Seize Opportunities to Appeal Property Tax Bills

Office property owners should contest excessive assessments now, 
before a potential crisis drives up taxes.

The Great Recession, from December 2007 to June 2009, was the longest recession since World War II. It was also the deepest, with real gross domestic product (GDP) plummeting 4.3% from a peak in 2007 to its trough in 2009.

Entering that recession, unemployment was at an unalarming 5%, on par with historical averages, and interest rates hovered around 6%. The roots of the recession lurked at the intersection of risky subprime mortgages and the repeal of the Glass-Steagall Act, which allowed for the mega-mergers of banks and brokerages to escalate.

The nation is still looking down a steep market slope. On the bright side, it is in a more advantageous position than at the beginning of the Great Recession. Through the fourth quarter of 2023, U.S. real GDP was a respectable $22.67 trillion (adjusted for inflation), up 8.2% from $20.95 trillion at the end of 2019. Unemployment is low, and values in the single-family housing market are increasing again, in part due to a lack of supply.

The investors standing on unstable ground this time around are those heavily leveraged in major metropolitan markets, such as New York, Chicago and San Francisco, or other municipalities that rely on office values. The sharp increase in interest rates under the Federal Reserve’s tightening monetary policy, and the extreme drop in demand for commercial office space that accelerated during the pandemic, will have significant ramifications on all property types.

Dire Developments

What kind of ramifications? Assume a hypothetical “Metro City” that, like most major markets, has a tax base with 75% of its independent parcels classified as residential and 25% as commercial real estate. However, the assessment values are strongly weighted on the commercial properties, with 30% of the entire assessment value born by office properties.

The municipality has a total tax levy of $16.7 billion and an overall assessed property value of $83.1 billion. The office portion of the property makeup is 30%, or $24.9 billion in assessed value. The office share of the total tax levy is $5 billion.
Now assume that the city’s overall office market value collapses by 50%. This leaves Metro City with a $2.5 billion deficit — not a small number. To recapture that $2.5 billion, the city must increase its tax rate by 15%. That means tax liability increases by 15% for every taxpayer, even if their property’s assessed value is unchanged.

So, how can developers and owners protect themselves from excessive tax liability given current market conditions? One solution is to appeal property tax assessments aggressively. Regardless of the jurisdiction, regardless of property type, property owners must evaluate their opportunity for an assessment appeal.

Office-specific issues

Market transactions show vast valuation differences between Class A office properties, which are typically newer buildings with superior amenities, versus commodity properties that have been around 10 years or longer and offer fewer amenities. Properties that fall in the latter category have many opportunities for assessment reductions. Here are key points to consider:

Ensure the appraiser or assessor is using the property’s current, effective rental rates. In many instances, an owner will show a tenant’s gross rent on the rent roll without disclosing specific lease terms contributing to effective rent. For example, the lease may have been negotiated at $27 per square foot, but the rent roll does not account for free rent, amortization, free parking or other amenities the tenant receives.

Additionally, although office leases historically pass through taxes and other costs to tenants, many negotiated leases now cap expenses for the tenant, potentially shifting a portion of expenses to the landlord. That is a key issue the taxpayer should address in the income analysis of an appeal, because it provides evidence for a reduction in effective rental rates, as well as an imputed increase a buyer would demand in the capitalization rate to reflect the additional risk.

Appraisers need to understand this issue for rental comparables and for the subject property. Typically, they will confirm public information posted by various data services, but if they lack the finer details of a transaction, the rates they derive could exceed the true market.

Address vacancy and shadow vacancy. Before the pandemic, office vacancy in most markets hovered between 5% and 14%, depending on the location and building class. At the end of 2023, national vacancy was over 19%, according to CBRE.

CBRE reported that suburban Chicago’s office vacancy remained at 25.9% in the fourth quarter of 2023. Manhattan’s overall office vacancy rate, including sublease offerings, was 22.8%, according to Cushman & Wakefield.

Shadow vacancy, or space where the tenant is still paying rent but no one physically occupies the space, is the canary in the coal mine for an office building’s future. If a building is 12% vacant, the assessor probably won’t be sympathetic. But if the owner highlights that leases in the space expire in the next year or two, or that they are large blocks of space, the assessor (or at least the owner’s appraiser) should acknowledge that risk and apply a higher cap rate for the subject property.

Adjust for interest rates. Investment-grade properties are now worth less than they were two years ago, simply because of the rise in interest rates.

Because interest rates have increased significantly, the property owner can argue that the assessor should use the “band of investment” method, which calculates capitalization rates for the components of an investment to produce an overall cap rate by weighted average. This methodology considers not only the increase in market interest rates, but also the equity demands of lenders. Interest rates have increased over 3 percentage points across the last two years, which in many cases equates to a 100% increase in interest rates.

Additionally, the equity requirements on commercial mortgages have increased from 30% to 50%. Increasing the base capitalization rate to reflect these changes in an income analysis will offer significant relief in the 
assessment.

Jurisdictions that rely heavily on office values to support overall assessment value in the tax base will be experiencing increasing tax rates. This rate increase is factored into the loaded capitalization rate, which means a lower market value for assessment purposes. Analysts and appraisers should review the increased rates annually.

The near term will be challenging for entities that invested in office properties prior to 2023, but these strategies can offer some protection in this stormy market. 

Molly Phelan, Esq., is a partner in the Chicago office of the law firm Siegel Jennings Co., L.P.A., the Ohio, Illinois and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. Contact her at mphelan@siegeltax.com.

• Development/Ownership
• Property Tax