Measuring the effects of real estate taxes on property values in today's market

The high level of real estate taxes detrimentally affect real estate values. There are a number of ways to measure the effect. For income producing property the effect of real estate taxes can usually be readily measured by a mathematical technique using a tax load factor which is added to the overall capitalization rate. In an assessment district where properties are assessed at 100% of their market value, the equalization rate is 100%. Most areas in Upstate New York are near the official 100% equalization rates. However, in many of the downstate suburban municipalities, the equalization rates are much lower than 100%. The main reason for this disparity is that reassessments are expensive and politically unpopular. There are some municipalities which have equalization rates as low as 3%. As an example a property with a market value of $10 million would have an assessed value of $300,000 if the the equalization rate was 3%. The equalization rate by definition is assessed value divided by market value. In a perfect world, all assessments reflect market value and therefore the equalization rate is 100%. However, downstate is an example of an imperfect market which means value and assessed values are different. The adjusted overall capitalization rate is used to determine what the equitable assessed value should be. In putting the fee simple interest rent into the equation, it is important to use rent comparables which include real estate taxes in the lease agreement. Furthermore, fee simple market rents usually have to be considered unless there is a strong historical trend such as long term established leases. This is the case for many subsidized housing projects. The tax load factor is based upon the tax rate divided by 1,000 multiplied by the equalization rate. This is under the assumption that the tax rates are multiplied by each $1,000 of assessed value. This is an important assumption. The tax load factor mathematically connects the cap rate with value. If the tax load adjusted capitalization rate is used the real estate taxes are taken out as an expense in order to estimate an equitable value. Unloading the real estate taxes as an expense is done to remove the bias from the mathematical model and rely upon purely the relationship that the tax rate is applied to the assessed value which is theoretically market value in a perfect world. Using the tax load factor adjustment helps directly measure what the equitable assessed value should be. As an example, it is assumed a property has a stabilized net operating income (NOI) of $270,000 without real estate taxes being used as expense. Also, the overall rate is assumed to be 9% and the tax rate per $1,000 of assessed valuation is $49. The tax load adjusted overall rate is 13.9% (9%+4.9%). The tax load factor of 4.9% is calculated by the following: $49(the tax rate) divided by 1,000. multiplied by 100% (the equalization rate). The equitable assessed value is $1,942,446 ($270,000 divided by 13.9%). Thus, in this example the equitable assessed value is $1,942,446. Another method in quantifying overtaxation and the effect on value is by using an offshoot of a debt service coverage ratio model. As an example, if the property taxes are assumed to be $100,000 too high, there is $100,000 less NOI that be can be used for debt coverage. If market mortgage terms are 6.5% interest rate amortized over 20 years, the annual constant is 8.95%. The impact on mortgage affordability can be found by taking the excessive real taxes divided by the annual constant. In this example, $100,000 (excessive real estate taxes) divided by the annual constant 8.95% equals $1,117,318 less mortgage which can be afforded on this property if the incremental debt coverage ratio was 1.00. If the incremental debt coverage requirement was higher the loss in the mortgage amount would be less than $1,117,318 This would be more likely. In summary, these are two of a number of methods to measure the effect of real estate taxes on value. The owner of commercial property should be familiar with these techniques to insure their portfolio is equitably assessed and can maximize their investment. John Rynne, MAI, SRA is the president and owner of Rynne, Murphy & Associates, Inc., Rochester, N.Y.