Understanding Real Estate Taxes During Construction

We’re obsessed with accurately forecasting real estate taxes. It’s a service we offer our clients at Cavalry and the focus of our new Due Diligence product line at Taxonics. However, its value has been historically overlooked in our industry – particularly during the construction phase.

It’s a known fact that the traditional real estate tax consulting industry focuses primarily on reactive services via tax assessment appeals. Keeping taxes in check through appeals is always smart, but doing the legwork up front during underwriting before you buy or build is where the value of a good real estate tax forecast pays huge dividends.

That importance is most notable during development. In our experience, we’ve found that less attention is given to the interim real estate taxes paid during the development of a new property. New construction is often assessed only once during construction. However, that tax bill is not only significant, it’s also a baseline for future assessments once the building is complete, in lease-up, and eventually stabilized.

And here’s where the wheels fall off.

In most jurisdictions, a supplemental (i.e., new construction or interim) real estate tax assessment is issued once a development project is “substantially complete.” The definition of substantially complete varies. In many jurisdictions, the triggering event is when the first certificate of occupancy is issued. In others, it is a discretionary decision based on the assessor’s subjective interpretation of when the property looks to be substantially complete. Many assessing offices will follow the permitting process to determine the progress, while others may simply make a judgement call during a property drive by.

In all cases, regardless of the timing, there is still a methodology that dictates the value issued. In most cases, assessors typically estimate cost based on three sources, or a combination of sources.

Method 1
In jurisdictions like Washington, D.C., a cost schedule form is sent to the property owner to self-report total construction costs for a project. In D.C., failure to supply that information can result in a financial penalty. This construction cost information is used as the basis for a supplemental assessment.

Method 2
In many jurisdictions where actual costs related to the specific project are unknown, an assessor or appraiser will use surveyed cost data to reproduce an estimate of project costs. Data services like Marshall and Swift sell subscriptions to cost data accumulated from market surveys. Utilizing this data, an assessor will estimate the development costs of a project.

Method 3
A select few jurisdictions will develop a stabilized value of the project under development using an income valuation and then discount that value based on the percent complete. For example, if the assessor estimates that the project will be valued in the market at $100M upon completion, but the project is only 70% complete at the time the supplemental assessment is issued, that supplemental assessment will be issued at a taxable value of $70M.

Each one of these methods can be dissected and evaluated for fairness and correctness. But the most important component in determining both equity and correctness is to pay attention to the date of valuation. Every supplemental real estate tax assessments issued should have an assigned date of valuation. This is the same requirement that drives the valuation of a standard real estate assessment for stabilized properties that are issued each year. The importance is that for a supplemental assessment during new construction, it isn’t always necessarily about how much you are spending overall for the entire construction project, it’s how much you’ve spent as of the date of valuation.

For example, assume you are building an apartment building and your total hard and soft costs are estimated at $50M. Let’s also assume that once your project is 80% complete and you receive your first certificate of occupancy on April 1, you receive a supplemental assessment for $40M. On the surface, a total project cost of $50M that is 80% complete with a supplemental assessment of $40M might seem okay. However, if that supplemental assessment arrives with a valuation date of April 1, and you have only expended $35M as of that date, regardless of the total cost of the project upon completion, you may be over-assessed.

What’s the punchline? When it comes to interim assessments during construction it’s important to properly forecast an accurate estimate and timing of the assessment, so the deal continues to pencil out. It’s equally important to understand the nuances of the assessment methodology so an appeal can be filed to reduce the assessment if needed. Of course, we can help you on both counts! Don’t wait until it’s too late – let’s chat about your development now and map out a tax strategy that helps maximize your investment.