When Real Estate Isn't Just Real Estate

In the world of real property taxation in New York State, Assessors are charged with the responsibility of “assessing” real property.

The New York State Constitution limits assessments to no more than a property’s full value. Article 16, §2.

The Real Property Tax Law defines assessable real property, and specifically states that “personal property, whether tangible or intangible, shall not be liable to ad valorem taxation”. RPTL §300. At the very outset, therefore, it becomes necessary to distinguish “real property” from “personal property”.

Traditionally, to establish a value for tax assessment purposes, particularly those that are purchased for an income stream, commercial properties have been valued via an income approach.

While there are statutory definitions of real property [RPTL §102 (12)] that determine whether certain properties, or parts thereof, are assessable, there are several types of “real estate” that are so intertwined with the operations of a business (not assessable), that a very careful analysis must be made for property tax purposes. In other words, while certain properties generate an “income” that could support a value greater than the value reflected by the Assessor, those property types that are “business related” must have their income “adjusted” to reflect income related to the real estate only.

For example, golf facilities have been valued, not based upon the highest and best use of the land, i.e., residential development, but by developing a rental value to be capitalized. This value excludes tangible and intangible personal property associated with the operation, as well as any business enterprise or going concern¹ value inherent in the operations. Merely capitalizing revenue less operating expenses does produce a value, but not necessarily the correct real estate value.

Recently the valuation of assisted living facilities was explored. First, it should be noted that the sale of such a facility usually reflects the property’s going concern value. The sale price, in and of itself, may be of little relevance for real estate tax purposes. The same can be said for any attempt to ascribe a real estate value by reference to the sales of comparable facilities.

¹ Going concern value has been defined as the value of an operating business which is greater than the sum of its assets when they are sold separately because it includes tangible and intangible operating efficiencies, management, employee facility, etc.

In an assisted living litigation, two appraisers, one representing the taxpayer and the other representing the municipality, recognized the need to make adjustments in order that their income analysis excluded the business aspects of the operations, etc. Not surprisingly, the appraisers differed on methodology.

One appraiser attempted to value the property as a not-for-profit entity (which it was) by utilizing actual, audited financial statements reflecting the revenue earned. Operating expenses were deducted based upon actual experience and an average expense ratio published by the American Senior Housing Association (“ASHA”). Because the appraiser was appraising a not-for-profit facility, no deduction was made for “business” income. This appraiser did, however, make a final deduction from value for personal property, furniture, fixtures and equipment (“F, F&E”). In his opinion, his final conclusion reflected a real estate value only.

The other appraiser appraised the property as a private, for-profit Assisted Living Facility in an attempt to maximize the property’s income potential. The Potential Gross Income was calculated by establishing a market revenue for the property based upon other similar facilities located within the same general area. His concept was to determine the applicable private pay rate for all rooms and beds. In essence, he presented the hypothetical operation of this facility as if it were operated totally for private pay patients.

This appraiser relied upon a business expense ratio obtained by reference to industry data, finding it more appropriate then the property’s actual operating expenses.

However, this appraiser recognized that merely subtracting operating expenses from projected, effective gross revenues would not produce a net income that could be capitalized to produce a real estate value, since without further adjustments, the resultant net income still reflected income attributable to the for-profit business activity. As a result, the appraiser adjusted the Net Operating Income (NOI) by deducting 4% of the subject property’s Potential Gross Income. Further adjustments were made for other non-real estate items, including returns on personal property, and/or FF&E. Unlike the first appraiser, who deducted FF&E directly from the market value, this appraiser deducted FF&E from the Operating Expenses.

Even in the selection of capitalization rates, the appraisers differed in their analysis. One appraiser utilized rates that were reported in both the Senior Care Report and the Senior Care Participants Survey; the other appraiser discounted the rates reported by both The Senior Care Acquisition Report (“SCAR”), and The National Investment Center for the Seniors Housing and Care Industries, since he believed he had already made adjustments for the business operation.

These examples demonstrate the following:

The valuation of certain types of real estate for property tax purposes is becoming more complex, as the appraisal profession becomes more sophisticated in recognizing and accounting for going concern/business elements.

Even when appraisers recognize that only the real estate is to be valued for
property tax purposes, they can, and often do, differ as how to accomplish
that goal.

A bare bones statement that a property generates too much revenue does
not prove that the property is fairly assessed for real estate tax purposes.

The real property tax arena is complex, confusing and still in a state of flux, both legally and from an appraisal perspective. At times, there are differences as to methodology even between and among the Judges who hear these matters.

The real property tax burden has reached the point where it is not only prudent, but good business sense, to review a property’s tax assessment on a yearly basis.

Remember, reductions in property tax go directly to one’s “bottom line”.

The more intertwined real estate is with the business conducted at the property, the greater the need for a thorough and professional review.

Copyright © 2010 Realty Tax Challenge, Inc.