By Morris A. Ellison (MultiFamilyExecutive.com Article) — Developers frequently ask how to estimate property taxes on newly constructed multifamily properties, and tax assessors often provide an easy answer by adding up the value of building permits or by projecting the project’s value when fully rented. However, this seemingly simple question grows complex when the assessor’s valuation date precedes full occupancy, and the ramifications of a wrong answer can linger for years.
Consider these points to ensure that your new multifamily project is valued accurately.
Charged with valuing hundreds, or even thousands, of parcels, assessors often seek a quick way to value new apartment projects.
The cost approach offers the quickest and easiest method, allowing the assessor to estimate what it would cost currently to construct an identical structure. One way to do this on a new project is to add the value of the building permits to the land value.
While building costs are clearly a factor in the decision to build, the cost approach ignores the market preference to value income-producing projects based primarily on income.
The assessor’s second-easiest option is to rely on an appraisal’s stabilization value and ignore the time and cost required to achieve stabilization. In valuing a not-yet-built multifamily project using an income approach, however, appraisers preparing a financing appraisal should, but don’t always, calculate two different values: the “at completion” value and the “stabilized” value.
“At completion” is the project’s value when construction is complete but the property isn’t yet fully leased, whereas the “stabilized” value, or prospective market value, reflects the property’s projected market worth when, and if, it achieves stabilized occupancy.
Real estate dictionaries define stabilized value in terms of the expected occupancy of a property in its particular market considering current and forecast supply and demand and assuming it’s priced at market rent. To determine a property’s fair market value prior to stabilization, one must account for the monetary loss the owner would incur prior to stabilization.
Property improvements generally trigger reassessments. With this point in mind, the developer makes assumptions during the development process, calculating the cost of building and operating the improvements as well as the rents that can be achieved. This calculation serves as the basis for a pro forma of an income-and-expense analysis of the project when fully leased. The assessor’s statutorily mandated valuation date, however, typically ignores the development calendar’s key milestones; most importantly, the construction commencement, completion, and revenue stabilization dates.
Lenders, in contrast, give construction loans that reflect the estimated building costs and subsequent time and money needed to achieve full lease-out or stabilization. The completed, but not yet stabilized, project incurs costs in the form of income not received during initial leasing until it reaches stabilization.
Further, permanent loans depend on the property’s stabilized value, which, in turn, depends on the project’s income. Banking regulations require the lender to obtain an appraisal. Appraisals for permanent-loan commitments obtained prior to the project’s completion use a prospective valuation date and must contain various assumptions as to the property’s financial condition on that prospective date. The Uniform Standards of Professional Appraisal Practice require disclosure of these assumptions as of an effective date subsequent to the appraisal report’s date.
Assumptions regarding the anticipated rent at stabilization and the time required to lease the property are key to calculating the stabilized value. Also critical are incentives the owner may offer prospective tenants during lease-up and the project’s projected income once fully leased. The appraisal should clearly disclose these assumptions, but they can still prove incorrect.
Clear disclosure of assumptions is essential. Unfortunately, many appraisers fail to adequately disclose their assumptions and take shortcuts to determine the project’s stabilized value.
Most state statutes prohibit taxation of property improvements while they are underway. Rather, a project usually comes on line for tax purposes after completion but prior to stabilization.
Being mandated by statute, the valuation date often doesn’t account for where the multifamily project is on the spectrum between completion and stabilization. Unsophisticated assessors charged with valuing these projects often employ mass-appraisal techniques and may value the asset similarly to the market’s stabilized properties.
Some states cap potential increases in tax value, which may magnify the impact of the initial tax valuation. Caps can limit increases that would otherwise bring values up to the market level. For example, South Carolina properties undergo countywide reassessment every five years, but property values ordinarily can’t increase by more than 15% from the previously determined value.
Assessors know that a project’s value at completion will nearly always be lower than its stabilized value because stabilization takes time and costs money. Competition, too, may lower the project’s achievable income. This knowledge can spur assessors to reach for stabilized values regardless of whether the project is yet stabilized. This taxes the unrealized, additional value between the completion and stabilized levels.
A Matter of Time
All of the above considerations involve a timing disconnect between the property’s actual condition on the statutorily mandated valuation date and its estimated future value based on fallible projections by the lender, developer, or assessor. Axiomatically, assumptions don’t always hold true. Lease-up may take longer than expected and may require concessions that increase cost. In overbuilt markets, the stabilized income may be lower than originally anticipated.
Charged with calculating true or fair market value as of a statutorily mandated valuation date, the assessor should examine how the market would value the property as of that date. If the asset hasn’t achieved stabilization, the assessor should discount appropriately for the time and financial costs required to achieve stabilization. That’s what the market would do, and that’s what the assessor is statutorily obligated to do.
And that should be the answer to the seemingly simple question of how to value newly constructed multifamily projects for tax purposes.