A New Strategic Driver?
Commercial real estate (CRE) is widely considered to be the fourth asset class, and as a result there is an increasing amount of competition for available assets and greater expectations for existing asset performance. The pressure to operate efficiently has never been greater and firms are looking for ways to derive greater asset value and returns from their portfolios. While many expenses such as property management costs are heavily scrutinized, only 25 per cent of over 200 C-level and senior CRE property tax and finance executives surveyed by Altus Group incorporate property tax management directly into their investment strategy and decision-making. With USD$515 billion of asset investment sales last year in Canada and the U.S., this results in USD$165 billion 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 the single largest operating expense affecting commercial properties, and implementing a proactive approach to property tax management presents firms with a significant opportunity. In fact, 73 per cent of respondents said their firms could make better investment decisions with enhanced property tax planning. Often viewed as a fixed expense driven by market and government assumptions, property tax has been frequently overlooked as a factor that could drive strategic investment decision-making. Many have adopted the standard practice of implementing a three per cent growth factor 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 don’t typically grow at consistent rates. This carries with it a significant risk of inaccurate property tax forecasting, which in turn erodes value.
A proactive approach to property tax management requires a strategy that incorporates many considerations, outside of the standard periodic reviews and appeals. While a successful appeal could generate significant tax savings and reduce overall operating expenses, firms can be doing more to ensure they’re getting maximum value from their portfolios. For example, whether the property is designated for current or future development and variations of purchase prices relative to assessment values are both crucial in reducing property tax liability. The appeal process alone does not provide the critical insights on current and future investment performance that can come from benchmarked tax information. Efforts to understand a portfolio’s tax liability versus a competitive or comparable set of properties within the market are much less common than appeals, but it is important for owners to know where their property stands in comparison to competing properties for leasing and disposition purposes.
Even though benchmarked tax information can provide these critical insights, only 21 per cent 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 32 per cent said that property tax exposure has very little impact on their underwriting assumptions. Where a property stands relative to the market is important not only in ensuring property tax rates are accurate, but this knowledge also provides highly strategic benefits to investment decision-making and directly contributes to what, where, when and how assets are bought, sold and managed.
In order to implement a proactive property tax management approach, firms must have access to and utilize the right tax data and analytics. While the majority of firms surveyed (83 per cent) indicated that they have the right metrics necessary to optimize their investment strategy, three key inhibiting factors were identified. Tax data comes from a variety of sources including taxing authorities, research reports, market data subscriptions as well as consultants and industry peers which lead to inconsistencies in formats and reporting, and 39 per cent of firms identified the lack of normalized formats as a barrier to utilizing property tax data. Further to this, the data must be properly aggregated, vetted and analyzed so firms can extract meaningful insights, and 52 per cent of firms surveyed said they lack the tools to assist with both data capture and analysis, while 44 per cent lack internal expertise or resources to identify property tax data sources.
These gaps in tax planning will only grow if firms continue with a reactive approach, leaving portfolios at risk of underperformance. Rather than treating property tax as a fixed cost, firms that invest resources in strategically managing their property tax expense can realize a high return on investment through reduced operating costs and transactional efficiencies which will lead to higher NOI’s and greater asset values. Implementing proactive forecasting is essential in 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 property tax. There is a growing recognition and need for better real estate tax intelligence with the collective majority of executives affirming its significance, but enhanced real estate tax analytics are still underutilized. Firms need to take a critical look at their property tax strategies because with the right investments in process and technology, there is a significant opportunity for property tax to play a more strategic role in investment decision-making.
Terry Bishop is Executive Vice President, Eastern Canada- Tax Group at Altus Group.