July 1, 1998

6 Min Read
Forecasting Real-Estate Taxes

Forecasting Real-Estate Taxes

By Michael Donohue

Each year storage owners conduct a budgeting process that includes forecasting the nextyear's real-estate taxes. This article will examine the factors that influence real-estatetaxes, offering the reader a checklist approach to perfecting the forecast.

Why Real-Estate Taxes?

An inaccurate real-estate tax forecast can significantly affect investor returns. Forexample, take a REIT that recently acquired several storage properties for $20 million ona 10 percent cap rate. The properties were last assessed at $10 million. Utilizing theexisting real-estate taxes of $200,000, the REIT expected a first-year equity dividend(which equals cap rate in this example) of 10 percent. However, the property wasreassessed upon sale to the sale price, triggering a real-estate tax increase of $200,000and thereby lowering the equity dividend by one basis point to 9 percent.

About Real-Estate Taxes

Real-estate tax is the most difficult line-item expense to predict due to thecomplexity of its derivation. It is generally derived by multiplying a real-propertyassessment by a real-estate tax rate. The real-property assessment is typically theproduct of the real property value1 multiplied by an assessment ratio2.The real-property value is determined by an assessor who works for an assessing authority."Value" is a matter of opinion; two qualified individuals working with the exactdata can form different value conclusions. Usually, two or more individuals interested inderiving value on the same property do not have the same data available (imperfectmarket). For these reasons, property owners and their representatives do not always agreewith the value derived by assessors. So, to forecast real-estate taxes, one must focus ontwo broad components: property value and real-estate tax rate. Each component requiresseparate consideration.

To predict the value the assessor will place on subject property we will consider: 1)all information available to an assessor, 2) the assessor's track record of valuation andanalysis and 3) any jurisdictional nuances regarding the use of data. First, we identifythe valuation method or methods utilized by the assessor.

Generally, three valuation methods exist: income, sales and cost. Do not assume thatall methods are available. For instance, in some jurisdictions, owners are usually boundto employ only the cost approach to value, whereas in other jurisdictions, the incomeapproach to value will be considered the controlling method.

We must ask ourselves: Is the concept of "equalization"3 relevantin the jurisdiction? If so, we must consider the history of assessments of similarlysituated properties and how they might influence the assessment of the subject property.Does the jurisdiction survey actual income and expense information from property owners?If so, how is it used to determine value? By answering these questions, we know whether wemust incorporate the subject property's actual income and expense into the prediction ofthe assessed value.

What information is available to the assessor? We review market information such assales comparables and third-party published information (e.g., expense comparables,investor capitalization rate-requirement surveys, etc.). We interview the assessor todetermine what market information might dominate the process.

For the subject property, what have been the historical annual net operating incomesand capitalization rates employed by the assessor in his previous valuationdeterminations? We must understand what opinions the assessor has previously expressed anddocumented regarding the subject property. For example, if the assessor has previouslyemployed net operating incomes (NOI) significantly above previously reported actual NOIs,then our forecast of the assessed value (absent consideration of an assessment appeal)should be consistent with this approach.

Taking all of this information into consideration, we essentially undertake the sametask as the assessor. Having reviewed the assessor's history of assumptions and datainterpretation, we employ the assessor's same methodology (whether or not we consider itto be flawed) to predict the assessed value for the upcoming year (assuming the annualreassessment process). Concurrent to this process, we would forecast the real-estate taxrate.

The real-estate taxes can consist of a variable tax rate and fixed-dollar componentssuch as a trash tax. The fixed-dollar components are generally obtained directly from thetaxing authority. The variable-tax rate is determined each tax period by the taxingauthority and local electorate. We review the rate history and interview the taxingauthority to determine the direction and quantification of any tax-rate change. Forinstance, upon review of a fire district, we discovered that it was in need of a new firetruck; this information enabled us to accurately predict an increase in the tax rate. Manytax bills represent a cumulative tax from multiple taxing jurisdictions. Thus, all taxingjurisdictions must be investigated to properly forecast the next period's tax rate.

Once the assessed value and real-estate tax-rate forecast figures are determined, onemust understand how a jurisdiction applies (or phases-in) changes before making the finalforecast. Also, the jurisdiction's fiscal payment period may not be the same as theproperty owner's fiscal year, so adjustments must be made for the timing of paymentswithin the owner's accounting process. Payments made in advance or arrears must also beaddressed to accurately forecast the timing of real-estate tax payments.

This article best serves property owners with geographically dispersed portfolios. If ajurisdiction does not reassess annually, for instance, then the forecasting of real-estatetaxes becomes much easier. Our experience in reviewing real-estate portfolios forassessment appeal and real-estate tax-forecasting considerations indicates that eachportfolio owner has a subset of properties that are under-assessed. We recommend that eachowner perform a tax-spike analysis to better quantify the degree of under-assessment. Itis possible that a portfolio could significantly under-perform if many under-assessedproperties were suddenly fairly assessed by assessing authorities.

Here is a recommended checklist approach:

  • Identify jurisdiction rules

  • Identify valuation method of choice

  • Determine if survey of income is used

  • Determine if actual income and expenses are relevant evidence of value

  • Identify assessor's historical NOIs (for previous assessment years)

  • Identify assessor's historical cap rates (for previous assessment years)

  • Identify source(s) used to derive assessor's historical cap rate

  • Identify available market information

  • Determine NOI and cap rate, and then convert into predicted assessor value

  • Identify real-estate tax-rate history

  • Identify real-estate tax-fixed charges

  • Identify timing of real-estate payments

  • Interview taxing authority

  • Determine real-estate tax rate

Footnotes

(1) There exist different kinds of value (e.g., fair market value, investor value,value in use, etc.). Also, jurisdictions tax a defined element as defined by law, such asfree simple interests, leased fee interests, etc. The value derived by jurisdictions is afunction of a legal mandate.

(2) Assessment ratios can easily confuse the taxpayer. Some jurisdictions simply have a100 percent tax ratio; thus, the assessed market value multiplied by the assessment ratioof 100 percent is a figure easily understood. These ratios are simply part of amathematical formula leading to the real-estate tax derivation.

(3) Some jurisdictions utilize an "equalization" concept whereby propertiesmust be equalized. This concept has different meanings to different jurisdictions. Forinstance, to some jurisdictions, equalization is measured by value per unit, whereas toother jurisdictions, equalization is tested by the consistency of the methodology employedby the assessing authority. Typically, we consult our local attorney for the equalizationapplication in each area.

Michael Donohue is the founder of Storage Tech Specialists, Inc., which hasrecently merged with Coopers & Lybrand L.L.P. of Virginia. Coopers & Lybrandspecializes in property tax appeals for self-storage owners. Mr. Donohue may be reached at1751 Pinnacle Drive, McLean, VA 22102-3611; phone (800) 388-8270.

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