COVID-19 has had a swift and major impact to the US economy. A significant number of real estate owners will not be able to cover their debt service over the next few months while the economy remains in gridlock. Although the CARES Act should help mitigate the fallout, it may take months to administer. Additionally, some real estate sectors such as hospitality and retail will likely face long-lasting effects.
For most owners, property taxes are the largest operating expense. There is no doubt that assessments will decrease due to the economic downturn, but how long will it take? How quickly will local governments react and to what extent?
During the Great Recession, real estate values dropped relatively quickly throughout 2008. However, property tax assessments were not adjusted until 2009, a full year after the recession began. In 2008, our clients averaged an assessment increase of 9.7% (including new construction and properties with capital expenditures). In 2009, there was an average 1.9% decrease in assessments, almost a 12% turnaround
from the prior year. In 2010 there was another 5.5% decrease. It is clear that it took 12-24 months before assessments were adjusted appropriately.
Assessors generally follow a few key tenets that cause the delay in the change of valuations:
First, property tax assessments are done in arrears. In the marketplace, valuations and transactions occur based on anticipated future cash flows and IRR’s. However, assessors are always looking at trailing 12 month performance. This usually causes a lag in what is occurring in the market versus the assessor offices. In normal times of growth, this tends to benefit owners as assessments are below market values. However, during times when values are decreasing, assessments remain high.
Second, assessments are evidence based and assessors will not change unless there is sufficient evidence to prove otherwise. In 2008, cap rates spiked as valuations dropped, but there was not a significant amount of transactions to prove this. As such, assessing jurisdictions did not react until enough time passed and transactions occurred to indicate the shift in the market.
Third, assessments are done on an iterative basis (typically once per year). Nationally, most valuation dates occur on January 1 of each year. During the Great Recession, rental revenue did not materially drop until after January 1, 2008. As such, assessors could argue that as of that date, valuations had not changed. This means that owners had to wait until 2009 to argue successfully for lower assessments.
Given the tenets above, it is likely that assessors will be slow to react. Some have already sent Notices of Value over the past couple of weeks with complete disregard to the COVID-19 impact. Others will follow. It will be difficult for owners to formulate arguments of lower values as of January 1, 2020. For that reason, there will likely be a bigger downward shift in values in 2021 than in 2020.
However, given the sudden impact of COVID-19, assessors may give special consideration to the distressed asset classes (i.e. hospitality, senior living, etc.). Furthermore, even if valuations do not change, taxing jurisdictions may provide lower millages or temporary abatements to assist property owners through 2020. Some Collectors will also likely provide or extend payment plans.
There is still much unknown. Each state and jurisdiction will act differently. Many of them are still figuring out how they will react. Nonetheless, owners must remain active in their appeals and fight for every last dollar of relief.
RETC helps sophisticated real estate investors gain a competitive edge by prioritizing the most impactful aspects of property tax services, allowing for material gains on deal and fund-level returns. For more information about how changes in property tax law can affect commercial real estate investing, contact us or visit our website