Navigating Commercial Property Taxes and Their Impact on Value

Commercial property taxes play a crucial role in real estate investment decisions and property valuations. Understanding the assessment process, strategies for managing tax liabilities, and the impact on property values is essential for investors and property owners in today's dynamic market landscape.

The Property Tax Assessment Process

Methods used for commercial property valuation

Commercial property valuation employs three primary methods: the cost approach, the market or sales approach, and the income approach. The cost approach estimates value by calculating the expense of replacing the asset, considering land acquisition and construction costs, while adjusting for depreciation and current conditions. The market or sales approach compares the subject property to similar assets in the area, making adjustments for differences in characteristics such as size, age, and functionality[1].

The income approach is particularly relevant for properties generating lease payments, determining value by calculating the present value of future cash flows and considering factors like expected revenue, expenses, and appropriate discount rates.

Role of local tax assessors in determining property value

Local tax assessors play a crucial role in determining property value for taxation purposes. These professionals employ various methods to assess the worth of commercial properties, including the three approaches outlined above. Tax assessors typically conduct annual evaluations, requesting income and expense reports from property owners to calculate the Net Operating Income (NOI). They then apply a capitalization rate based on the property type to determine its value[2].

This process ensures that property taxes are based on current market conditions and the property's income-generating potential. Of note, assessors are required to stay impartial and adhere to strict ethical standards, relying on factual data and industry expertise rather than personal opinions.

Frequency and timing of property tax assessments

The frequency and timing of property tax assessments vary significantly across states, reflecting diverse approaches to maintaining accurate property valuations. Some states mandate annual reassessments, ensuring property values closely track market fluctuations. In contrast, other states allow up to 10 years between reassessments, potentially leading to substantial discrepancies between assessed and market values over time[3].

Many states fall somewhere between these extremes, with reassessment cycles ranging from 2 to 5 years. Some states employ a hybrid approach, mandating that all real property be subject to annual revaluation but requiring physical inspections only once every four years. This variability in assessment frequency can significantly impact property tax burdens and local government revenues, with more frequent reassessments generally providing a more accurate reflection of current market conditions.

Commercial Property Tax Strategies for Owners

Importance of accurate income and expense reporting

Accurate income and expense reporting is crucial for commercial property owners navigating property taxes. Local tax assessors rely heavily on this information to determine a property's Net Operating Income (NOI), which directly impacts its valuation and subsequent tax bill. Typically, assessors request annual income and expense reports, often using specific forms that property owners must complete[4].

To ensure accuracy, investors should meticulously verify each line item in their proforma, including rental income, other income, vacancy rates, and operating expenses. This verification process is essential for calculating key metrics like potential returns and property valuations, as well as for pitching to potential investors or lenders. By providing precise, comprehensive income and expense data, property owners can contribute to more accurate assessments and ideally avoid unfavorable tax outcomes.

Documenting tenant concessions and cost shortfalls

The proper documentation of tenant concessions and cost shortfalls is key when property owners navigate commercial property taxes. Tenant concessions, such as rent reductions or free rent periods, can significantly impact a property's net operating income and, consequently, its assessed value. Additionally, cost shortfalls, including increased vacancy rates and higher operating expenses, should be carefully documented.

Property owners should meticulously track these factors, as they may provide evidence for lower property valuations during assessment appeals[5]. By maintaining detailed records of these concessions and shortfalls, owners can build a stronger case for property tax reductions and ensure their assessments accurately reflect current market conditions.

Proactive measures to manage property tax liabilities

Proactive measures to manage property tax liabilities are essential for commercial property owners seeking to optimize their investments. One crucial strategy is to build a comprehensive property tax management plan before assessments arrive. This approach involves designating responsible personnel, understanding appeal guidelines, and preparing for potential challenges in advance[6].

At Crexi, we understand the importance of leveraging technology and data to estimate property tax responsibilities. Our commercial real estate data and analysis tools provide valuable insights that can help property owners make informed decisions and identify opportunities for tax savings, even before an acquisition.

Impact of Property Taxes on Commercial Real Estate Value

Relationship between property taxes and property value

The relationship between property taxes and property value is complex and dynamic, particularly in the context of different sectors of commercial real estate. Property taxes are typically calculated based on the assessed value of a property, which is derived from its market or just value. This value, especially for commercial structures, is often determined by the net rental income generated by the property, though it can be determined by the measures covered above[7].

Changes in a property's income-generating potential can have significant implications for its assessed value and, consequently, its property tax burden. However, the impact of market fluctuations on property taxes is not immediate due to the nature of assessment cycles. Many jurisdictions set tax valuations effective from January 1st of a given year, meaning that sudden economic shifts may not be reflected in tax assessments until the following budget cycle.

Effect of tax rates on investment decisions

Property tax rates can significantly influence investment decisions in commercial real estate. Higher tax rates can erode profitability and affect cash flows, reducing potential returns on investment. Investors often consider tax implications when selecting investment locations, as understanding property tax rates helps them forecast future costs and evaluate potential returns[8].

The impact of tax rates varies across states, with some having median commercial property tax rates below 1.5% while others exceed 2.5%. Additionally, the availability of tax incentives, such as those for property development in specific areas, historic preservation, or environmental sustainability, can further sway investment choices.

Long-term implications for property appreciation

The long-term implications of property taxes on commercial real estate appreciation are multifaceted and require careful consideration. While pre-leased properties may offer the allure of steady income and potential appreciation, investors must navigate a complex landscape of risks and opportunities. Market fluctuations can significantly impact property values and rental yields, potentially eroding returns over time[9] depending on the lease structures of existing tenants.

Strategic location selection becomes paramount, as properties in up-and-coming or prime areas with high demand and robust infrastructure are more likely to maintain value and attract tenants, even in challenging economic conditions. Diversification across multiple pre-leased properties in various locations and with different tenant profiles can help mitigate risks associated with market volatility and tenant departures.

Challenging Property Tax Assessments

Grounds for appealing a commercial property tax assessment

Commercial property owners have several grounds for appealing tax assessments. One common reason is overvaluation, where the assessed value exceeds the property's fair market value. This can occur due to errors in property records, such as incorrect square footage or building features. Another ground for appeal is the inclusion of assets no longer owned or double assessment of the same property, which can artificially inflate valuations[10].

Unfair comparisons to dissimilar properties or those in different market conditions can also justify submitting an appeal. Recent changes in property status, such as renovations or damages not reflected in the assessment, provide additional grounds for appeal. 

Property owners should carefully review their assessment notices, compare valuations to similar properties, and consider consulting with tax professionals to determine if they have a valid case.

Steps in the appeal process

The appeal process for commercial property tax assessments typically involves several key steps. Property owners must first review their assessment notice, carefully examining the property description and valuation for any discrepancies. If grounds for appeal are identified, the next step is to file an appeal with the county's Assessment Appeals Board within the specified timeframe[11].

Preparation for the hearing is crucial: owners must gather compelling evidence, such as recent sales of comparable properties, independent appraisals, and relevant documentation. During the hearing, property owners or their representatives present their case to the Assessment Appeals Board, which also hears from the county assessor before making a decision. Throughout this process, effective communication, thorough preparation, and professional assistance can significantly enhance the chances of success.

Importance of timely filing and documentation

Timely filing and meticulous documentation are paramount in the commercial property tax appeal process. Property owners typically have a narrow window of 30-45 days from the date tax bills are sent to file their appeal, regardless of whether they received the assessment notice. Missing this deadline can result in forfeiting the right to appeal for the current tax year[12].

Comprehensive documentation is also crucial for building a strong case. This includes gathering current and previous property tax bills, official assessment notices, property records, deeds, and improvement permits. If necessary, conducting a thorough comparable property analysis can supplement you with enough compelling evidence to support the appeal.

Commercial Property Taxes in the Current Economic Landscape

Recent trends in commercial property tax revenues

Recent trends in commercial property tax revenues reveal a complex landscape of growth and challenges. In 2022, the combined economic contributions of new commercial building development and existing commercial building operations in the United States resulted in direct expenditures of $826.9 billion, contributing $2.3 trillion to U.S. GDP and supporting 15.1 million jobs[13].

Property tax revenues have shown remarkable resilience, with state and local governments collecting $757 billion in the last year ending Q3 2023, representing an 11.6% increase over the previous year. This growth has exceeded 10% for three consecutive quarters, a phenomenon not seen since 2009, driven largely by rising home value assessments that typically lag market prices by one to two years[14].

Challenges faced by local governments

Local governments face significant challenges as they navigate the potential shortfalls in commercial property tax revenues. As one example, studies suggest that office building values could plummet by up to 50% in many cities, raising concerns about the severity of budget impacts. The degree of vulnerability varies widely among municipalities, with some cities deriving over 20% of their general revenue from commercial property taxes[15].

While projected revenue shortfalls of 2.5% to 3.5% by 2031 in median cities present challenges, they also open avenues for positive developments. These relatively modest shortfalls provide a manageable framework for cities to adapt without drastic measures. Cities can seize this opportunity to diversify their revenue streams, reducing reliance on commercial property taxes and fostering a more resilient economic base.

The lag between market value changes and official reassessments offers municipalities additional time to implement strategic financial planning, explore alternative funding sources, invest in economic development initiatives, and optimize existing resources. By proactively addressing these challenges, cities can strengthen their financial health and enhance their ability to support community needs.

Navigating the complex landscape of commercial property taxes requires a deep understanding of assessment processes, market trends, and strategic management techniques. As the commercial real estate market evolves, property owners and investors must stay informed and proactive in managing their tax liabilities. By leveraging accurate data, staying abreast of market trends, and utilizing professional resources, stakeholders can make informed decisions that optimize their property investments.

At Crexi, we're committed to providing the comprehensive market data and valuation tools needed to navigate these challenges successfully. Ready to take the next step in your commercial real estate journey? Explore properties on Crexi today and discover your next investment.

References

1. Avalara. (2023). Best method and tools for commercial property valuation appeals.
2. High Peaks Capital. (n.d.). Understanding Property Taxes in Commercial Real Estate.
3. Tax Foundation. (n.d.). State Provisions for Property Reassessment.
4. City of Alexandria, VA. (n.d.). Real Estate Assessments Income & Expense Surveys.
5. Institute on Taxation and Economic Policy. (n.d.). The Impact of Work from Home on Commercial Property Values and the Property Tax in U.S. Cities.
6. Joyner, A. (n.d.). 5 Must-Know Tactics for Effective Commercial Property Tax Management. LinkedIn.
7. GAI Consultants. (n.d.). How COVID-19 Impacts Property Tax.
8. CoreLogic. (n.d.). Comparing the Cost of Owning and Operating Commercial Real Estate Across the United States.
9. PropReturns. (n.d.). Risks of Investing in Pre-leased Commercial Property.
10. Avalara. (2023). How to submit property tax appeals.
11. Paramount Property Tax Appeal. (n.d.). Grounds for Appealing Property Tax Assessments in California.
12. Fair Assessments. (n.d.). What You Need to Know About the Property Tax Appeal Letter.
13. NAIOP. (2023). Economic Impacts of Commercial Real Estate, 2023 U.S. Edition.
14. National Association of Home Builders. (2023). Property Tax Revenue Continues to Climb.
15. Tax Policy Center. (n.d.). Navigating the Looming Commercial Property Tax Shortfall.
16. The Pew Charitable Trusts. (2024). As Property Tax Bills Rise, States Look for Long-Term Solutions.