Multifamily products in many national markets, which had been stable throughout much of the mid-'90s, have taken some large leaps in assessed value due to very strong institutional investor activity.

There has been a substantial amount of multifamily development, sales and repositioning in recent years. Interest rates are steady in financing markets, rents are rising and demand for space is fairly strong. In a number of sought-after markets such as Minneapolis, Chicago, Seattle, Atlanta and Austin, intense competition for product acquisition has driven prices dramatically upward.

The challenge for owners in light of recent high sale prices is to control the assessor's response to the sales. A by-product of the high purchase prices has been a wholesale increase in assessments and a corresponding substantial jump in real estate taxes. Many investors have been surprised by the increases, since taxes have been declining or stable since the early-'90s.

The following discussion points out a few of the factors which lead to unanticipated increases in values. First, many analysts do not factor in dramatic increases in property taxes when creating proforma income approaches for a potential acquisition target. Another factor is unrealistically inflated proposed rent or income expectations and underestimated expenses. These combined factors can set very low going-in cap rates.

Although investors are by nature sanguine, the prediction of a dramatic revenue growth may be overly optimistic. In addition, cap rates, upon reversion, could be much higher than are currently predicted. These aggressive factors can create a paradigm that leads to a very high sale price, unsupported by the project's past history.

Despite record sale prices, there are some ways to control property taxes. A recent example we have encountered involved a large complex in a Minneapolis suburb. In the assessment period immediately following the sale, the assessor increased the complex's assessment by 25%, or $5 million. Another large increase followed in the subsequent year. In this case, the assessment even after the increases was still under the purchase price.

Upon appeal, we persuaded the assessor to reduce the assessments for the second and third increased years by emphasizing the post-sale actual performance of the property. The actual income, market vacancy and expense levels, together with a higher than originally projected cap rate, yielded a value substantially lower than the purchase price, thereby saving a 30% reduction in taxes.

A careful analysis and discussion of the actual performance of the property and identification of components of the purchase prices are necessary steps on the path toward recasting them in terms of traditional income valuation models. These and other methodologies have been discussed at American Property Tax Counsel seminars where owners, property tax managers and lawyers come together to develop new approaches to property tax reduction.

Cautionary tales abound from markets throughout the country. Though the apparent lower cap rates of 4% to 8% appear to be derived from sales of upper-end product, such factors are even more inappropriate for middle to lower end multifamily products. The optimistic revenue predictions have even less chance of succeeding, and the desired happy ending of a re-sale at a similar cap rate may not result.

Indicators in the national apartment market in the recent quarter show that the average discount rates and overall cap rates have increased slightly. If this trend continues, then investors whose exit strategy includes revenue production and resale at a low cap rate might want to sell quickly or be prepared to hold the product through the next market cycle.

In markets where there is a high demand for Class-A multifamily product, investors should not ignore the corresponding competition from condominiums, co-ops and single-family homes. If interest rates continue at a stable rate or increase only incrementally, the perceived demand for luxury rental product could be ephemeral.

Recasting sales projections within frameworks created by the above observations have been useful in arguing for lower multifamily values in today's rosy, transactional climate. The bottom line is, high prices don't always mean high taxes.