All Bets Are Off on Property Tax Assessments

by Kristin Harlow

By Jerome Wallach, The Wallach Law Firm

In the budgeting process each year, property owners ask tax attorneys to estimate their projected tax exposure for the coming year or, in the case of multi-year cycles, what their property’s assessed value will be.

Customarily, attorneys experienced in real property tax appeals find answers to those questions by using traditional valuation methods: The cost approach is applicable to newer properties; the income analysis approach is tied to capitalization rates; and the comparable sales approach draws on recent, market-value transactions involving similar properties. In addition, the attorney will review the local assessor’s treatment of similar properties.

Jerome Wallach, The Wallach Law Firm

Armed with such analogies, the advisor will predict the probable range of assessed values for the taxpayer and provide a computation of the tax rate against that value. These analyses are reliable within a reasonable range. At least until now.

The nation may or may not be entering a post-pandemic economic recovery. What is certain is that the challenges created by COVID-19 have badly disturbed traditional methods of determining value.

The concept of using a property’s recent historic performance as a predictor of future performance, used universally by market participants and assessors, has been gutted by a year of the pandemic. Global health concerns jeopardize the validity of each of the approaches to value, from cost to income and comparable sales.

No one would deny that the pandemic presents serious challenges in the valuation of real property. All bets are off in this economy, and any value opinion based on any of the three recognized approaches is subject to challenge. Nevertheless, states and communities must forge ahead, and it is the task of tax assessors to go first in expressing an opinion of value.

Reproaches of approaches

Cost, the most objective of the three approaches to value, is typically applied in valuing recently constructed improvements. On its surface, this method appears to be both accurate and reliable as an indicator of value, but in some cases it is neither. The older the property, the less reliable the cost approach becomes as a measure of value. The more recent its construction, the more the consideration of deal momentum comes into play.

“Deal momentum” refers to the history, motivations and commitments driving a real estate development. Someone acquired land, arranged financing, solicited and accepted bids, drafted and entered into contracts, and hired staff and management. These are the elements necessary to propel bricks and mortar out of the ground and into the marketplace as a functioning profit center. And most of these steps taken are irreversible.

The cost of a project is not its value, and the cost of a project that opened its doors in March 2020 is certainly not its value. The underlying question is whether the market would have absorbed the improved property at its cost after the pandemic changed so many economic and market conditions.

Many appraisers and tax tribunals prefer the use of past income performance to indicate present or future value. Assuming the data is reliable, as it must be, past income demonstrates how the market has responded to income-producing properties.

However, applying the income approach requires an analysis of historic economic performance, and that presents a problem. The commercial real estate market has suffered profoundly from lost profitability for the past year, with no clear end in sight. If the valuation date for the tax year or first year of a multi-year cycle is Jan. 1, 2021, the property’s economic performance was likely a flat line for the preceding year.

The comparable sales approach is in many respects an extension of the income approach. Investors and owner-occupiers acquire commercial properties for their yield, either in the form of rental income or as a monetary benefit to the buyer. The pandemic has compromised such benefits dramatically.

Value judgements

We return to the property owner’s annual budgetary question, “What is the tax exposure of this property in the coming cycle?” The honest answer is, “I don’t know, and neither does anyone else.”

Decisions still must be made, however, and budgeting must occur. Under the property tax system, the assessor must determine a value. It is reasonably predictable that, for most properties, the assessor’s opinion of value will be reduced from previous years.

Whichever method or methods the assessor uses, their assessment will be subject to challenge. And once challenged, the owner/taxpayer will face the same issues as the assessor in putting forth an opinion of value. But, importantly, the taxpayer’s challenges will reflect the realities of COVID-19’s effects on the property, market and economy.

Whatever the assessor’s opinion of value may be, it will be subject to the challenges of valuing properties under the pandemic’s shadow. The question will not be whether there is an absence of data; the question will be whether the assessor accepts the data.

Jerome Wallach is a partner at The Wallach Law Firm in St. Louis. The firm is the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys.

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