Reduce Your Property Taxes

By:  John Garippa, as published in Real Estate New Jersey, July/August 2001

Recently, a purchaser paid $18 million for a property with an electrical generating facility on it.  At the time the deed was executed, the purchase price for the real property was designated as $18 million.

The tax assessor for that jurisdiction, acting in a lawful manner, used that purchase price to increase the tax assessment on the property twofold.  The purchaser's property tax lawyers reviewed the details of the deal and advised the client that more than 50% of the purchase price should've been designated for machinery and equipment, which is non-taxable in New Jersey.  The benefit of this allocation is quite apparent: the ongoing real property tax assessments will be at a substantially reduced level.  While this is obvious, there are often more subtle instances where similar allocation issues should be addressed.

As property tax becomes an ever-increasing component of complex real estate portfolios, the issue of separating non-real estate assets from traditional real estate can bring dividends to the bottom line.  Our purpose here is to introduce the concept of business enterprise value as it impacts real property.

In any complex income-producing real property, significant management is required in order to produce the highest income stream possible.  Often, nearly identical pieces of property produce disparate net income because of the quality of management and name brand recognition.  that disparity in the level of management expertise that affects net income is not necessarily attributable to the "sticks and bricks."  Rather, that increase in income above prevailing market rates is an intangible that should not be taxed as real property.

In the current edition of Appraisal of Real Estate, business enterprise value is defined as a value enhancement that results from items of intangible personal property such as marketing and management skill, an assembled workforce, working capital, franchise agreements, trademarks, non-realty related contracts and some operating agreements.  The conglomeration of these items all increase net income for a property but, clearly, that net income is not all real property-related.

And the reporting requirements of the Uniform Standards of Professional Appraisal Practice corroborate that definition.  They state that in preparing appraisals form property involving tax appeals and eminent domain, value should be allocated among its various parts, including real estate, business enterprise and other intangibles.

Business enterprise value affects a wide variety of property, including super-regional shopping centers, hotels, assisted-living facilities and properties that utilize brand names.  The concept can best be described as the premium paid for above-market rentals.  Typically, effective management is able to secure rental sat rates that cannot be received in other similarly situated properties.

This concept is most easily understood in relation to hotels.  When hotel properties are sold, the sales price includes, in addition to the payment for traditional real estate, sums for furniture, fixtures, equipment, value of any franchise agreements, license, permits, value of operating contracts and the value of an established workforce on site.  Hypothetically, with two identical hotels, one with the Marriott name and the other bearing a local developer's name, no one would seriously expect to see the same level of net income.

Likewise, when a large mall is sold, the purchaser acquires land, building, leases, tenants, an established name and reputation, operating agreements and a management staff on-site.  the well known national mall developers use their special management skills to create a tenant mix unavailable to others.

Another example of property where business enterprise issues surface is senior housing.  This property type requires active management.  An insight into the recognition of the interrelationship between business value and management in these facilities can be gleaned by reviewing the U.S. Department of Housing and Urban Development (HUD) notice H-97-01.  this notice relates to mortgage underwriting standards for this property type, stating that the inexperience of the developer is a bug reason for mortgage default.  With the focus on hospitality coupled with healthcare, these units need more intensive management than rental apartments.

Skilled owners of income property should make every effort to allocate from the income stream, elements that relate to business enterprise.  With tax burdens increasing, good management should seek every advantatge.

John Garippa is the senior partner of the law firm of Garippa, Lotz & Giannuario, with offices in Montclair, NJ and Philadelphia.  He is also president of the American Property Tax Counsel, the national affiliation of property tax attorneys.