Benjamin Blair: Add Value Through Correct Valuation

by Katie Sloan

Even in a booming market, managing expenses is the best way to ensure the long-term profitability of investment properties. For most student housing, the largest expense after debt service is property tax.

Assessors in college towns are happy to shift the tax burden onto out-of-town students and investors in student housing communities. And due to the perplexing assessment systems in most jurisdictions, owners and developers of student housing communities often treat tax assessments as a given, making appeals the exception rather than the rule. Yet any reduction in the tax burden can substantially increase profitability, so prudent owners monitor tax assessments closely.

Most ad valorem tax disputes hinge on property value. Developers are adept at valuing assets for investment, but there are substantial differences between taxable value and how much a property is worth as an investment. Knowing these differences can protect owners from overzealous assessors.

Identify the right income

Because student housing communities are income-producing properties, developed and purchased for the high-quality income streams they generate, most assessors argue that capitalized income is the best indication of their real estate value. Accordingly, assessors often ask for the property’s historic income and expense information. Taxpayers should be hesitant to provide the property’s operating statements without considering appropriate caveats, however.

In most states, property tax assessments reflect the property’s market value. Consequently, the assessor should value the asset using market levels of rent, vacancy, and expenses – not the property’s actual financial results. Just because the subject student housing operator maximizes revenues, for example, doesn’t mean that all of its competitors do.

Consider vacancy: Because of the school calendar, many student housing communities generate the majority of their annual income in a nine-month window and sit nearly vacant over the summer months. That equates to a market-wide effective vacancy of 25 percent. The fact that one complex appeals to summer students does not mean that competing properties should be valued as fully occupied year-round.

Further, unlike most standard apartments, the rent a student housing community can generate is attributable to substantial non-realty components. Most units are furnished, and rent often includes utilities, premium cable television, high-speed internet and other amenities. As a result, the income stream is not exclusively attributable to the real estate, but to personal property, intangibles, and business value as well. Likewise, some developments have favorable contracts with the university whose students will be housed by the community. Such non-realty components are not taxable, and must be removed. Failing to cleanse the income stream solely to its realty component can result in an overstated, overtaxed property value.

Scrutinize comparable sales

In certain markets, evaluating the selling prices for other student housing communities may be a valid method of determining a property’s taxable market value, but assessors often misinterpret that sales data. Just as a property’s income stream reflects more than the value of the real estate, a sales price – usually based on the same income stream – may reflect more than the value of the realty alone.

The most relevant sales for comparison are those where the real estate transacts without any personal property, intangibles, or business value. Since such sales are rare, an assessor using the sales of nearby student housing communities must take care to remove the value of everything but the realty. This task, often overlooked by assessors, requires identifying and measuring hard-to-value assets with certainty.

Moreover, comparable sales have to be adjusted to account for differences between the sold property and the property being assessed. Three communities might all have the same number of beds, but one might have mostly one- and two-bedroom layouts, while another has more community amenities that appeal to a different mix of students. They may serve different schools with different demographics. If the differences between the properties affect their respective rents, then the sales prices should be adjusted accordingly so they best match the configuration of the subject property.

In the absence of sales of purpose-built student housing, some assessors might be tempted to use sales of other types of multifamily housing. Despite superficial similarities, the properties compete in different markets, which appear as structural differences between the properties. An assessor failing to account for such differences may be making a fundamental error.

Cashing in on unusual cases

As the student housing market grows and matures, a particular community may face other circumstances that require a closer look during tax season. For example, public-private partnerships (P3s) are becoming more common in the student housing marketplace. Whether a taxpayer enters a P3 for monetization, development, or operational purposes, the agreement’s characterization can have substantial property tax consequences. Parties to P3s should keep taxability in mind as they draft contracts.

Similarly, in some states dormitories are exempt from property tax because they are deemed educational property. This exemption has historically extended to dormitories owned and operated by colleges and universities. But some properties owned or managed by third parties may still qualify for exemptions because, for example, the school can be deemed the beneficial owner of the property. Of course, the inverse can also be true, so operators should be cautious when drafting contracts so as not to convert an exempt property into a taxable one.

As the student housing market continues to surge, assessors are eager to expand the local tax base by capturing a piece of that growth. But by focusing on the key distinctions of the student housing market, diligent owners can improve the profitability of existing properties and free capital for new investment.

— Benjamin Blair is an attorney in the Indianapolis office of the international law firm of Faegre Baker Daniels LLP, the Indiana and Iowa member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at [email protected].

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