Loading the Capitalization Rate for Real Estate Taxes
By Carl Schultz, MAI, SRA, CRE, SGA, FRICS
In June 2010, the Georgia Legislature passed a Property Tax Reform Bill into law to be
effective January 1, 2011 that dealt partially with over-assessed properties based upon ad
valorem taxes in the various counties in Georgia. The bill is identified as SB 346. It can
be accessed at:
http://www1.legis.ga.gov/legis/2009_10/versions/sb346_SB_346_APP_9.htm
This law specifically states in Part V, Section 5-1 to 5-3:
PART V
SECTION 5-1.
Said title is further amended in Code Section 48-5-2, relating to definitions, by adding
new paragraphs to read as follows:
“(.1) ‘Arm’s length, bona fide sale’ means a transaction which has occurred in good
faith without fraud or deceit carried out by unrelated or unaffiliated parties, as by a
willing buyer and a willing seller, each acting in his or her own self-interest,
including but not limited to a distress sale, short sale, bank sale, or sale at public
auction.”
SECTION 5-2.
Said title is further amended in Code Section 48-5-2, relating to definitions regarding ad
valorem taxation of property, by revising the introductory language of paragraph (3)
preceding subparagraph (A) as follows:
“(3) ‘Fair market value of property’ means the amount a knowledgeable buyer would
pay for the property and a willing seller would accept for the property at an arm’s
length, bona fide sale. The income approach, if data is available, shall be considered
in determining the fair market value of income-producing property. Notwithstanding
any other provision of this chapter to the contrary, the transaction amount of the most
recent arm’s length, bona fide sale in any year shall be the maximum allowable fair
market value for the next taxable year. With respect to the valuation of equipment,
machinery, and fixtures when no ready market exists for the sale of the equipment,
machinery, and fixtures, fair market value may be determined by resorting to any
reasonable, relevant, and useful information available, including, but not limited to,
the original cost of the property, any depreciation or obsolescence, and any increase
in value by reason of inflation. Each tax assessor shall have access to any public
records of the taxpayer for the purpose of discovering such information.”
SECTION 5-3.
Said Code section is further amended in paragraph (3) by revising subparagraph (B) as
follows:
“(B) The tax assessor shall apply the following criteria in determining the fair market
value of real property:
(i) Existing zoning of property;
(ii) Existing use of property, including any restrictions or limitations on the
use of property resulting from state or federal law or rules or regulations
adopted pursuant to the authority of state or federal law;
(iii) Existing covenants or restrictions in deed dedicating the property to a
particular use;
(iv) Bank sales, other financial institution owned sales, or distressed sales, or
any combination thereof, of comparable real property;
(v) Decreased value of the property based on limitations and restrictions
resulting from the property being in a conservation easement; and
(vi) Any other existing factors provided by law or by rule and regulation of
the commissioner deemed pertinent in arriving at fair market value.”
How does this impact the seller, the buyer and the appraiser? Will sellers and/or their
broker use this law as a marketing tool for potentially lowering the property taxes after a
sale and therefore increase the potential sales price of income-producing properties? Will
the purchasers recognize this potential and actually be willing to take a guaranteed tax
reduction into consideration in their purchase price decisions?
Many county taxing authorities have been slow to lower tax valuations in today’s
depressed economy, particularly on commercial, multi-family and industrial properties.
While there have been some adjustments, generally commercial properties are valued for
tax purposes at more than an “Arm’s length, bona fide sale” would likely bring.
If the appraiser utilizes the existing taxes in estimating the Market Value of an incomeproducing property and the value conclusion is less than the taxing jurisdiction’s Fair
Market Value estimate, what should the appraiser do? While there are no specific
requirements for this special circumstance, the Uniform Standards of Professional
Appraisal Practice (USPAP) states in Standards Rule 1-1(b):
(b) not commit a substantial error of omission or commission that
significantly affects an appraisal
Some questions that the appraiser might consider are:
•
Is the difference significant?
•
Would a purchaser and/or seller consider the potential tax savings in their
purchase/sale decisions?
•
What is the tax assessor likely to do in the second year after the taxes are reduced
to the sales price?
Should the appraiser decide an adjustment needs to be made to the appraiser’s
preliminary value opinion for this factor, one way to ascertain the possible enhancement
is to use a trial and error system until the estimated tax value for computing taxes and the
market value estimate are equal. This is a tedious process.
However, there is an easier method by loading the capitalization rate for taxes and
capitalizing the net operating income before deducting ad valorem taxes. The result of
this formula will accurately calculate the value estimate to equate to the tax value in one
step without trial and error.
The formula is:
Capitalization Rate + (Assessment Ratio x Tax Rate) = Implied Cap Rate Before Taxes
Then utilize the Implied Cap Rate on the NOI before deducting Taxes.
Let’s look at an example and proof of the formula’s accuracy. Let’s assume a property
has a Net Operating Income of $100,000 after deducting vacancy, collection losses and
all expenses including ad valorem taxes of $35,000, based upon a tax value of
$2,500,000. The Capitalization Rate derived from market analysis has been estimated to
be 9.5% for the subject property. Counties in Georgia assess properties at 40%, or .40
(Assessment Ratio) of the assessor’s Fair Market Value estimate. Assuming the total tax
rate for the taxing authorities (City & County) in this case is $35.00 per $1,000 of tax
assessment, or 0.035; then the Implied Cap Rate Before Taxes is calculated:
Capitalization Rate + (Assessment Ratio x Tax Rate) = Implied Cap Rate Before Taxes
0.095 + (.40 x 0.035) = Implied Cap Rate
0.095 + 0.014 = 0.1090, or 10.9%
The indicated value would therefore be:
NOI + Taxes ÷ 0.109 = Value with Reduced Taxes
$100,000 + $35,000 ÷ 0.109 = $1,238,532
Proof:
Value / Sales Price
$1,238,532
Times Tax Ratio
X 40%
Tax Assessment
$495,413
Times Tax Rate
x 0.035
Taxes based upon Sales Price of
$1,238,532
$17,339
NOI Before Deducting Taxes
$135,000
Less Revised Taxes
-$17,339
NOI After Sale & New Tax Value
$117,661
÷ 0.095
Capitalized
Indicated Value
(Rounding Error)
$1,238,537
In this case simply capitalizing the NOI of $100,000 at 9.5% using $35,000 as a tax expense indicates a vale of $1,052,632. Yet, with taxes reduced based on the sales price, a value of $1,238,532 is indicated. The key question is what will purchasers do? Will they take into consideration this potential tax savings, as it could result in a significant difference in NOI the second year and therefore value? The author, J. Carl Schultz, Jr., MAI, SRA, CRE, SGA, FRICS is the Director of the Atlanta office of Integra Realty Resources (IRR). He is also the Managing Director of the IRR‐Savannah office. He was the 1991 President of the Georgia Association of Realtors® and 1989 National President of the Appraisal Institute, which awards the MAI and SRA designations. He was also the Chairman of the Appraisal Foundation in 1996, and began serving as Vice‐Chair of the Appraisal Standards Board (ASB) of the Appraisal Foundation in 2009 and 2010. He is now serving as the Chair.