Dismissing an actual transaction is asking the assessor to ignore everything the assessor has been taught about valuing a property.
REITs entered the new millennium riding high, with many real estate stocks outperforming such market indicators as the Dow Jones Industrial Average and the Nasdaq Composite Index. High on the list were industrial and office REITs, and strong performance is expected through 2001. However, under the surface of placid economic health reports swirl questions for REIT managers relating to the predictability of their largest controllable expense — property taxes. This unpredictability arises most commonly from quick acquisitions and new construction projects.
After the acquisition, the first question that usually comes my way when advising a property tax manager for a REIT is: “What will the assessor do? Of course, they won't place the value anywhere near the transaction amount — will they?”
When a REIT is entering a market, particularly with the goal of closing a deal quickly, high transaction prices result. These prices often will be above transaction prices other entities pay for comparable properties in the market. The lower cost of funds for REITs certainly has allowed the trusts to pay more than others would offer for a property. These arguments traditionally are used to discount a “high” transaction price. The value after this first discount may still fall short of the price that many REIT managers have targeted for a property tax budget in the future.
One explanation for this is that many assessors are reluctant to believe arguments that rely on discounting a recent sale. According to Hennepin County (Minn.) Assistant Attorney Mark Maher, the laws of many taxing jurisdictions require assessors and judges to recognize a sale as the best evidence of market value. In their view, they are not hypothecating a sale; they have an actual sale at hand. Dismissing an actual transaction is asking the assessor to ignore everything the assessor has been taught about valuing a property.
To overcome this objection, the lawyer must find out as much as possible about the deal and the factors influencing it. For example, one way to quantify the non-real estate components of REIT transactions involves setting forth the purchaser's expectations when deciding on a transaction price. When the target-time horizon is short, the due-diligence process sometimes is done in haste. Instead of presenting the transaction as a fait accompli, this is the time to involve your property tax lawyer. When the lawyer is forewarned about the details of the acquisition price, the projections done for a quick purchase decision can be separated into real estate and non-real estate values. This way, the taxes can be more accurately predicted.
REIT managers who have unrealistically low tax projections based on internal calculations can be confronted with a tax bill that will be higher than expected. To prevent this disappointment, the acquisition process should be a collaborative effort between REIT acquisition players, property tax managers and property tax lawyers. If projections are based on specific local market information and knowledge of local assessor behavior, accurate predictions follow.
The second situation in which REITs face uncertain tax bills involves predicting property taxes for new construction. The shifting requirements of various tenants can dramatically alter the final form of a project. Initial tax projections based on a given rent, tenant improvement costs, square footage and any special design or construction situation can become obsolete if a tenant is signed at a higher rental rate, or for a different amount of space and a lesser-level finish. Value and the resulting tax bill become a moving target unless accurate information is continually communicated between property tax managers and lawyers.
To that end, a valuation form has been developed and made accessible to clients via the Internet. This proforma document estimates partial or completed construction market values on a project once the client inputs a number of variables such as square footage, expected rental rates, expected tenant improvements, etc. Tied into the proforma document is a database of effective tax rates for the taxing districts in the area. As quickly as a potential tenant deal changes, a property manager can get new estimates on market value and property taxes for that project.
In summary, early communication and consistent information flows among the whole team of REIT professionals — managers, leasing agents and attorneys — lead not only to the lowest tax burden, but also to greater levels of predictability for REIT property tax managers.
Margaret Ford is a partner in the Minneapolis law firm of Smith, Gendler, Shiell, Sheff & Ford, P.A.; the Minnesota member of American Property Tax Counsel, the National Affiliation of Property Tax Attorneys.