A growing number of commercial properties incorporate efficient attributes that exceed basic code requirements. While conserving resources, these sustainable building strategies can also enhance the owner’s bottom line by reducing operating costs.
As investors consider developing or buying green properties in certain markets, though, they should consider a less obvious source of savings — their property tax bills.
No single set of attributes defines a green building. Instead, sustainable structures lie on a spectrum. At one end are otherwise-conventional buildings with modest upgrades, ranging to a high end of properties employing comprehensive design and operational strategies that approach zero net consumption of energy or water.
Benjamin Blair, Esq.
Faegre Baker Daniels LLP
The features most commonly associated with green building tend to be efficient heating and cooling equipment, better insulation, rainwater catchment and on-site power generation methods such as solar, wind or geothermal.
While rooftop solar panels garner attention, other design attributes including passive solar collection, drought-tolerant landscaping, and building-control systems can be equally effective at achieving sustainability objectives.
Ultimately, each attribute adds costs to the construction or operation of a property, while not necessarily generating the same incremental gain in value.
Seeking competitive edge
Green design and operations have become standard for Class A properties in many primary markets. With above-average adoption rates, the investment premium for energy-efficient attributes may disappear, and properties lacking those attributes may decline in value. Similarly, buildings without green features may be at a competitive disadvantage in attracting potential tenants and buyers.
In many secondary and tertiary markets across the Midwest, Southeast, Great Plains and elsewhere, however, buyers and tenants have not shifted their preferences toward green construction. This greatly reduces the direct economic benefits of green features. When the pool of tenants willing to pay premium rent for energy-efficient features approaches zero, the pool of buyers demanding those features likewise declines.
Accordingly, whether green attributes have an overall positive or negative impact on a property’s market value is highly dependent on the local market, even when the nation overall shifts demand toward such features.
Energy-efficient construction may be a market prerequisite in one location, but constitute too much engineering and overbuilding in another. The question for owners of sustainable buildings evaluating their tax assessments, then, is how buyers and sellers in that market react to specific green features.
What’s ‘superadequacy’?
Assessors often value properties, at least initially, based on the cost of construction, using either replacement cost tables or information from construction permits. But most green buildings have higher upfront costs, with a goal of achieving long-term efficiency objectives.
A green building assessed purely on a cost basis, without considering whether its features are above market, may be overassessed and, as a result, overtaxed.
Any cost-based property valuation must account for all depreciation, from ordinary wear-and-tear to obsolescence brought about by market factors.
One type of functional obsolescence is “superadequacy,” which applies to an attribute that exceeds current market requirements. Essentially, a superadequacy is a cost without a corresponding increase in value.
Importantly, obsolescence is measured against the market, so even a newly constructed property with no physical deterioration could suffer from substantial obsolescence.
A particular green feature might represent a positive value element, a market requirement, or functional or external obsolescence, depending on the property type and location.
Of course, as market demands evolve, some features that were superadequate when originally constructed may become standard. Tax assessments must reflect property and market conditions on a certain date, however, and until the market changes, must account for superadequacies.
And while superadequacy is an element of the cost approach to value, it should be a consideration in income- or sales-based analyses as well. The value of green features, like everything else in an appraisal, must be supported with market research and data. If no demand exists for the property’s features, then that must be reflected in the value conclusion.
Getting the value right
Assessors may ask: “If a green building has an out-of-pocket cost of $1 million, how can it appraise for only $750,000? Why would an investor spend the extra money?”
Certain items may motivate a particular owner, but property tax assessments are usually based on the real estate’s market value alone, regardless of business value or intangible value. If the market does not recognize a feature as valuable, then the value a particular user assigns to that feature is irrelevant for property tax purposes.
In questioning how a green feature affects a property’s market value (as opposed to its value to the user), consider whether the feature creates a direct monetary benefit to the property owner or user, either in the form of higher income or lower expenses.
Sustainability features may boost the owner’s business, perhaps resulting in goodwill or broader market recognition, but that increase will not necessarily accrue to the real property itself. And indirect benefits — those non-monetary benefits to the community or environment — are unlikely to change real estate value.
Valuing a green building involves most of the techniques used for conventional properties, but the nuances and complexities require greater knowledge and training.
Local tax assessors, particularly in smaller jurisdictions where sustainable features have not reached market acceptance, often lack that requisite knowledge.
It is no wonder that assessments often fail to consider all of the relevant market factors, creating opportunities for taxpayers to appeal excessive assessments.
As demand for sustainable buildings expands, assessors want to capture that growth in the local tax base. But by focusing on whether the local market demands or ignores energy-efficient features, diligent owners can reduce their property’s tax assessments and achieve significant savings.
Benjamin Blair is an attorney in the Indianapolis office of international law firm of Faegre Baker Daniels LLP. The firm is the Indiana and Iowa member of the American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at benjamin.blair@FaegreBD.com.