Property Tax Underwriting and Due Diligence

Property Tax Underwriting and Due Diligence for Real Estate Investments

Property taxes can be one of the largest expenses, and one of the most difficult variables to predict, when acquiring, developing, financing, or investing in commercial real estate. An inaccurate assumption about future property taxes can materially affect a property’s net operating income, valuation, investment returns, and overall investment thesis.

Skoloff & Wolfe, P.C. provides property tax underwriting and due diligence services to help investors, developers, financial institutions, and investment committees make informed real estate decisions. Rather than relying on market assumptions or generalized rules of thumb, the firm uses property-specific data and analysis to evaluate potential property tax exposure from acquisition through stabilization and disposition.

With a focus on the capital markets, the firm has completed property tax due diligence and underwriting involving billions of dollars in real estate transactions.

Why Property Tax Underwriting Matters

Property tax assumptions can have a significant impact on the financial performance of a real estate investment. A property may appear financially attractive based on current taxes, only to face a substantial increase following an acquisition, development project, reassessment, or change in ownership.

Property tax underwriting can help investors evaluate:

• Current and projected property tax expenses
• Potential reassessment following an acquisition
• Property tax exposure associated with new construction
• Tax implications of renovations and improvements
• Potential assessment reductions
• The effect of property taxes on net operating income
• Property tax assumptions used in financial models
• Potential risks to an investment thesis
• Property tax considerations through stabilization and disposition

A property-specific analysis can provide investors with a clearer understanding of potential tax exposure before a transaction closes.

Property Tax Due Diligence for Acquisitions

Property tax due diligence is an important component of commercial real estate acquisition analysis. Reviewing only the property’s current assessment or relying on historical tax expenses may not adequately capture potential future liability.

A comprehensive review can examine the property’s current assessment, applicable valuation practices, local assessment procedures, comparable properties, and potential changes resulting from the proposed transaction.

This analysis can be particularly important when acquiring properties in jurisdictions where an ownership transfer, physical improvements, or other circumstances may affect future assessments.

Property Tax Underwriting for Developers

Developers face additional property tax considerations because a completed project may have a substantially different taxable value than the underlying land or existing property.

Before construction begins, investors and developers may need to estimate the potential assessment and resulting property tax burden after completion. These assumptions can affect development budgets, financing, projected operating expenses, returns, and the overall feasibility of a project.

Property tax due diligence can help identify potential tax exposure associated with:

• New construction
• Major renovations
• Redevelopment projects
• Added assessments
• Changes in property use
• Stabilization following completion
• Future disposition

Property Tax Due Diligence for Financial Institutions and Investment Committees

Financial institutions, investment committees, and institutional investors often need to evaluate property tax assumptions as part of their underwriting process.

A material increase in property taxes can affect debt-service coverage, projected cash flow, capitalization rates, asset values, and investment returns. For this reason, property tax analysis may be an important component of a broader commercial real estate underwriting review.

Data-driven property tax analysis can be incorporated into investment memoranda, financial models, underwriting packages, and investment committee materials.

Property Tax Analysis From Acquisition Through Disposition

Property tax exposure can change throughout the lifecycle of a real estate investment. An analysis performed at acquisition may need to account for potential changes during ownership, including reassessment, construction, improvements, changes in income, and market conditions.

Property tax underwriting can therefore be used at multiple stages:

Acquisition

Evaluate the existing assessment, current tax expense, potential reassessment exposure, and opportunities for future tax savings.

Development and Construction

Estimate potential post-construction assessments and incorporate projected property taxes into development and investment models.

Stabilization

Review actual property performance and assessment information as the property reaches stabilized operations.

Hold Period

Monitor changes in assessments, local tax practices, and other factors that may affect projected property tax expenses.

Disposition

Evaluate the property’s tax profile and potential assessment issues when preparing for a sale or other disposition.

Data-Driven Property Tax Opinion Letters

Property tax assumptions are sometimes based on broad market averages, historical tax bills, or informal expectations about how an assessment may change. These approaches may not adequately account for the specific characteristics of an individual property or transaction.

Formal or informal property tax opinion letters can provide investors and investment committees with a documented analysis of potential property tax exposure. The analysis can be incorporated into acquisition underwriting and used to evaluate how property taxes may affect the value and economics of a transaction.

Examples of Property Tax Due Diligence Matters

Skoloff & Wolfe, P.C. has counseled clients on the following matters:

• Hotel Portfolio: counseled client on property tax risk and opportunities related to acquisition of national hotel portfolio.
• Value Add Multifamily: counseled client on $85M acquisition of asset assessed for $45M. Client executed investment thesis and exited without receiving a material reassessment.
• Provided property tax due diligence on $1B+ multifamily portfolio.
• Corporate Headquarters: counseled client on potential property tax reduction associated with acquisition of $1.1 billion square-foot corporate headquarters.
• Super Regional Mall: counseled client on potential property tax reduction associated with acquisition of super regional mall.

All assessments are rounded to the nearest million. Results may vary depending on the particular facts and legal circumstances.

Property Tax Risks Should Not Be Based on Generalities

Property tax rules and assessment practices can differ significantly between jurisdictions and property types. Market assumptions that may be appropriate for one property may not accurately predict the tax consequences of another acquisition or development project.

A property-specific review can help investors identify potential risks and opportunities before committing capital. It can also provide a more informed basis for underwriting projected operating expenses and evaluating the potential impact of property taxes on investment returns.

Experienced Property Tax Underwriting and Due Diligence Counsel

Property taxes can materially affect the economics of a commercial real estate investment. Understanding potential tax exposure before an acquisition, development, or investment decision can help investors, lenders, and developers account for a significant operating expense and evaluate the potential impact on property value.

Skoloff & Wolfe, P.C. provides property tax underwriting, due diligence, and opinion letter services for commercial real estate transactions nationwide. To learn more about property tax due diligence services or discuss a prospective acquisition or development project, call 973.992.0900.