How Commercial Real Estate Gets Hammered by 3% Property Tax Caps

Below is an excellent guest post from Jim Baker at Baker Commercial Real Estate in Jeffersonville Indiana.  Jim is a major commercial real estate hitter with more than 30 years in the commercial real estate business.

Why the 3% Property Tax Caps are creating problems for many Indiana Businesses and Investment Property Owners.

In the recent November, 2010 election, the public referendum to amend Indiana’s Constitution regarding property tax caps was passed overwhelmingly.  Homeowners will now have a 1% cap each year for the amount of property tax that they pay on their home’s assessed value. Apartments, rental homes and farms will have a 2% cap and commercial properties will have a 3% cap on the property taxes that can be charged on the amount of the assessed value.

While few objected to the idea of having caps placed on the amount of their assessed values, businesses and investment property owners objected to the distribution of the caps which put the heaviest cap and burden on commercial and investment properties.

The following are 3 reasons why the 3% property tax caps are creating problems for many Indiana businesses and investment property owners:

1.  3% can represent as much as 30% to 50% of the property’s gross income and therefore decreases the total value of the property by 20% to 30%. This can easily be proven by the following formula: the additional 2% (as compared with properties in neighboring states such as Kentucky that pay about 1%) when divided by a capitalization rate of 10% = 20% of the property’s  value. When a lesser capitalization rate is used, say 9%, the loss in value jumps to 22.22%. At a capitalization rate of 8% the loss in value is 25%. This represents hundreds of millions of dollars in lost property values when applied across the entire State of Indiana.

2. The 3% for most income properties represents 30% or more of the property’s annual income and makes these properties difficult to cash flow and maintain (not to mention difficult to pay the existing mortgage payments and debt service). For example, a $1,000,000 property that has a 10% annual net lease rate based on its market value would produce $100,000 in annual income. If the property taxes are 3% of the property’s value/assessment, the property taxes would be $30,000 per year and therefore 30% of the gross income. This high of a percentage of gross income for property taxes makes no sense from a business owner’s  or investor’s perspective. There are no examples that I am aware of where a business in any industry is able to pay 30% or more of GROSS REVENUES (not net revenues) in taxes and thrive, or possibly survive, in today’s economy.

3. The 3% cap on property taxes creates losses of jobs. Those who pay these additional property taxes are not just the commercial property owners, but are also many times the tenants who have NNN (net, net, net) leases. Most small business tenants are finding it difficult to stay in business and some have gone out of business due to the added pressure that the additional property taxes have created for them. A tenant or owner who is paying $30,000 per year in taxes on a $1,000,000 commercial property (as in the above example), is paying an additional $20,000 per year in taxes versus a business in a state that is only paying 1%. This additional $20,000 per year could easily represent another job that now can’t be added or that needs to be eliminated from the business due to the higher property taxes.

In addition to the issues that are created by the 3% property tax caps on commercial real estate, there are two other major issues which I feel  will continually need to be addressed concerning all property taxes and property tax caps:

1. Property tax assessments will always have inaccuracies due to a subjective system that determines the amount of the assessed values. There is no method or system to accurately assess every property for the correct current market value. Appraisals/assessments always: a) vary from one appraiser/assessor to another,  b) are the result of a non-scientific process and c) are the opinion of the appraiser/assessor (even when the very best sale/lease comparables and methods of valuation are employed).

2. Many municipalities have been unwilling to create spending caps or decrease the growth of their operations which has created an ever increasing demand on tax payers to fund government. Although many property tax rates throughout Indiana are not currently at the maximum cap rates allowable, without a cap on spending, municipalities will be forced to increase their property tax rates to maximum 1%, 2% or 3% rates allowed under the new property tax cap amendment.

In summary, the property tax caps that have been approved by the voting public will create some unwanted burdens for Indiana businesses and investment property owners, as well as be part of a system of taxation that will continue to struggle to be fair to all .[END]

Real Tax Caps: Duke’s Take

The real property tax combines two taxes, one on buildings and one on land. The tax on buildings is bad because it makes owning buildings more expensive, reduces production, and creates a drag on growth. The buildings tax should be capped at zero. The tax on land value is better than neutral, because it puts land to its most productive use, lowers the price of land, is not shifted to tenants, eliminates real estate bubbles and crashes, and promotes decentralized local governance. The land value tax should be capped and bottomed at market value. What is your take on property tax caps?  Good, Bad, Helpful,or Harmful?

Duke Long

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