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Exclude Branding and Similar Elements from Property Tax Valuation, Says Consultant

A key to establishing realistic taxable values for commercial real estate is to exclude intan­gible qualities — such as a commercial brand — and value only the real estate. While this concept is a standard ap­praisal practice and imbedded in most states’ tax codes, it continues to elude many tax appraisers who assess prop­erties by business values that extend well beyond brick and mortar.

Assessment Methodology

In valuing hotels, apartment com­plexes, malls, shopping centers and other income-producing properties, appraisers most often apply the in­come approach, calculating value based on the real estate’s revenue stream. To value hotel properties, for example, an appraiser would deter­mine income flow using occupancy rates, expenses incurred in service de­livery and maintenance costs.

Income approach calculations re­quire an overall capitalization rate or the owner’s annual return on their ini­tial investment. The assessor divides a hotel’s net income from occupied rooms by the total capitalization rate to determine the property’s value.

The overall capitalization rate comes from two other calculations. One de­termines a mortgage capitalization rate based upon the mortgage equity ratio, placing a percentage value on the mortgage against the property. The appraiser also must determine an eq­uity capitalization rate from the equity component of the real property. The assessor should then subtract personal property to obtain taxable value.

In most jurisdictions, the analysis would end there, subject to viewing similar properties for comparison. That is a problem when the value thus calculated also reflects intangible as­sets that are exempt from property tax. Intangibles commonly stem from a business operation.

For example, the hotel may rely on a popular brand that enables it to charge a higher room rate. That does not make the real property more valuable for tax purposes than an otherwise identical hotel without a recognized brand, but in most instances, tax assessors ignore branding and over-assess.

By excluding the brand valuation from the real estate, an appraiser can obtain a more accurate taxable value. This requires an analysis not only of the business operations in a particu­lar taxing jurisdiction but an overall impact that may extend outside the taxing jurisdiction due to the brand’s popularity. In other words, nation­wide popularity may affect the in­tangible success of a local business operation.

Florida Court Intervenes

Florida’s Fifth District Court of Ap­peals recently addressed this issue. In the case of Rick Singh, as Property Ap­praiser, vs. Walt Disney Parks and Re­sorts U.S. Inc. et al., Disney challenged the methodology of attributing higher values to its resorts for association with the Disney name.

On June 19, 2020, the court rendered an opinion that the tax appraiser’s as­sessment conflicted with Florida law and professionally accepted appraisal practices because the assessor’s de­rived value exceeded market value and erroneously included intangible prop­erty value.

The parties agreed that the income approach was the professionally ac­cepted appraisal practice, as is the case with many income-producing proper­ties. On Disney’s behalf, an appraiser separated the intangible assets from the real property to establish a fair mar­ket value of the intangible assets, as if a hypothetical buyer were interested in purchasing the property. The approach provided an intangible asset value sep­arate from the other assets the hypo­thetical buyer would purchase.

Disney also presented expert testi­mony on the real property’s value us­ing an income capitalization approach, which is applicable to properties where space is rented. This required some as­sumptions about how the property was used, distancing the retail components of the business operations from the real estate. Disney presented additional ex­pert testimony examining the business value versus the value of the real prop­erty itself, such that the goodwill, cus­tomer base loyalty and the assembled workforce would be excluded from the real property’s value.

The court felt that the tax assessor impermissibly included intangible business value in the assessment. The franchise value and management ex­penses needed to be deducted to elimi­nate the business value imposed on top of the real property value.

Other Property Types

Appraisers apply a similar analy­sis to other types of rented properties, such as malls and shopping centers. Typically, appraisers use the income approach, modified for the particular industry. A hotel operates differently from a shopping center, but the prop­erties’ square-foot values are similarly analyzed.

Malls and shopping centers present an additional consideration in that the business model grows increasingly ob­solete as consumers shop more online. Thus, an analysis will be made based upon similar properties but will ex­clude intangible asset value for a prop­erty that has a highly popular retail chain operating within its walls. This would be a situation with a high-end department store anchoring a shop­ping center versus a discount depart­ment store.

The value of the real property itself is unchanged by the tenant’s branding. Furthermore, two similarly situated shopping centers can support addition­al analysis using the market approach, which values the real property as if it were vacant and placed on the market for sale. This deviation from the income approach could be useful in establish­ing the parameter around which inves­tors establish real property value.

A similar issue arises with apart­ments. Two similarly respected apart­ment complexes within reasonable proximity could be charging different rents because the brand associated with one property may be substantially more valuable than the brand on the other. This is similar to the resort or ho­tel analysis, but the differences in intan­gible asset values may be more subtle.

The trend today, and moving for­ward, is to place real estate assessments under a sharper microscope and iden­tify intangible asset values incorrectly included in the real property valua­tions. There will be significant push back by taxing jurisdictions, and not only because the practice threatens to constrain overall tax revenues to that jurisdiction. Resistance will also stem from an incomplete understanding of the differences between the value of the real property versus the value of the business operation as an intangible factor affecting overall revenues for the property.

At the end of the day, commercial property value is unchanged by the brand associated with onsite business operations. However, for property tax purposes, in order to exclude brand value from the real property’s taxable value, the assessor or appraiser must value the entire operation as a hypo­thetical sale, allot that value by com­ponents and then remove intangibles from the real estate value.

— By Brian Morrissey, attorney at Ragsdale, Beals, Seigler, Patterson & Gray LLP. This article originally appeared in the August 2020 issue of Texas Real Estate Business.

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