How to Appeal Your Property Tax Part 2: The Three Approaches
In the first article we went over the concept of fair market value and introduced the three widely accepted methods for estimating fair market value. In this article I will go over the three approaches and what you should look for to help with your appeal.
The cost approach to value is used by most, if not all, taxing jurisdictions to value both residential and commercial properties. The cost approach estimates the replacement cost new of the property, or the cost to build a structure of equivalent utility (functionality) using today’s construction standards. From that an estimate of total accrued depreciation (physical, functional, external) is deducted from the cost estimate to get a depreciated replacement cost new. To that an estimate of the site (land) value is added to get an estimate of the fair market value of the property.
There are, however, some subjective elements that county appraisers frequently insert into cost approach. For example, most properties are assigned to a quality or construction class which tells the computer assisted mass appraisal system (CAMA) what level of replacement costs to use. When neighborhoods are new, typically the properties in them are put in the system with the same quality codes. Over time however, due to appeals or description updates, these quality ratings begin to change per property. Thus, you may find that your neighbor, who appealed his value last year, has a quality code of “B” and your house, built by the same builder in the same year, has a quality code of “A”.
Depreciation is another important aspect of the cost approach. Usually all properties within a neighborhood are assigned to the same depreciation schedule resulting in building values depreciating at the same rate. However, the county will usually assign a condition code to each property which will alter this depreciation schedule. If you think that your property is in inferior condition compared with your neighbor’s property with the same condition rating, this may be a good point to argue when appealing your tax assessment.
When the sales comparison approach is used to generate market values it is typically used to adjust the cost approach values. For example, if all properties are valued using the cost approach, and on average the county’s sold properties have assessments that are eighty percent of sale prices, they may raise their cost tables inside the CAMA system by ten percent. The resulting sale ratios would then be approximately ninety percent of sale prices.
The other time you may encounter sales data is when you appeal your value. The county appraiser may bring property sales to an appeal hearing in support of their CAMA generated cost approach value. They will typically bring the most similar properties with the highest sale prices they can find.
As a result you need to know the value of your property based on the sale comparison approach. Unfortunately, unless you are a real estate professional with access to real estate data services you will have to do some digging to get the required data. Luckily, free websites such as trulia.com and realtor.com can help you find a list of sold properties in your market area. You can also go to the assessor’s website and look for sales street by street in your neighborhood. It’s here you want to make sure you look for low priced sales that may not appear on the free websites.
Identifying the lowest sales in your neighborhood is extremely important because the county will be using the highest sales they can find to support their values. In contrast, your research into the lowest sales will help you argue a lower value. If there are several foreclosure sales in your market area, you may be able to use them to your advantage. The county may say that those aren’t valid fair market sale prices. However, you may be able to justify using them if the foreclosure market is the only market in your neighborhood.
The income approach to value can be, but rarely is, applied to single family properties. Most CAMA systems have an income approach built in for the valuation of commercial properties. The three arguable variables in the income approach are income, expenses, and capitalization rate.
In order to estimate fair market value the assessor should use fair market rents. Today asking and recently contracted rents are lower than they were several years ago. The county is going to want to see your profit and loss information and if your rents are high they may balk at your assessment reduction request. If you have long term tenants, whose rents were established near the top of the market you need to make a case that you aren’t getting market rents. You need to prove that market rents are lower than what you are currently getting. Again, if you aren’t a real estate professional, you will have to do some digging. You can find rent listings online at sites like loopnet.com and cbre.com.
Operating expenses may be tougher to argue. The county may have, for example, all warehouse properties appraised with a fifteen percent operating expense ratio (fifteen percent of effective gross income). They may be unwilling to change this ratio for individual properties. But if you have a property with a special situation that results in consistently higher than typical operating expenses then by all means bring it to their attention.
Unless you are willing to spend some money capitalization rate information will not be easy to acquire. Ideally, these rates are derived from sold properties, where the net operating income and sale price are known. Appraisers and research firms spend a lot of time verifying the information on commercial sales and trying to ascertain the capitalization rate. One thing to keep in mind is the higher the “cap rate” the lower the property value. The lower the cap rate, the higher the property value. So, if you can get the assessors property record cards (CAMA generated property information) for your property and your competition, you can find out whether they are using different cap rates on your property and your competitors.
In the next article I’m going to discuss the other approach to value – equity. Let’s keep saving money!
