Property Tax Tip: Beware of Misleading Comp Sales

By Jerome Wallach, Esq.

To estimate a property’s value for taxation, assessors customarily draw on in-house databases.  Sales chosen for comparison are selected on the basis of general characteristics, such as location, use and zoning.

However, those characteristics do not tell the entire story. To begin with, databases are neither designed nor maintained to record crucial details. Although buyer motivation is assumed to be implicit within the transaction that information is rarely included, if ever.

In practice, no two property sales are identical. In order for the assessor to draw value conclusions, comparisons must reflect adjustments for the unique characteristics affecting the price. A real property transaction may meet one standard of a market sale: the arm’s-length test, which establishes that the buyer and seller are independent and acting in their own interest.

Finding the motive

Nevertheless, the taxpayer must examine the buyer’s motivation, which may very well turn out to disqualify the transaction as a comparable market sale. If the buyer’s needs are unique to that transaction, reflecting a motive that other investors are unlikely to share or value, that disqualifies the exchange as a valid transaction for comparison.

The assessor’s records should include such basic information as the buyer and seller, the property’s size and location and the closing date. This provides a starting point for further inquiry.

In many instances, the needs of the seller or buyer create an exchange value unique to the parties and do not reflect market value. They may include one or more of the following situations.

Strategic premium. The buyer under this scenario is protecting its own enterprise by eliminating opportunities for competitors to move into its trade area. An owner of convenience stores that sell gasoline, for example, may acquire sites likely to attract other operators, impose deed restrictions that preclude competition, and resell the restricted property. To that convenience-store owner, the value of the deal is to enhance sales volume by eliminating competition. Other categories of retail chains may employ the strategy. One big-box retailer typically imposes deed restrictions on sites it vacates, thus thwarting competitors from moving into its former space.

Part of a larger deal. The assignment of value within a portfolio transaction is always subject to question. When investors buy multiple properties in a single deal, they may be compelled to take on some under-performing assets along with the most desirable ones. For that reason, values assigned to individual assets in the transaction may be arbitrary, or at best driven by other priorities, not the least of which may be depreciation schedules for federal tax purposes.

Unique buyer needs. A business that must expand its footprint to keep growing has two choices: Buy the property next door, or move to a larger location. The value of the neighboring property to that buyer does not necessarily reflect how the market would typically value the property, but indicates only the buyer’s need at that time.

Sale-leasebacks. The transfer of a property with a leaseback agreement is more a financing arrangement than a conventional sale. It generates cash for the seller and returns to the buyer through lease payments that may bear little or no relation to actual market lease rates. The value in exchange lies in the entirety of the arrangement, which is essentially equivalent to a loan secured by a deed of trust that includes outside collateral.

Assemblage. In order to create a parcel large enough to meet its needs, a buyer may acquire several tracts to create a single property. The individual parcels cease to exist separately and become an undefined part of the new, larger assemblage. Sometimes the owner of the key tract—perhaps the final one required to complete the assemblage—is able to extract a higher price than the property would otherwise command. To the buyer, it is a must-have piece without which the project cannot be completed. Since the buyer pays more than the market value, the excessive price is an unreliable barometer.

These examples demonstrate that the values an assessor references as comparable purchase prices may well be misleading. Indeed, the prices paid for those assets regularly stem from strategic priorities, rather than from actual market. By carefully examining the assessor’s database of comparable sales, taxpayers can reduce property assessments that do not reflect the fair market value of a property.

Jerome Wallach is a partner at The Wallach Law Firm, the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at [email protected].