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.
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.