Changing Industrial Areas
How to Fight to Reduce Your Taxes
By: Philip J. Giannuario, Esq, as published in Office & Industrial Properties, April 2001
In good times and bad, the assessing community endeavors to find a silver lining (i.e., increased tax revenues). They rely on one truism - every sale that will help defend an assessment is a market transaction and every sale that will allow a taxpayer to argue for a reduction is distressed. We are seeing this phenomenon in action today as industrial neighborhoods begin to change.
Residential or commercial development is encroaching on what were once industrial bastions. Taxing jurisdictions, hungry for more revenue, see their silver lining in the higher prices these residential and commercial entities are willing to pay for industrial property. In essence, the assessment community is using these higher prices to defend its hypothesis of the optimum use for the industrial property that remains in a neighborhood changing toward residential or commercial.
Highest and Best Use
Generally, the market value of industrial property is based on a very clear concept: What would a property sell for in an arms-length transaction? This is termed "value in exchange."
Buyers and sellers act knowledgeably in an open market to arrive at a price both can agree on. The assessing community understands the market and how it works. They understand the concepts and principles that guide appraisal theory to be implemented for assessment purposes. The reason there is continued argument about the use of these market value concepts is that taxing jurisdictions understand that if they are applied unbiasedly they will result in lower values.
Further challenging the taxpayer's cause is their acceptance of any number of distortions of market concepts put forth by the taxing authorities. One fundamental that is often distorted today is the concept of highest and best use.
In its simplest terms, this begins with an industrial area that starts to change. A purchaser, such as a big box retailer, buys an old industrial site for the land. Often, these purchasers will pay a hefty sum for the land. The per-acre price normally exceeds other commercial land purchases in that area and regularly far surpasses industrial land values.
The intent of the big box store buyer is to demolish any existing buildings which signals a change in the highest and best use of the property. The old industrial plant will become a new popular retail location. As more commercial purchasers come into the neighborhood, the industrial manufacturer who stays will find it difficult to be taxed fairly.
The Cost Approach
Of the three approaches to value, only the cost approach values the land and building separately. This allows the taxing authorities to pervert highest and best use theories. First, they will value the land using the excessive purchase price paid by a big box store. Then, they will add, at inflated cost numbers, the current buildings on the property. Taxing authorities do this in the name of finding the highest value for the property's current use. It is a subtle, but major distortion. When added together, the resultant value is inflated.
The genesis of highest and best use distortions was highlighted in a New Jersey case involving Brockway Glass. The tax court handed down a decision holding that the highest and best use of the property was limited to its current use as a glass manufacturing plant. In so doing, the court ascribed a value to the property "in use," or as that lower court put it, "continuing use," which contemplated a very limited and specific use.
The New Jersey Supreme Court, on review, re-established the cardinal valuation principle. The market value can be determined only by an examination of the reality of the marketplace and of the actions of the buyers and sellers within that market. Thus, the court concluded that if one narrows the prospective demand for a property solely to its present occupancy, one has eliminated the use of any inflated sales data (such as a big box store purchase) in seeking to value real estate from a market reality perspective.
Highest and best use may be defined simply as the best and most economical use of the property that is legally permissible. One key to countering assessors' bastardization of the highest and best use concept is to make a detailed study of the use history of the subject property and show proper market comparables.
Defend Yourself
Once the highest and best use of a property is established, it's critical to be consistent in your valuation method. More importantly, it's crucial that you expose the taxing authority that is not being consistent. You can't allow the use of increased land values for alternate highest and best use, nor fail to recognize that the existing buildings are not functional for the proposed use - a big box store. For example, if you are committed to valuing the property as industrial, then your land and building values must reflect that fact.
Taxpayers must counter the argument that sales for alternative uses are not comparable. They cannot be used to value a current industrial property simply because they are proximate in location. While they may be close in location, these transactions are for totally non-comparable highest and best uses. If you agree to the assessor's use of comparables sales for alternative uses, it will cost you money.
Your own analysis of the property not only needs to include the proper use of comparable land sales, but an extensive analysis of the general economy, the economy of your industry and the functional problems at your site. The changing nature of the neighborhood itself often provides facts for a meaningful economic and functional argument. The alternative use sales will help highlight your argument regarding the economic and functional deficiencies in the industrial site as it currently exists.
Further, a detailed analysis of the extra cost to run your business because of the outdated nature of your property needs to be performed. Much of the changing neighborhood dynamic will work in your favor when analyzed thoroughly.
Just because your neighborhood is changing, you still should be taxed fairly. When the taxing authorities present their distorted arguments, they are not easy to counter. It takes detailed analysis and proper preparation to demonstrate the fallacy of their approach to the highest and best use of your property. Otherwise, local decision makers find it very easy to accept the taxing districts' arguments and that allows them to find their silver lining at your expense.
Philip J. Giannuario, Esq., is a partner in the Montclair, N.J., law firm of Garippa, Lotz & Giannuario. He can be reached at phil@taxappeal.com.