PEPennington & Co Property Tax News

Dear Commissioners:

Please accept this letter as my rebuttal of testimony present by the Louisiana Assessors Association (LAA) on or about February 12, 2009.

I would like to restate that facts noted in my first letter (Exhibit A).  Notably that LIHTC properties lack liquidity, the use is restricted, operating expenses run higher that conventional multi-family expenses and income is regulated.  I suggest that it is undisputed that these factors adversely affect the capitalization rates for these types of properties.

In the conventional multi-family markets Marcus & Millichap recently reported “…During the past 12 months, Class A assets in primary markets have traded with average cap rate increases of 25 basis points to 50 basis points and 75 basis points in secondary markets. Class B/C assets have sold with average cap rate increases of 100 to 150 basis.”  No one disputes that LIHTC properties do not trade.  However, if one was to argue hypothetically that they do trade, then I would argue that trends we are seeing conventional properties would be greater in would be greater in LIHTC properties. 

Finally, if the LAA wishes to propose capitalization rates for LIHTC properties, one would expect to see generally excepted appraisal techniques utilized.  In proposing the use of capitalization rates of conventional properties on LIHTC properties with no adjustments relating to the differences in characteristics, is in my opinion does not comply with Uniform Standards of Professional Appraisal Practice (USPAP).

 Thank you in advance to consideration of my comments.    

Dear Commission Members:

  Re:   Commission Consideration of Adopting Capitization Rate for Affordable Rental Housing

I respectfully request that the following comments be reviewed and considered by The Louisiana Tax Commission.  Based on my experience (see attached), I would like to submit the following four points which in my opinion justify higher capitalization rates for Low Income Housing Tax Credit (LIHTC) properties: 

1. Lack of liquidity:  LIHTC properties were created in 1986 by the Tax Reform Act of 1986, (IRS Code Sec. 42).  The creation of the program was to provide affordable low income housing.   Generally speaking, tax credits are awarded by IRS to state housing authorities as a means of financing LIHTC properties. These tax credits are sold to third party entities.  The buyers of these tax credits would be corporations with large federal income tax liabilities. The revenue raised from the sale of these credits are used by the general partner/developer to buy down the permanent financing for the property, therefore allowing the property to offer reduced rents to low income individuals and/or families.  Additionally, there is a 15 year compliance period for these properties.  During this period the property must adhere to strict state and federal operational guidelines.  If the property fails to meet these guidelines the IRS may recapture the tax credits which had been previously sold.  Additionally, the general partner/developer can not sell the LIHTC property during this period as this would also trigger a recapture of the tax credits. Thus, the lack of liquidity with LIHTC properties is something not seen in conventional multi-family properties.  

2. Use Restrictions:  LIHTC properties are required to have a Land Use Restriction Agreement (LURA), which effectively deed restricts the use of the property for up to 40 years.  Even if the highest and best use of the property changes on a LIHTC property, the LURA stays in place until the end of its term.

3. Expenses:  LIHTC properties must adhere to stringent state and federal rules and regulations as the operating expenses on these properties tend to be significantly higher than conventional multi-family properties.

4. Income:  Governmental regulations control the income on LIHTC properties.  The U.S. Department of Housing and Urban Development calculates the maximum rent that can be charged to the low income tenants. Further, LIHTC properties are generally described as tax driven investments rather than the return on equity properties.

 It has been my experience in representing approximately 100 LIHTC properties, that assessing jurisdictions have generally used 8.5% to 9.0% capitalization rates on Class A & B properties, and 9.5% to 10.0% on Class C properties.  With that said, the above rates represented rates as of 1/1/08.  In today’s economy and with the collapse of credit markets I would argue that the aforementioned rates should be higher in tax year 2009. I would be more than happy to address any questions and/or comments you might have regarding this matter.

 Most economists tell us that the economy will continue to deteriorate in 2009.  Some say that we have a one in five chance of entering a depression.  Warren Buffett tells us the economy has “…fallen off a cliff.”  During these challenging times Texas appraisal districts will be under pressure to hold values to 2008 levels and in some cases raise values.  The taxing entities need and want growing tax rolls to pay for the goods and services provided by municipalities.  On-the-other hand, property owners believe that their assets are not worth what they were in 2008.  Thus, the stage is set for gigantic battles between property owners and appraisal districts.  The scenario described above has occurred before during the S&L Crisis which occurred in the late eighties and early nineties.  During that period appraisal districts experienced shrinking tax rolls and values declined to unprecedented levels.  To make up for budget short falls municipalities raised their tax rates and other service fees.  As the Crisis played out investors purchased foreclosed assets at bargain basement prices and slowly values began to rise again and recovery returned.     Today with the worsening economy property owners need to develop property tax appeal strategies going forward.   Cost analysis models need to be created to determine how far and much should be paid by owners to pursue favorable results of their appeal(s) in tax year 2009.  Does the potential tax saving support the cost and extent of an aggressive appeal?  Further, the owner should assume that appraisal districts, as they did at the beginning of the S&L Crisis, will not be willing to grant significant tax relief.  Their excuse will be that as of the assessment date January 1, 2009, things were not as bad as they are today.  In-other-words, their sales data collected by them between January 1, 2008 and the current assessment date, will not justify whole-sale value reductions.  Counter arguments will be that the number of properties trading during the same period have fallen short of historical norms because of the lack of available credit and new underwriting requirements.  Additionally, the number of foreclosures has increased substantially during the same period.  Property owners understand that their market value(s) have dropped significantly over the past year.  They also understand that property taxes are their second largest expense, only exceeded by debt service.  Property taxes can make the difference between profitability and in extreme cases keeping a property out of foreclosure.    Since the early nineties commercial tax rolls have experienced continuous growth.  With that said, all markets at some point in time need and experience corrections.  We are at that point with property tax valuations.  Entering the 2009 property tax appeal season property owners will demand tax relief during administrative remedy and if denied will seek relief through Judicial Review in record numbers.  Appraisal districts need to come to terms with the realities today’s economic environment and grant significant taxpayer relief to avoid an unprecedented increases in property tax appeals and/ or litigation.

In the event that a valuation settlement cannot be reached during the administrative remedy, the property owner and/or manager often ask for recommendations regarding possible litigation from their property tax consultant.   Since litigation support is a large practice area in the property tax consultant industry, consultants play various roles.  These roles can range from passive to intricate participation during the litigation process.  The absolute least agent participation level should include advising the client that an ARB order has been issued and the deadline for filing appeals. In both scenarios, the consultant handles the property tax appeal through the administrative remedy, which includes protecting the taxpayer’s rights and providing remedies available in the Texas Property Tax Code.  In a passive role, the consultant’s participation typically ends with issuance of the Appraisal Review Board’s (ARB) Notice Of Final Order.  At this point the property owner assumes the responsibility of appealing a protest provided by Subchapter C of Chapter 41, Section 25.25 or Subchapter B, Chapter 24.  The taxpayer will retain legal representation and expert witnesses necessary to proceed with their litigation.   In the latter case the owner will rely on the consultant to become part of the litigation team, typically made up of an expert witness, attorney and the consultant.  Each team member has a fiduciary relationship with the property owner and this must be understood and kept in mind.  The members of the litigation team bring different areas of expertise, which are needed in order to bring a successful conclusion to a property tax lawsuit.  For example, a real estate appraiser might be designated as the expert witness.  In addition to preparing a market value appraisal, fair and equitable study and giving testimony, the appraiser may be asked to provide additional services, including: [1] 1.      Advising an attorney on matters of standards of practice, professional code of ethics, market data sources, and industry trends 2.      Helping frame questions for appraisal experts on either side of the case at depositions and during trial testimony 3.      Case management Additionally, the appraiser can also be utilized to identify incorrect methodology, inaccurate data, and an inaccurate application used by appraisal districts.
The attorney is the captain of the litigation team and his fiduciary relationship with the property owner trumps all other activity involved in the litigation.  The relationship with all other team members is secondary to that of the relationship between the attorney and the property owner.  Further, other team members must be aware not to engage in any activity that constitutes the unauthorized practice of law.  Once litigation has been filed, the property owner will become the Plaintiff and will be the direct client of the attorney.  The agent is not the attorney’s client.  Thus, communications between an attorney and the tax agent may or may not be confidential and may be discoverable.  Privileged communications should most often be directly between the owner and attorney.The attorney’s role includes counseling the property owner on the feasibility of litigation, defining and explaining the taxpayer’s rights, disputed facts, and remedies.   Generally, the litigation process includes the filing of the petition, discovery of the facts (informal and formal interrogatories, requests for production, depositions, disclosure of experts, requests for admissions, etc.), motions to the court, pretrial proceedings such as case management conferences, settlement conferences, referral to mediation or arbitration, preliminary motions to allow or exclude evidence at trial, pretrial briefs, trial preparation, jury selection and instructions, trial by judge or jury, post-trial motions, and appeal of the judgment.

Consultants who participate in litigation support can be divided into two categories; involved and heavily involved.  The consultant that falls in the first category will generally work as a conduit of information between the owner and the attorney.  For example, the consultant would forward the attorney copies of evidence used during the administrative process, Notices of Final Order, and other general information. 

[1] As defined in The Appraisal of Real Estate, Twelfth Edition

2008 Dallas County commercial property sales 

Source: Roddy Information Services     

FORECLOSURE POSTING of COMMERCIAL REAL ESTATEAnnual ComparisonDALLAS/FOR WORTH METROPLEXThe Commercial Real Estate Network

National Real Estate Investor reported “…The faltering economy, credit crunch and the net loss of 1.2 million jobs this year will weigh on consumers to make this holiday shopping season one of the weakest many retailers can remember, Duffy predicts. “Looking ahead to 2009, it’s highly unlikely conditions will stage any type of recovery until the second half of the year at the earliest.” Here in Texas the Dallas Business Journal Recently published an article titled “Overexposed? D-FW banks’ infatuation with commercial real estate loans could lead to problems.”  The article quoted an investor Tom C. Davis, who stated, “If I am right, we’ll have a dismal Christmas retail season, and in the first quarter with retailers under pressure, you’ll see more bankruptcies,” he said. “The credit tenants that used to be in strip centers are no longer to be there.” As noted below we see the national retailers are suffering from the economic storm we find ourselves in:

• Circuit City (filed Chapter 11) 
  Ann Taylor- 117 stores nationwide closing
  Lane Bryant, Fashion Bug ,and Catherine’s to close 150 stores nationwide
  Eddie Bauer to close stores 27 stores and more after January
  Cache will close all stores
  Talbots closing down specialty stores
  J. Jill closing all stores! (owned by Talbots)
  Pacific Sunwear (also owned by Talbots)
  GAP closing 85 stores
  Footlocker closing 140 stores mo re to close after January
  Wickes Furniture closing down
  Levitz closing down remaining stores
  Bombay closing remaining stores
  Zales closing down 82 stores and 105 after January
  Whitehall closing all stores
  Piercing Pagoda closing all stores
  Disney closing 98 stores and will close more after January.
  Home Depot closing 15 stores 1 in NJ ( New Brunswick )
  Macys to close 9 stores after January
  Linens and Things closing all stores 
• Movie Galley Closing all stores
  Pep Boys Closing 33 stores
  Sprint/Nextel closing 133 stores
  JC Penney closing a number of stores after January
  Ethan Allen closing down 12 stores.
  Wilson Leather closing down all stores 
  Sharper Image closing down all stores 
  K B Toys closing 356 stores
  Loews to close down some stores
  Dillard’s to close some stores

How does all this negative retail news effect Texas tax rolls?  It seems to indicate that 2009 commercial real estate apprised values will trend downward, which will intern cause property tax rolls to shrink. When tax roll shrink tax rates go up.  Time will tell. 

 The figures noted above are a good example of the declining values of commercial properties between 2007 and 2008.  Declining values will translate into shrinking property tax rolls.  Shrinking tax rolls will create pressures on local tax collecting jurisdictions to raise tax rates.  People will complain about the increased tax rates however goods and services administered by local political subdivisions require revenues from property taxes. Source: Dallas Business journal and Foreclosure Listing Service Inc.

In an August 17, 2007 Dallas Business Journal article, Dallas developer Craig Hall said, “it’s over,” he said of Dallas-Fort Worth’s recent property boom. “It’s gone. It’s done. “It won’t be a temporary thing,” he continued. “It’s a permanent change in the pricing of real estate. It’s a permanent change in the market.”  Additionally, he said, “Overnight, the whole world changed,” Hall said, “and it’s not going to change back.”  No one else came forward and publicly supported his assessment in  the summer of 2007.  Today, over a year later The Dallas Morning News in a front page article titled “Vultures set to swoop on ailing assets,”  Mr. Hall and others discuss real estate opportunities created by the credit crisis.

This is bad news for for Texas tax rolls.  When residential and commercial real estate loose value, tax rolls shrink.  Pressure increases on political subdivisions to increase  tax rates.  The good news for Texas property taxpayers is that they should see lower property tax valuations.  The problem will be the taxes they pay due to future tax rates.

I have written a lot about the economy and its effect on property taxes.  The actions today by the federal government to bail out financial institutions, I believe is a clear message both nationally and here in Texas.  For example Bloomberg reported, “Lehman Brothers Holdings Inc.’s bankruptcy filing may delay the sale of about $30 billion of commercial real estate assets at a time when property values are eroding, leaving less on the table for creditors.”  Additioanlly, The Wall Street Journal reported that, “retail giant Centro Properties Group, New York developer Macklowe Properties, office-building investor Broadway Real Estate Partners LLC and others are now facing an even rougher ride in the wake of Lehman Brothers Holdings Inc.’s bankruptcy, the collapse of American International Group Inc. and the buyout of Merrill Lynch & Co. by Bank of America Corp.”  Further, “After these and other market crises, cash-flow projections for properties are being scaled back in anticipation of a greater economic slowdown. The sales market — long considered the last hope of many distressed players — has virtually ground to a halt.”

These sort of developments will effect tax rolls nationaly.  In Texas tax rolls which had enjoying double digit growth rates in prior years which dropped to single digit growth this year will see further decline in the future. 

The fundamental of doing business have changed.  The construction, development and buying and selling of real estate will continue to suffer.  The loss of value in real estate will be reflected in future tax rolls.  The Texas Legislature would be well advised to keep the changing business environment when they address changes to the Texas property tax system in the upcoming session.