Key Takeaways

• Property taxes demand special attention from underwriters, as they make up a large portion of total expenses and are subject to a variety of factors that can change from year to year
• Modeling property taxes requires that an underwriter bridge the gap between knowns and unknowns by using historical trends and applying assumptions when projecting out tax information

How Property Taxes Affect Multifamily Underwriting

Property tax is one of the most significant expense items involved in multifamily commercial real estate. Unlike many other multifamily expenses, projecting out property taxes is much more complicated than just setting up a straight-line rate of growth. As such, its incorporation into the underwriting process often requires a separate and thorough analysis.

There are several factors that an underwriter needs to consider when developing a property tax model. These include:

• Millage Rates
  • The rate used to calculate property taxes based on the property’s assessed value set by each jurisdiction which are added together to find the total rate for an applicable region. Often represented as a tax rate percentage in a model for the sake of simplicity, this rate is usually updated annually and may change year over year.
• Assessment Rate
  • The percentage of the property’s fair market value used to determine the assessed value, which is the value actually applied towards the Millage Rate (in some states it's 100% while in others it may be as low as 10%).
• Additional Taxes
  • Does the property have any additional taxes not included in the Millage Rate? These can occur in some jurisdictions and might be set at a fixed-rate.
• Reassessment on Sale
  • Will the sale of a property cause its value to be reassessed, and if so, how soon after the sale? If the sale is closed at a price higher than the fair market value, will the assessed value then increase? This could impact both your initial purchase and the exit purchase.
• Frequency of Reassessments
  • Will there be a reassessment during the projected length of ownership, and if so, in what year? Would a large capital expenditure such as a renovation plan trigger a reassessment?
• Tax Abatements
  • Although they may last several years, because abatements are temporary, their expiration is important to keep track of as they could impact the resale value, exit cap rate, or future total expenses.

"Unlike many other multifamily expenses, projecting out property taxes is much more complicated than just setting up a straight-line rate of growt"

Modeling Multifamily Property Taxes

The modeling process for multifamily property taxes often requires breaking up the relevant factors listed into two groups: knowns and unknowns. Because Millage Rates and other tax policies often change over time, the further out you are in a model, the greater the proportion of unknowns.

To bridge the gap between knowns and unknowns, an underwriter needs to analyze historical information, look at past trends, and determine what assumptions are most appropriate to use in their model. To better explain this process, we will be using an example property located in Davidson County, TN which we will be acquiring at the start of 2022.

Entering Historical Information: As an underwriter, you should begin by compiling and organizing the historical information available to you. This could include tax bills and other relevant financials provided by the current owner of the property, as well as historical property tax rates posted online by the county or city where the property is located.

For our example, I was able to find these tax rates from the Nashville Assessor of Property’s website. These figures are per $100, meaning that for 2021 the property tax rate was 3.288%. Luckily, I am also able to see the rate set for 2022, which will be useful in projecting out our property taxes for Year 1.

The goal should be to write out all of the following information for at least the past two years in your model:

• Fair Market Value
• Assessed Value
• Assessment Rate
• Millage Rate
• Additional Taxes (if applicable)
• Total Tax Due (pre-abatements if applicable)

In the end, your historicals should look something like this:

Modeling Year 1: Year 1 of ownership requires special consideration, since there is a high possibility that your property will be reassessed upon sale. Depending on how long ago the property was last assessed, there may also be a reassessment due in Year 1 regardless.

If either of these are the case, you need to ensure Year 1 of your model reflects the value upon reassessment by multiplying your purchase price by the assessment rate.

If neither of these are the case, it should be acceptable to reuse the previous year’s assessment value. Last year’s figure for Additional Taxes should also be used.

In our case, we are assuming a reassessment is taking place. Our model automatically applies the purchase price towards the assessment rate to determine a current assessment value. Since we have the Millage Rate data for 2022, I will also be entering that value.

Based on our entered data, we could see that our pre-abatement property tax bill for 2022 is projected to be $221,000, a nearly 40% YOY increase!

Projecting Property Tax Growth: For any given year, the goal is to have an estimate for the following four pieces of information:

• Assessed Value
• Assessment Rate
• Millage Rate
• Additional Taxes (if applicable)

"The modeling process for multifamily property taxes often requires breaking up the relevant factors listed into two groups: knowns and unknowns"

From there, you can find the amount due in property taxes using this formula:

Assessed Value * Millage Rate + Additional Taxes = Tax Due Before Abatements

It is usually a safe assumption that the total amount owed in property taxes will increase over time. For that reason, many underwriters establish a straight-line growth rate and work backwards through the formula to fill in gaps in their model.

For a conservative projection, underwriters may assume that the overall property tax amount will increase ceteris paribus anywhere from 2-3% each year. More conservative projections are used to understand worst-case scenarios and tend to be favored by risk-averse players such as lenders.

For a more precise model, you could instead prescribe separate growth rates to the Assessed Value, Millage Rate, and Additional Taxes based on historical trends and calculate the total property tax amount using those estimates. Either way, a straight-line growth rate can only take you so far since time sensitive factors, such as reassessments and tax abatements, require greater complexity.

For our model, I am assigning a 2.5% growth rate which will apply towards the total tax due for each year starting with Year 2.

Factoring for Reassessments: Property reassessments occur periodically, typically every one to five years depending on the area. Significant capital expenditures made towards improving the property may also trigger a reassessment by the local tax authority.

A reassessment can significantly change the amount of tax owed on a property in a single year, and will continue to affect the property tax model until the next reassessment occurs.

To account for this, your model could include a formula that checks whether a reassessment will occur in a given year. If a reassessment does occur, your model could then update the fair market value of the property for that year by taking the projected Net Operating Income and dividing it by the Cap Rate. This value can then be multiplied by the Assessment Rate to estimate what the reassessed value of the property will be in that year.

Factoring for Tax Abatements: Because Tax Abatements are temporary, your first step should be to establish a timeline for any abatements that apply during your projected hold period, including any current abatements that will carry over.

With that done, your next step will be entering the savings you will have for each year in those periods. Optionally, you could apply a growth rate to these savings, especially if your abatement is a percentage of your total property tax or property value. For our model, I will be assuming that our abatement lasts 5 years, grows at a rate of 3% each year, and covers the entire Year 1 tax bill.

For the purpose of financial analysis, it could be beneficial to discount your abatement savings to reach a Net Present Value (NPV). This would more accurately reflect the benefits of these tax credits as an underwriter and is included as a feature in the SeeCares Model.

If any abatements are still present after or expire near the projected Exit Year, then you may additionally have to adjust your exit assumptions. Any thoughtful prospective buyer will factor in a temporary abatement when valuing your property, and the knowledge that expenses will increase after a certain period could drive your property’s potential sale value down.

Modeling After the Exit Year: As an underwriter, it may seem pointless to model out property tax for years after the projected hold period, however, because of how significant property taxes are as an expense item, any foreseeable changes in property taxes could significantly impact your exit assumptions. For example, if properties are reassessed after sale, a diligent underwriter should project out property taxes for the first year after the property is sold using a new assessed value based on the assumed sale price. This is important because a prospective buyer is likely to do the same when underwriting for your property.

Every property is different, and because of how many elements are involved in property taxes, your specific model may require a greater or lesser degree of sophistication. This guide serves as a framework for understanding and underwriting multifamily property taxes in a way that is intuitive but still accounts for its potential complicating factors.