Why do Tax Assessors Load the Cap Rate?

Posted by Daniel Jones on Feb 22, 2013 3:17:00 PM

Cap Rate

In the Income Approach, the deductions from gross income are typical and reasonable operating expenses, and taxes are considered typical and reasonable expense items. However, for tax assessment purposes, the taxes are not known. The values are being established so that the tax rate can be calculated for the current year. If the assessor is establishing a value for 2013 and is doing it at the beginning of the year, the tax rate is typically not known yet. If they are to include a tax component in the Income Approach as an operating expense, then they would have to use the prior year’s tax amount. Because the Income Approach and resulting value is going to have an impact on the current year’s tax rate, last year’s tax would affect the new tax rate. As a result there is a circular argument against using last year’s tax in the Income Approach.

Instead of including property tax as an expense item, the tax assessors add their effective tax rate to the appropriate capitalization rate for a particular property type in a particular market area. This gives a property tax component influence on the final value, but it’s not used as an operating expense and it’s not used as an actual number, such as the prior year’s tax amount. The loaded capitalization rate is then applied to all net income produced by the property, which, in turn, produces a value estimate.

Loading the cap rate is a relatively simple process. Let's say you have a limited service hotel cap rate from RealtyRates.com that is based on polling of market participants and the average is 11.74%. Your 2012 real property tax bill was $20,550 and the 2012 taxable value was $1,500,000. Your effective tax rate is $20,550 divided by $1,500,000 which is 0.0137 or 1.37%.

Your loaded cap rate will be:

0.0137

+ 0.1174

= 0.1311 or 13.11%

The higher the cap rate, the lower the value, so loading the cap rate has the same effect on value as deducting property tax as an expense item would: Deducting property tax as an operating expense lowers the net operating income to be capitalized. Many commercial property owners don't understand this process of loading the cap rate instead of "using taxes" to estimate taxes. They want high cap rates and taxes as an expense item too. That would be nice, but its "double dipping" and the tax assessor won't allow it.


Topics: property tax appeal, non operating expenses, Net operating income, Capitalization Rate, Cap Rate, Operating expenses

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