CITY BIZ LIST: MANAGING THE LARGEST LINE ITEM IN COMMERCIAL REAL ESTATE OPERATING EXPENSES

Are you a commercial property owner who just received a property valuation from your local appraisal district? Or, are you an investor going through the due diligence process before closing an important deal? These processes can present obstacles for owners and investors such as decreased cash flow and/or increased net operating expenses due to a lack of knowledge and general understanding about property taxes and the underwriting process. Therefore, it becomes increasingly important to arm yourself with tips about overcoming these challenges successfully while still seeing a return on investment!

When looking at purchasing a deal, investors are always seeking strategies to enhance yields and thus value. Most often, those strategies involve increasing occupancies or effective rents. Owners also seek to manage and at times, lower controllable expenses. However, what is most important is that investors have as much clarity as possible into the timing and amount of changes in how an asset is performing currently versus the future.

Many investors do not pay enough attention on how to underwrite property taxes nor do they have it as part of their business plan upon acquisition. This problem is accentuated when investors are not familiar with the local property tax laws. The easy way out is to apply some type of flat percentage increase year over year (typically two-to-three percent) for all properties regardless of location and differences in property tax laws. This is not a good strategy due to the simple fact that property taxes are often the largest line item in operating expenses.

Each jurisdiction is unique in how they value properties and administer property taxes even within state lines. To top it off, the more dynamic a property is, the more volatility there will be in taxes. Class A multi-family and hospitality have seen assessed values increase, ranging from 10 to 35 percent on average. Both sectors have seen increases in revenue due to increases in rates and occupancy. Class A multi-family has also had the highest number of transactions leading to compressed cap rates. Coupled with the increases in revenues, the values have increased exponentially rather than linearly. Most recent purchasers haven’t yet realized the “fruit” of the increased values and instead are dealing with the downside of increased taxes.

Investors should hire localized experts who can help not only lower property taxes, but also help in the underwriting and budgeting process. Key questions investors should be asking?

· Will the assessed value be reset after acquisition?

· What appeal options are available and how long before resolution?

· How often are properties revalued?

· Are there any abatements or exemptions that may be applicable? (There may be some properties with expiring exemptions/abatements)

· Can and will millage rates increase? If so, how much?

At the end of the day, general partners are paid and promoted for how well they can predict future cash flows; ensuring the best method is in place for predicting property taxes is paramount. Just like all the other line items, it is impossible to predict property tax amounts with 100 percent accuracy but the goal is to limit the margin of error. This should help prevent unwelcome surprises and also increase the level of confidence during the due diligence process.

Look to the experts for help – now is the time since valuations have been released. A good property tax agent will not only help curb assessed values, but will also make investors better underwriters.