CREJ - Retail Properties Quarterly - February 2015

Revaluation of taxes in a strengthening economy

Nicholas J. McGrath, Associate/Neil B Oberfeld, Shareholder, Greenberg Truarig Denver

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2015 could shape up to be an especially important year for property tax purposes for retail and commercial property owners. There is a strong likelihood that retail and commercial property owners could see significant increases in property tax valuations given the improving real estate values and general economic conditions in Colorado over the last three years.

We have seen several indicators of an improving real estate market and strengthening economy. For example, according to the Colorado Secretary of State’s Quarterly Business and Economic Indicators, state employment, wealth and building activity signal sustained economic growth; employment increased 2.8 percent year over year in second-quarter 2014 (reaching a new high of 2.4 million in June 2014); and annual foreclosure filings and sales decreased significantly in second-quarter 2014 (24.7 percent and 41.5 percent, respectively).

County assessors re-determine property values every two years. This two-year period is referred to as a reassessment cycle. Under Colorado law, county assessors are required to value properties based on data from an 18-month data collection period.

County assessors will revalue properties this year using a data collection period of Jan. 1, 2013, to July 1, 2014.

The valuations for both years of the reassessment cycle (2015 and 2016) will rely on the same data collection period. As such, property owners should pay particular attention to their 2015 property tax valuations when notices of valuation are issued in May because absent unusual circumstances, such as new construction, the valuations property owners receive in May will be used to determine their property taxes for the 2015 tax year and for 2016 as well.

County assessors may consider the income approach, the market approach or the cost approach to valuation for retail and commercial properties. The following is a brief explanation of these three approaches to valuation, and the impact of the data collected for each approach on 2015 revaluations.

The Income Approach

Using the income approach, the assessor calculates an operating income, expenses and vacancy; selects a capitalization rate; and divides the net operating income by the capitalization rate to determine the value of a property. Market rents increased while vacancy rates remained relatively low during the data collection period. According to the CoStar Group, the average rental rate across retail property types in Denver increased from $13.30 per square foot mid-year 2012 to $15.07 per sf as of first-quarter 2014, and the average vacancy rate across retail property types in Denver was 5.9 percent as of first-quarter 2014 (up slightly from an average vacancy rate of 4.9 percent mid-year 2012). In addition, cap rates continued to trend lower during the data collection period.

According to CoStar, capitalization rates ranged from 6.96 to 7.86 percent based on approximately 14,500 retail sales nationwide between October 2013 and September 2014.

Property owners should expect that higher net operating incomes and lower capitalization rates could result in higher 2015 valuations.

The Market Approach

Using the market approach, the assessor determines the value of a property by analyzing the sales prices of comparable properties sold during the data collection period. Generally, the market approach is the only approach to valuation permitted for vacant land and residential property.

For 2015 revaluations, the assessor will be using purchase and sale transactions from Jan. 1, 2013, through June 30, 2014. There was a considerable uptrend in retail and commercial values through 2013 and moving into 2014.

According to CoStar, the average sales price of office buildings 15,000 sf and larger increased from approximately $135 per sf at the beginning of 2013, to a high of approximately $235 per sf in third-quarter 2013, before declining and leveling off at prices of approximately $160 per sf, which is still higher than prices seen during much of the previous data collection period.

As a result of the up-trend in real property values, the application of the market approach may result in higher 2015 property valuations.

The Cost Approach

Using the cost approach, the assessor determines the value of a property based on the anticipated development and construction costs of the property.

Retail deliveries, construction and inventory grew during data collection.

According to CoStar, a total of 772,057 sf of retail space was built in Denver between third-quarter 2013 and thirdquarter 2014. There was an additional 379,028 sf of retail space under construction at the end of third-quarter 2014, and total retail inventory in the Denver market was 190.37 million sf in 14,065 buildings and 1,507 centers as of the end of third-quarter 2014. When the cost approach is applied, increased construction activity and construction costs during the data collection period may result in high 2015 revaluations.

Look Carefully at Your 2015 Valuation

So, what should you expect in the year to come? By May 1, 2015, county assessors will mail a notice of valuation indicating the valuation of your property for the 2015 tax year. Based on the discussion above, there are good reasons to expect that your valuation will increase this year, resulting in higher property taxes. Given the likelihood of increases, it will be particularly important to carefully consider the accuracy of your 2015 valuation and whether a tax protest is appropriate. For the 2015 tax year, the deadline to file a property tax protest is June 1.