The Madness of City Property Taxes
Tom Acitelli Feb. 17, 2011, 1:42 p.m.
About a month ago, the city’s Department of Finance published the tentative assessment roll for fiscal year 2012 (July 2011-June 2012). Projected market values in the upcoming year increased by 3.75 percent to about $823.5 billion for New York City’s more than one million properties. This statistic confirms what property owners have known for a very long time: The city will increasingly look to the real estate industry for a growing percentage of its revenue, regardless of the fairness of its tax policy.
Last year, real estate taxes—and related real estate charges such as transfer taxes and mortgage recording taxes—represented approximately half of the total tax revenue collected by the city. As the city relies more heavily upon property owners to pay for constantly increasing government spending, the tax burdens on owners continue to escalate the time when market conditions blatantly indicate they should be doing the reverse.
In order to illustrate the unfairness of the present system, we need look no further than the fact that, on average, citywide property values on a per-square-foot basis have dropped about 38 percent from the market’s height to present levels. At the same time, assessed values (which are what real estate taxes are based upon) had increased by 26.4 percent, according to a report from the Real Estate Board of New York. This inequity is being felt by property owners across the board and is beginning to dissuade some investors from continuing to purchase New York City properties.
If you are a regular reader of Concrete Thoughts, you know that one of the things I always mention that has exerted upward pressure on value is an acute supply-demand imbalance. Demand for Gotham’s properties has been overwhelming, as both domestic and foreign purchasers have been scouring the city for opportunities. Unsurprising, the supply of available properties for sale is very low, as it historically is, leaving many of these potential buyers, extremely frustrated. It might, therefore, seem unimportant that some investors are getting turned off by ever-increasing real estate taxes, but what is important to realize is that a forest fire starts with a single spark.
There is an old saying that goes, “If something happens once, it is an isolated incident. If it happens twice, it is a coincidence. If it happens three times, it’s a trend.” Based upon this maxim, the trend has been that investors who have purchased New York City properties for years are, increasingly, looking at opportunities outside of the Big Apple as real estate taxes continue to spiral out of control. This leaves them feeling like they are working hard to drive revenue just to pay real estate taxes, water and sewer charges and other fees levied by the city.
FROM A PROPERTY owner’s perspective, the only thing that really matters about real estate taxes is the amount of their real estate tax bill each year. It is difficult for owners to fathom how their tax bills continue to increase year after year when property values have been dropping since 2007. In order to understand the real estate tax issue more clearly, we must look at how real estate taxes are calculated.
In what is a gross oversimplification, real estate taxes are determined by multiplying a property’s assessed value by the appropriate real estate tax rate. The assessed value is the property value ascribed to the property for tax purposes. The New York City Department of Finance determines a property’s assessed value by multiplying its estimated full market value by the assessment ratio for the property’s tax class.
In New York City, a property can have three different assessed values: an actual assessed value, a transitional assessed value and a billable assessed value. There are four different tax classes of properties in New York. Class 1 generally is for one- to three-family homes; Class 2 is for larger residential properties, including rental buildings, co-ops and condos; Class 3 is for public utilities; and Class 4 covers commercial properties. For the purposes of this discussion, we will not address Class 3 properties.
The assessment ratio for Class 1 properties is 6 percent of market value; Class 2 and Class 4 properties carry ratios of 45 percent of market value. Market value is determined by the Finance Department using different methods, which are usually manipulated toward whatever approach is beneficial to the city (more to come on this later). These methods include using comparable sales data for Class 1 properties and either a gross-rent-multiple approach or a capitalization-rate approach for Class 2 and Class 4 properties.
After assessed values are determined, they are multiplied by the appropriate tax rate (expressed in percentage terms) for each class of property. In the 2010-2011 tax year, the tax rate for Class 1 properties is 17.364 percent; for Class 2 it is 13.535 percent; and for Class 4 it is 10.312 percent.
The recent tentative assessment rolls for fiscal year 2012 have left property owners scratching their heads. For example, according to the city, Class 1 properties saw value rise by 0.86 percent based upon comparable sales, and assessed values rose by 2.65 percent. Market values for Class 2 properties rose by 13 percent and resulted in assessed values increasing by 8 percent. In Class 4, market values rose by 9.95 percent, pushing assessed values up by 7.25 percent.
While these figures are difficult enough to comprehend under current market conditions, what is more perplexing is that during the recent downturn, in which we saw average prices per square foot for Class 2 and 4 properties drop from peak levels in 2007 through 2010 by about 38 percent, assessed values continued to increase. According to a REBNY report, from 2008 to 2012, the city’s estimate of market value increased by 3.46 percent and assessed values increased by 26.4 percent.
While I could take up several pages of The Commercial Observer with examples of simply crazy assessment increases, I will use just one to illustrate what is happening.
The 49-unit apartment building at 315 West 115th Street changed hands about a year ago. Since the sale, no regulated units were deregulated, so the income has not changed much. The present owners are renovating a few of the vacant units, but no significant major capital improvements were completed. The assessed value here nearly tripled in the 2012 tentative assessment roll from $422,550 last year, up to $1,233,900. How can such an increase be explained when essentially nothing has changed at this property? This is just one example amid thousands that just don’t make sense.
These unfathomable numbers have left a dynamic in which real estate taxes are constantly rising as a percentage of gross revenue.
When I mention that valuation methodology is manipulated by the city, remember that in the 1980s, Class 2 and 4 properties were reassessed upon sale at 45 percent of the sale price, and the difference between the resultant number and the old assessment was phased in equally over a five-year period.
This left some properties with multiple assessment “clocks” running at any particular time, making it very challenging to project where taxes were headed. The city loved this method during the mid-to-late 1980s, when values were increasing annually. However, as soon as values started to decline after the savings-and-loan crisis in the early 1990s, assessed values were dropping too rapidly and the city abandoned their previously beloved methodology. Assessed values were then going to be determined based upon income and expenses and value trends within neighborhoods. This shift was clearly implemented to keep real estate tax revenue from dropping too sharply.
IN ADDITION TO these meandering assessed value calculations, we mentioned that tax rates were also subject to manipulation. When we hear elected officials proclaim that “real estate taxes will not go up,” they are commonly referring to the tax rate itself. If a rate was 10.5 percent one year, and remained 10.5 percent the next year, politicians cheer that “taxes did not go up.” However, a property owner’s tax bill is sure to increase as the assessed value rises. As I stated before, the amount of the check written to pay real estate taxes is all that an owner is really concerned about.
Interestingly, if we look at historical tax rates, we generally see more rapid increases when times are tough than when times are good. While this is counterintuitive, it is not surprising as municipal tax revenues slide during recessionary periods and real estate taxes are a way to help bridge the gap. From 1981 through 1991, tax rates among all classes of properties remained consistently between 9 and 10 percent. In 1992, during the height of the S&L crisis, rates increased about 10 percent to about 11 percent.
Tax rates remained fairly steady throughout the balance of the 1990s and early 2000s. During the 9/11-and-dot-com-led recession in the early 2000s, tax rates jumped significantly. From fiscal years 2002 to 2004, Class 1 tax rates increased from 11.609 to 14.550, a 25.3 percent increase; Class 2 rates increased from 10.792 to 12.620, a 16.9 percent increase; and Class 4 rates climbed from 9.712 to 11.431, a 17.7 percent rise.
If we analyze tax rates during our most recent recession, we see that tax rates have jumped again. From 2008 to 2011, Class 1 rates are up 12.5 percent, moving from 15.434 to 17.364; Class 2 rates have climbed 13.5 percent, from 11.928 to 13.535; and Class 4 rates increased 2.5 percent, going from 10.059 to 10.312. To pound property owners at times when they are being slammed by broader economic conditions is a one-two punch that can be demoralizing.
If we compound the tax assessment increases we have seen with these tax rate increases, we see that today’s real estate tax burdens are disproportionately eating up gross revenue at higher percentages than ever before. This dynamic is taking a toll on investors and operators. It will be interesting to see if the governor’s tax-cap pledge will be implemented and, if so, whether it was meant to simply cap the tax rate, or the amount of the check property owners have to write to the city.
Owners have the ability to fight their tentative assessments. Owners of Class 1 properties who wish to file an appeal must do so by March 15. Owners of all other property types must file by March 1. The final assessment roll will be published on May 25. In June, the Finance Department will use this final roll to calculate property tax obligations for fiscal year 2012, beginning July 1.
Fiscally, there is much optimism today, as Governor Cuomo appears to be resolute in his quest to cut government spending as the way of addressing the state’s budget woes. The mayor also seems to be on board with this approach, and the importance of a successful implementation of this route cannot be overstated. To the extent they are unsuccessful, there is no doubt that additional real estate tax increases will be right around the corner.
Robert Knakal is the chairman and founding partner of Massey Knakal Realty services and in his career has brokered the sale of more than 1,125 properties, having a market value in excess of $7 billion.