Newsletter – June 2023
“How has the recent property tax increase in Colorado negatively impacted my property’s value?” This is a question that will be asked by many commercial real estate owners in the coming days and weeks. Let’s take a dive into the effects of Colorado’s record high reassessment rates and discover what it will do to a building’s tax bill, NOI, and cap rate value.
In the State of Colorado, property taxes are reassessed every two years. Your commercial property tax bill is determined by three factors: the actual value, the assessed value, and the mill levy.
Your actual value is determined by comparable sales of like property in the last two years (July 1st, 2020-June 30th, 2022). Once determined, the Actual Value is multiplied by the tax assessment rate, which for commercial real estate in Colorado is now 27%. Finally, your assessed value is multiplied by the area’s mill levy which is composed of mills from schools, county roads, and other local taxable responsibilities.
One of the largest risks in Colorado commercial real estate this year is the biannual property tax reassessment which will reflect an increase of between 30% and 60%, the largest tax increase in Colorado history.
Let’s look at a hypothetical example to see how this would impact the value of your commercial real estate. Assume a property’s real value is $5,000,000.00. If we multiply this by the tax rate of 27%, we get $1,350,000.00 or the Assessed Value. Let us now assume the mill levy in the area is 114.632. If we multiply the Assessed Value by the mill levy (divided by 1000 for the purpose of mathematical continuity) we get the estimated tax bill for this property, $154,753.00. This is a large bill, but a reasonable case study for our purposes. Now let us assume the property value is being reassessed based on a transaction that took place between July 1st 2020-June 30th 2022, or the analysis period. The sale of this property took place in 2022, a year that saw some of the highest average sale prices in the history of commercial real estate. This “$5,000,000.00” building sold for $6,750,000.00 in the analysis period. Now the state wants to reassess the property at this new Actual Value. I’ll let you run the math! Your tax bill has gone from $155K to $209K! A 34.7% increase in the Actual Value will result in a 34.7% increase in the final tax number, all else remaining equal. The case study we just ran through represents the low end of a large range of property tax increases that can be expected in 2023.
Now let’s explore what this could mean for the value of your property. If you have a NNN lease structure, these property tax increases would be reimbursable by the tenants (assuming there isn’t language in the lease capping the possible increase to expenses each year). The danger here lies in the tenant’s ability to withstand the large increase in their monthly additional rent. With the economy already in a dip, increasing expense numbers will make Gross and Modified Gross leases the first thing that tenants look for. If the building has a gross or modified gross lease structure, the increase in expenses will come directly out of NOI. If there is a $54K decrease on a $500K NOI, then at a 6 CAP the value drops from $8.333M to $7.433M. The value of your building has dropped almost $1,000,000.00, or 10.80%! The low-end reassessment in 2023 changes the viability of the investment, and seriously alters the frontier of the commercial real estate market.
Taking a look at the higher end of property tax increases, the math gets stickier still. Taking the same $5M building, and assuming a reassessment at $8M (a 60% increase), you see an increase in the initial tax bill of $154K to $246K. This nearly $100,000 increase in the building’s expenses correlates to a change in value from the initial $8.333M to $6.8M, or 18.40%! This $1.5M loss in value is hypothetical here, but a very real problem for so many property owners across Colorado. So what do you do? The best plan of attack is a property tax protest. Approach the county and argue with comparable sales and building NOI that they have overvalued your investment. Otherwise, you will need to wait till sale prices increase again and absorb the loss as best you can. Creativity will be required to boost the building’s NOI. While overcoming a large loss to your income in this down market may seem impossible, in the words of Nelson Mandela, “It always seems impossible until it’s done.” Good luck out there!