Lack of Strategic Property Tax Planning Leaves Assets at Risk of Underperformance
With the recent upward cycle in the commercial real estate (CRE) market, both property values and property tax disbursements are reaching record highs. As the CRE industry continues to attract capital at record levels, the competition for available assets and expectations for existing asset performance have never been higher. Property tax is the single largest operating expense affecting commercial properties, yet it is an area often overlooked as an opportunity to drive strategic investment decision-making. Unlike most operating costs, taxes cannot be negotiated or lowered through contracts, but there are established processes to manage them. A proactive approach to property tax management presents a significant opportunity for firms looking to derive greater asset value and returns from their portfolios.
Many CRE firms believe they have adequate property tax planning strategies, however, a recent Altus Group survey revealed that few manage their property tax as they would other operational expenses. Three quarters (75%) of over 200 C-level and senior CRE property tax and finance executives surveyed describe their property tax management as reactive and purely or largely operational and cost reduction oriented. With $515 billion USD of asset investment sales last year in Canada and the U.S., this results in $165 billion USD of CRE assets, including $9 billion in Canadian CRE assets, that are at risk of underperformance due to the lack of strategic property tax planning.
Property tax is often viewed as a fixed expense driven by market and government assumptions. The lack of analysis of historical or benchmarked tax data has led to an industry standard of applying a static growth factor, typically of three percent, to the property tax liability when budgeting and underwriting. But, an overall assessment of past industry underwriting and transactions shows that most property tax growth assumptions are inaccurate as taxes do not typically grow at consistent rates. This carries with it a significant risk of inaccurate property tax forecasting, which in turn erodes value.
Less than a quarter (21%) of firms surveyed said they use enhanced real estate tax analysis that includes benchmarking to identify exposure of their portfolio compared to the market, and thirty-two percent said that property tax exposure has very little impact on their underwriting assumptions. With multiple ways to add tangible value to assets and increase the bottom line, why are only a quarter (25%) of executives incorporating property tax management directly into their investment strategy and decision-making?
While a lack of rigorous tax processes seems to be one of the major issues inhibiting a more strategic approach, having access to and utilizing data is another critical factor. The majority (83%) of respondents believe their firms have enough property tax information, but fifty-two percent said they lack the tools to analyze this data, and forty-four percent said they lack the expertise and resources to identify property tax data sources.
There is a growing recognition of the critical role property tax must play in asset management and portfolio strategy. In fact, seventy-three percent of respondents firmly acknowledged that improvements to their tax planning analysis would help with better decision-making. With the right investments in process and technology to provide better visibility into tax growth, risk and savings, the opportunity for property tax to play a more strategic role in investment decision-making is significant.
Implementing proactive forecasting is essential to maximizing asset performance and, as property values and tax assessments continue to rise, so too does the amount of money firms are missing out on by not proactively managing their property tax. Maintaining an annual review of all new property assessments or mid-cycle assessments, adopting standardized reporting across asset types, and benchmarking a property against itself and similar assets in the portfolio are some steps firms can take to ensure property tax plays a more strategic role in investment decision-making. Undoubtedly, these steps can have a huge impact on the bottom line.
Look for the full version of this story in the next edition of Canadian Property Valuation.