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Taxing a property value decline

October 5, 2009 | Alumni

The process seems simple. A government entity – usually a county – values residential, commercial, and agricultural real estate. Based on those valuations, the government applies a tax rate and collects taxes from property owners.

But the simplicity ends with varying opinions of property values, massive and complex commercial properties, and, as experienced the last two years, one of the most dynamic real estate markets in generations.

As property values have fallen at various levels in nearly every nook and cranny across the country, homeowners in some of the hardest hit regions have flocked to their local auditors’ offices asking for their property values to be lowered.

If they’re successful, they’ll pay a smaller tax bill. Multiply that scenario throughout entire cities and include highly valued commercial properties and it’s easy to see how the cities and schools that rely on the tax dollars could feel a financial pinch.

But, besides the effects on your own personal property, when should you recommend clients further investigate similar reevaluations. What are the risks? Is now the right time?

“It seems like this should be a no-brainer, but it can sometimes be difficult and costly,” said Rick Daley ’78, a senior lecturer of law at Moritz. Daley’s professional background includes 12 years in private practice as a partner with Squire, Sanders & Dempsey LLP and 13 years as executive vice president and general counsel of The Pizzuti Companies, a regional developer headquartered in Columbus. “It seems like it is something that everyone should be doing, but they are not. It is at least something that everyone should be thinking about.”

Not all, but most real estate markets around the nation have experienced varied levels of decline in the past two years. Of course, the major, headline-grabbing regions stick out – southern Florida, Las Vegas, southern California – but the even not-so-drastic drops in other areas have similar, although smaller, effects.

Nationally, from the second quarter 2008 to the second quarter 2009, median home sale prices dropped 15.6 percent from $206,400 to $174,100, according to the National Association of Realtors. Midwest sales in the same time frame dropped 8.6 percent, while dropping 10.3 and 26.6 percent in the South and West, respectively.

Commercial real estate values are believed to have dropped 27 percent in the first six months of 2009, according to the Moody’s/REAL Commercial Property Price Indices.

Historically, when property values have dropped, property owners have rushed to their local auditors’ offices in hopes of aligning their tax bills with the reduced value of their assets. Reports show that those requests seem to be flowing in at various speeds across the country.

According to a July New York Times article: “In suburban Atlanta, thousands of people lined up at government offices to file their requests for reassessments … In parts of Ohio, appeals have multiplied fivefold. Tax lawyers in the northern suburbs of New York say they have never been so busy, and some towns have hired extra employees to sift through the paperwork and are spending hundreds of thousands of dollars on legal fees to deal with the cases in tax courts.”

In Franklin County, Ohio, officials have experienced a 103 percent increase in filings from 2007 to 2008, according to Franklin County Auditor Clarence E. Mingo II ’98. Mingo said that about 54 percent of the 2008 filings – which included residential and commercial properties – resulted in decreased valuations.

“As auditor, my job is to reflect what the market indicates property values to be,” said Mingo, who recently was appointed to the position. “We do that by carefully looking at the evidence brought to us and evaluating it in a fair and equitable manner.”

Tax rules vary by district and in some districts the taxed amount does not directly correlate with new property assessments. But in most a decreased valuation will mean smaller tax bills and subsequently less revenue for the taxing district.

“In Ohio, school districts receive the majority of property tax revenue, and with property owners filing complaints to have those assessments lowered, it is definitely going to have at least a short-term impact on those school districts,” said Andre Porter ’05, an associate at Schottenstein Zox and Dunn in Columbus. Porter represents Central Ohio school districts in their efforts to ensure properties are taxed at an appropriate rate and the district receives the revenue it should.

Ohio law says that the best indication of a property’s fair market value is an arm’s length sale between a willing seller and willing buyer. Similar guidelines are followed in most states.

“If a property is on the market for $100,000 and it sells for $150,000, the law in Ohio as set forth in statute and by the Ohio Supreme Court says that sale is the best indication of the property’s price,” said Karol Fox ’89, an attorney with Rich & Gillis Law Group in Dublin, Ohio, which represents several Central Ohio school districts on real property taxation issues. Partners in Fox’s firm were some of the first in Central Ohio to start pursuing property tax increases on behalf of school districts in the late 1970s.

In those days, attorneys would wait at a county auditor’s office for the release of property sale information. When a sale was filed that was higher than the valuation for tax purposes, they would file a complaint to the board of revision.

Today, in most areas that information is readily available on the Internet. Larger taxing districts now have more advanced features that allow property owners to see comparable, historical, and neighboring sale information by a click of a button. These sophisticated, yet user-friendly, sites sometimes allow visitors to create custom maps of areas that quickly can designate comparable properties.

School districts almost entirely pursue large commercial and multi-family residential properties, not individual, residential landowners, Fox and Porter said.

“Our legal services generally pay for themselves,” Porter said. “When values are increasing or owners are making improvements to real estate, we’re filing complaints at the Board of Revision to ensure that the county auditor’s valuation of a property reflects the recent sale price or the improvement to the property.”

But Porter and Fox said that tables have turned in this market.

“Now we’re seeing the opposite,” Porter said. “If there is a legitimate arms-length transaction and it is below the county auditor’s valuation, property owners are coming forward to obtain a decreased valuation . . . and the property owner is generally going to prevail in that case.”

In Ohio, county auditors are required to perform reappraisals of properties every six years and those values are updated every three years. Property owners and school districts could benefit greatly if they succeed in landing a change that is favorable to them.

For instance, if your client owns a property that is currently appraised at $1 million, and the client files for and is successful in receiving a 20 percent reduction of that property’s valuation. A property tax bill of roughly $31,000 a year would drop to about $24,800 – an annual savings of about $6,200.

“You have to remember that that new tax rate ($24,800 a year) would be the starting point for the county when they came around for their increase every three years,” said Moritz Professor Michael Braunstein, an expert in real property and real estate finance. Braunstein has taught at Moritz since 1986. “That savings could continue for quite some time.”

But the more complex the property and sale information, the more difficult it may be to convince a taxing district that the property value is incorrect, Professor Daley said.

A 10-year-long battle over the value of the Nationwide Arena in Columbus hinged on which value – the cost of building or sales and income – should be used. When originally entered on the tax duplicate, Nationwide Arena – a concert venue and home to the Columbus Blue Jackets, a professional hockey team – was valued at $129.7 million. The arena cost $147.1 million to construct.

The arena’s owners challenged the valuation, indicating that the price was inappropriate. The owners asked for the three-member board of revision to reduce the value of the property to $46.5 million, which was based on what other comparable arenas in North America sold for and the rental income it expected to receive. They also argued that the structure lost $107 million the day it opened because of obsolescence – meaning it paid more to acquire the building than it would receive if it were resold.

A compromise was reached in 2007 that allowed for the arena to pay taxes that are not directly tied to the property’s valuation.

If the best indication of a property’s value is a recent sale, then a close second is the sale of closely comparable property. But commercial property sales oftentimes include other items and intellectual property that are not directly tied to the property’s valuation.

And finding a comparable property can also be a tough task in this market, Daley said.

“That is very difficult to prove in these times,” he said. “As the housing market turned, so have the number of sales. I bet there are only about four significant commercial property transfers in the Columbus area in the past year.”

So if a client has owned a strip mall for several decades and no comparable properties have sold in the past couple years, what’s going to help that client prove that his property value has decreased?

“Their best bet is to find something that proves that the property has suffered a permanent and enduring hit to its income stream,” Daley said.

Maybe rent has declined drastically; maybe that strip mall has been replaced with a more popular, more lucrative one on the other side of town; maybe it has had difficulty finding tenants. As the nation sunk into a recession, commercial property owners began to experience many of these declines.

“For commercial properties, normally an income approach to valuation is used because there are so few good comparables,” Braunstein said. “If your rent rolls have gone down significantly it may be a good time to seek to have your property taxes reduced.”

Nationally, those rent rolls have slipped over the past couple years. According to the National Association of Realtors’ estimates, vacancies in office, industrial, and retail buildings are expected to continue increasing at least through 2010.

For instance, in the fourth quarter of 2008, 13.9 percent of office suites were vacant nationally, according to the group’s report. By the second quarter of 2010, 18.8 percent are expected to be empty.

During the same period, industrial and retail vacancies are expected to jump from 11.1 to 15 percent and 10.8 to 12.9 percent, respectively.  The National Association of Realtors is telling owners of multi-family residential properties that they can expect vacancy rates to peak nationally in the fourth quarter of 2009 at about 7.9 percent. Rent growth, which declined in the first and second quarter of 2009, is expected to begin turning by the end of the year.

If those factors affecting the property’s income are directly tied to the recession, a client’s decision to pursue a revaluation may be coupled with how quickly they believe the market will recover.

“If the market reaches some midway point and that is the new normal,” Daley said, “then it may be some time before prices are back to the levels that they were three or four years ago. It could be quite beneficial to pursue a reassessment.”

But if the market bounces back, any lower reassessment could have the potential to be erased more quickly and benefits may be short lived.

“It just depends on what happens with the economy and real estate,” Daley said, “which as we have seen is a pretty difficult thing to predict.”