 from 4.627 percent in 2009. (It dropped to 6.786 percent in 2018 due to the Chicago Reassessment.)
Fortunately, Mayor Lightfoot filled an $800 million budget deficit for 2020 without significantly increasing the property tax levy, using one-time windfalls. Pension obligations will increase by more than $600 million over the next three years, however, and Chicago will need nearly $1 billion in new revenue by 2023 unless significant changes are made.
Cook County’s assessment process already shifts an unreasonable burden to the commercial/industrial taxpayer, and failure to separate business values from real estate increases that burden. Every taxpayer is paying more because of the broken system in our local government, not because real estate investors are getting a deal.
— Molly Phelan is a partner in the Chicago office of law firm Siegel Jennings Co. LPA, a member of American Property Tax Counsel, the national affiliation of property tax attorneys.