Valuation methodologies place the greatest emphasis on the income capitalization approach, which estimates a property’s value in terms of its ability to generate financial returns as an investment. The income capitalization approach takes into consideration the cyclical nature of the industry, hence, in theory, property assessment values should vary according to the cycle’s ups and downs. The problem is that many municipalities do not reassess real properties every year, and even if they do, most tax assessors are not versed in the intricacies and fluctuations of the market. This can result in a property tax assessment that doesn’t necessarily reflect the true market value of the tangible real estate.


The key factor is stabilization, that is, whether or not a property’s revenue was stabilized when it was reassessed. The stabilized year is intended to reflect the anticipated operating results of the property over its remaining economic life, given any or all applicable stages of build-up, plateau, and decline in the life cycle of the property. Thus, income and expense estimates from the stabilized year forward exclude from consideration any abnormal relationship between supply and demand, as well as any nonrecurring conditions that may result in unusual revenues or expenses.


Assessors often assume that values consistently increase, but the financial meltdown that began in the summer of 2007 has in fact contributed to the downturn of the industry-and market values-in 2008. This decline is expected to continue into 2009 due to increasing cap rates and other less forgiving investment parameters.


In the current economic environment, controlling expenses becomes an integral part of a property’s profitability. Most often overlooked are so-called fixed expenses, which typically consist of property taxes (real and personal property), insurance, and rent/leases. The perception that these expenses are actually fixed is somewhat misleading.


Real property taxes, which are calculated by multiplying the tax rate by the real property assessment, can in fact be controlled through the revaluation of a property’s real estate assessment. The assessment is simply the real property market value multiplied by an equalization ratio, which is often 100 percent, but can also be lower or higher. Contrary to the ten-year discounted cash flow method utilized by many real estate appraisers to determine a property’s value for financing, warehouse and flex property’s value for assessment purposes is typically calculated through a direct capitalization method, whereby the appraiser capitalizes a one-year stabilized level of income and expense.


The Industry Downturn’s Effect on Assessments

What property owner’s need to understand is that many assets may currently be over-assessed if the municipality based its stabilized level of income and expense or cap rates on data from 2004 through mid-year 2007, when values began to reach their peak in many markets. By the end of 2007, supply had outpaced demand for the first time in five years, and in many cities and towns across the U.S. began to experience lower occupancy as a result. Average rental rate growth helped funds from operations (FFO) remain healthy in 2007, however, the downward trend has continued into 2008, which has resulted in revenue growth lower than inflation. Higher expenses have only worsened this situation.


More conservative valuation parameters have brought about increasing cap rates, which have in turn produced the greatest impact on value over the last two years. Mortgage interest rates have increased, amortizations have shortened, and loan-to-value ratios are lower. The lack of transactions in 2008 demonstrates a gap between what buyers are willing to pay and the asking price. While some transactions may occur in 2009, they are expected to be at prices discounted from 2006 and 2007.