By Brendan Kelly, associate, Siegel Jennings
Over the past decade, Mr. Rogers’ adopted hometown of Pittsburgh has been named the most livable city in the continental United States — a hipster haven, tech hub and other trendy titles. Affordable housing stock in a stable real estate market, access to the arts in an established cultural community and world-class healthcare and higher education place the Steel City at the forefront of medicine and robotics.
This attention has drawn real estate investors to submarkets well beyond downtown Pittsburgh’s Golden Triangle. As competition increases, investors from outside the region should be aware of idiosyncrasies and pitfalls lurking in Pennsylvania tax law and the local market.
Brendan Kelly, Siegel Jennings
Welcome, Stranger
As in most states, assessors in Pennsylvania cannot independently change a property’s assessment upon its transfer. However, Pennsylvania lets local taxing districts appeal assessments and request value increases, which they frequently do following a sale. Locals often call this the “welcome, stranger” tax.
“One of the most common reactions I hear from our out-of-state clients who are new to this market is disbelief that districts can appeal assessments,” says Sharon F. DiPaolo, Esq., managing partner of Siegel Jennings’ Pennsylvania property tax practice. “Of course, in most states that’s called a spot assessment, but in Pennsylvania, it’s just another appeal.”
In fact, local school districts (which take the largest piece of the property tax pie) filed more assessment appeals than property owners in each of the past three tax years, according to The Allegheny Institute for Public Policy data.
“The most difficult part for buyers is the ability to accurately estimate what is obviously a large part of a property’s value equation,” DiPaolo explains. “Buyers can budget for the legal costs of defending against an appeal by the government, but it’s much harder to underwrite the real estate taxes when they can’t know where the assessment will eventually be set. We have seen many investors choose not to enter this market because of that uncertainty.”
Understanding the local legal landscape can help investors budget for potential risks, and thoughtfully structuring a deal can sometimes help reduce that risk. For instance, when appropriate, transferring a property’s holding company rather than the property itself can avoid triggering an increase appeal.
Further, properly allocating a purchase price — either among multiple properties in a portfolio or among the different components of a going concern — can avoid misinterpretation of deeds and transfer tax statements by local taxing authorities. This also ensures Pittsburgh’s 5 percent transfer tax is applied to the real estate only.
Net-lease investors should also be aware that, while many states can be described as “fee simple” or “leased fee” jurisdictions, Pennsylvania is unique in that in practice, its courts will usually tax a leased property according to whichever of those values yields greater taxes. Through a series of cases over 15 years, Pennsylvania’s appellate courts have struggled to base a property’s taxation on its “economic reality.”
Currently, a property achieving above-market rent is assessed according to its leased fee value (which will be greater than the fee simple value), while a property with below-market rent will be taxed at its fee simple value (which will be greater than its leased fee value). Under this system, two physically identical properties within the same taxing district can be assessed at wildly different values.
A Beautiful Day in Some Neighborhoods
Anthony Barna, senior managing director of Integra Realty Resources Pittsburgh, cautions investors to vet property specifics. “People keep saying, ‘Pittsburgh’s hot,’ but it’s not the whole region,” he says. “It’s not even the whole city.”
While office vacancy in the CBD recently reached a 10-year high, some nearby neighborhoods including Oakland and the Strip District barely satisfy demand. Similarly, new apartments in popular neighborhoods like Lawrenceville are stabilizing quickly at record rental rates, but rents and occupancies in other neighborhoods remain flat, and some new projects have struggled.
“The lack of a significant population increase in the city, coupled with the large number of new residential units coming on line, threatens the economic balance and risks an oversupply,” Barna observes. Similarly, recent overbuilding of lodging properties has led to a surplus of hotel rooms in the region, with no significant demand increase.
“Everyone is pushing new development right now,” Barna says. “But a lot of our neighborhoods don’t yet have the infrastructure to actually support what someone might want to build.”
In fact, Amazon cited infrastructure concerns as a major factor in its decision to drop Pittsburgh as a final contender in its HQ2 search.
Similarly, developers should investigate available tax breaks, which vary by location. Frequently these come in the form of Tax Increment Financing or Local Economic Revitalization Tax Assistance. In 2019, Pittsburgh opened all neighborhoods to potential tax benefits for new developments that meet certain employment or affordability requirements.
Tammy Ribar, Esq., director at Houston Harbaugh who concentrates her law practice in commercial real estate transactions, advises that additional opportunities are available through various government bodies and can entail program-specific deadlines.
“I think the best advice I can give buyers is to research and understand in advance what programs are available and be informed about applicable deadlines, so that a relatively easy opportunity for savings is not missed,” says Ribar.
Based on the current pace of new construction throughout the city, many investors have clearly decided that Pittsburgh’s anticipated rewards outweigh its risks. And as many have learned, working with knowledgeable locals during planning can help to avoid headaches — and create significant savings later.
Brendan Kelly is an associate in the Pittsburgh office of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at [email protected].