Very odd property tax situation?

Question

Hey all:

Got some information on a building I'm trying to evaluate and was shocked by some of the numbers...specifically the property tax.  The owner is getting up in years and is looking to sell out & retire to the North country.  He admitted that he should have contested the tax situation years ago but never did.  Now it has grown  into something totally CRAZY.

The building is a 5k sq. ft. brick, single story office building in the Detroit suburbs.  It is in good condition.  It is leased at about 2/3 occupancy with rents approximately at market rate.  Rents are definitely not the cheapest, but nowhere near the highest....could they go higher?  Maybe, but not much more.

The current rent roll is about $38k a year (2/3 occupancy).   Asking price is $345k.

Now here is where it gets crazy...property taxes are just over $19k a year!

Who is really the owner here?  The title holder or the local government?  The city is taking almost 1/2 of the revenue generated by the property!!!!!!

I am sure the owner has the building outright, no mortgage/liens....so it is cash flow positive for him.  He also uses a very small amount of space in the building, so he gets that as a benefit too.

HOWEVER, anybody buying this building would probably be cash flow neutral/in the red?  This is assuming a 6% mortgage.

To get any type of return...you would either have to get to 100% occupancy OR get the taxes SUBSTANTIALLY reduced or some combination of the two.

I have seen many properties in the Detroit market where property taxes are simply not even close to what economic realities are.  I suspect the municipalities are desperate for cash and are putting the squeeze to property owners.  HOWEVER, this has got to be wreaking havoc with the real estate market.  Who would buy at that level of taxation?  The taxes are so high, properties have to be substantially discounted.

Anybody else encounter this in other parts of the country?

Russell Brazil · Answer

You should mention what the assessed tax value is to give some perspective as to the tax rate.

Robert Plumpe · Answer

George:

I appreciate the input, but while a new owner (new arms length transaction) will cause the municipality to reassess the taxable value of property...it will not necessarily be established at the price you purchase it at...ESPECIALLY if the assessor's office deems it to be a "below market" transaction.

I've been fighting & going around on this with a few properties that I purchased a year ago and already own.  I bought them for 20% of what they were assessed for...and wound up waging an extensive fight with the tax board.  I managed to get a 40% discount.  I was seeking an 80% discount.  I was told by the appeal attorneys that I did pretty good....the tax situation is out of control in Michigan.

I am sure that a lease can be made to reflect the taxes...but the overall amount left over for the property owner would be lower.  The taxes in Michigan are so high, it is (going to) drastically compress the cap rates of properties.

In a nearby city (Harper Woods), the NORMALIZED TAX RATE IS 5%

If you want to get an un-levered return of 10% on your commercial property (which might arguably be low), you need to be getting a gross rent roll of close to 20%.  Thus, the most you can pay is about 5X the rent roll.

10% return

+

5.25% tax rate

+

2-3% maintenance charge/reserve

+

1% insurance

+

1% misc. charges

One of the reasons I got my properties so cheap was that the former owner did not have the time/expertise/energy to wage a protracted fight over the rates...

I guess where there are huge problems, there are also opportunities?

George Skidis · Answer

In Illinois you can use an arms length transaction to establish the value of a property for tax purposes. This will last about two years. After that you will need to appeal annually.

In Illinois there is an owner occupied exemption for real estate taxes. You can structure your lease to make the tenants responsible for the taxes as part of their rent.

Robert Plumpe · Answer

Hey all:

Just an update....

I wanted to be 100% sure about the tax rates in this suburb of Detroit and actually spoke with a clerk at the assesor's office to get some more information and guidance.

She said every property is unique and different...but that the general guidance is a tax rate of just over 5% of the market value of the property.  Thus, if a commercial property has a true market value of $100,000, the taxes will be just over $5,000 per year.

HOWEVER, she stated that some of the values have difficulties in being assessed.  The market was way down and has come back somewhat, but is still not "what the actual value is".  Almost all of the properties are carried on the tax books at rates HIGHER than what the current market value is.  Thus the ACTUAL tax rate is higher than 5%.

So to break it down, the property taxes are like a mortgage that can never be paid off.

I will almost certainly NOT be buying any property in this area, nor will I even be looking at any.  A 5%+ commercial property tax rate is a real hinderance to any development or construction.  I also would speculate that current commercial property owners are "stuck" with their properties.  Who would be buying in such an environment?

Robert Plumpe · Answer

Hey all, woke up & this has been turning over in my mind the whole day.

I appreciate the feedback, and decided to do some research on the internet.  I have found out the following:

The owner did not say what the commercial property tax rate is in the city...but looking at the website run by the city it looks to be just about 11% of the "assessed value" which is 1/2 of market value.  So somewhere around 5.5% of the market value?

There is no question that the taxes on the property in question are $19,135 a year.  This is coming from the municipal website directly.

One of the myriad of problems is that the properties are "over assessed".  That is, their assessed value bears no relation to what their TRUE market value is.  The assessed value is supposed to be "true cash value" when the property is not sold under duress or at auction.

In this particular case, the "market value" (assessor's office) of the property is 35% more than the asking price.  The owner has been trying to sell for about a year or so...no takers.  If the property were to be reassessed at what the owner is trying (asking) to sell it for, the taxes would STILL be about $12.5k a year.  That is certainly better than the $19k a year currently, but still outrageously high.

The owner is getting up in years, and he admitted to me that he should have taken care of the tax situation years ago.

The property is zoned/classified correctly.

In Michigan, tenants leasing small offices typically do not pay property taxes, it is built into the price of rent.

I would be willing to bet that the current owner would take less than the asking price.  How much less is the $64,000 question.  Let us say $300k maybe?

So you get $38k a year in gross rent, minus 12k in taxes, leaves you with $26k.  You've got to pay a bit for non-allocated utilities, water & trash (water is INSANELY high in MI), insurance, repairs,  Maybe that might be $800 a month, which is probably WAY too low.  So that is another $10k a year in expenses and now you are left with $16k.  So you would be making 5% on your investment IF you get a reduction in price of over 10% AND you get a 33% reduction in the property tax AND no tenants leave!

Assume that the optimistic situation were to occur, THEN you add some more tenants and get the building to maybe a 90% occupancy...That would bring in about another $9k a year in rent.  So now you are NETTING (25k), 8.33% per year on your $300k purchase price.

Even if the property were to be purchased for $200k, you are still only making 12.5% on the most optimistic assumptions.  At $150k, you would be making 16.67%, which is pretty good...but you have a TREMENDOUS amount of risk from the property tax.  The property tax is acting as a form of gearing/leverage.

I just don't see how the numbers would work on this property, even under the most optimistic situation.  The main culprit is the high property taxes.

Matthew Olszak · Answer

@Robert Plumpe Here's a bundle of questions/thoughts:

• Why aren't the leases set up for the tenants to pay the taxes? 
• Have the taxes been appealed?
• Almost anyone with a brain appeals the taxes here in Illinois but since you're in Michigan maybe that's not normal. 
• Is the valuation correct? 
• Is the property classified correctly? 
• Can you get a reduction for the 1/3 vacancy?

Very odd property tax situation?

Most Popular Reply