Proper Basis of Value for Property Taxation

Many assessors' offices display the same cartoon. It shows a shack to demonstrate how the taxpayer views the value of a home and a mansion to illustrate how the home is seen by the assessor.
Some element of truth exists in this cartoon -- particularly as it relates to commercial properties. Strangely, there is no single value for a commercial property. The value depends on the purpose for which property is being valued. For instance, leased fee value, as derived from existing leases, represents a property's value for mortgage purposes. New construction and owner-occupied properties are valued on a fee simple basis at current economic rental values. Value for insurance proposes is normally based on a cost approach.
When it comes to valuing commercial property for property tax purposes, almost all appraisals are based on fee simple value. The courts in New York State long ago settled the contract rent versus market or economic rent issue in favor of economic rent. The value for assessment purposes includes the value of all interests in the property. This includes the lease hold bonus value that a lessee with a favorable lease may have. A typical example of a leasehold bonus value is the supermarket in a shopping center which has a long-term net lease for $5 per sf when the current rental value is $20 net per sf. Thus, the lessee's interest in the shopping center represents a higher value than the owner's interest. When considering real property taxes, the assessor need not impose a lower assessed value because the owner made a bad bargain - or a bad bargain as seen after time passes. The same principle applies to the purchase of a property subject to below market leases. In that case, there is unsold leasehold bonus value.
The converse also applies. Above market leases on a property should be ignored, with current economic rents used by the assessor. Similarly a sale price of property with an above market lease should be disregarded as inflated by such lease.
At the heart of value for condemnation purposes lies the concept of highest and best use. However, it's completely irrelevant for property tax assessment purposes, where properties are required to be valued at their "actual use and condition." Golf courses provide a perfect example. The highest and best use for a golf course is usually a high quality residential subdivision, which could be worth up to $100 million. This would be the value in a condemnation action. However, the golf course must be valued for property taxes in its actual use as a golf course - a value of, say $10 million. Another example is a two-story suburban or inner city department store with a second story that's more or less unused. It's valued as a one-story store for taxation purposes, but might be valued in a condemnation case at a potentially higher and best use if conversion to, say, an office building is likely.
Other examples of different and lower values for property tax purposes include net leased properties, hotels and nursing homes. In a case now on appeal, the trial court held that a drug store net lease was not appropriate proof of rental value because it was based on the cost of assemblage and a built-to-suit lease. Instead, market rent for similar sized retail buildings was applied. In other cases, courts refused to apply prices and rentals from sale-leaseback transactions since such values derive from "financial transactions," not normal real estate transactions.
In valuing hotels, a careful appraisal technique is required because hotel income streams include revenue from non-real estate sources. This income must be excluded from hotel assessments to avoid a business enterprise value. Since most hotel sales and appraisals are based on the hotel's entire business enterprise value, separation of non-real estate income is essential.
Nursing home values should also exclude income from non-real estate operations such as nursing, recreation and therapy services, as well as food operations. This position was upheld in a recent court case, which excluded the non-real estate value by adopting only the real estate portion of the Medicaid reimbursement rate paid to the nursing home owner.
Many factors contribute to establishing the basis for valuing different types of commercial property. Properly determining and explaining the appropriate basis of value often becomes the key element in a property tax case. The best results in these cases come from a team effort among the client, property tax attorney and appraiser.
source:By William D. Siegel, As published by Real Estate New York, November/December 2006.