Landlords and tenants of commercial buildings in the District of Columbia should brace for potentially significant increases in their property taxes payable in 2015 and future years. The District of Columbia Office of Tax and Revenue, the department within the District tasked with the assessment and collection of property taxes, recently modified its commercial property assessment process after considering the recommendations of a report prepared by an outside consulting firm. The modifications resulted in some significant increases in the assessed value of commercial properties and, subsequently, the resulting property taxes.
Landlords and tenants of commercial buildings should be mindful of these potential increases beginning in the new year, and they should consider what steps they can take to potentially minimize the financial impact of the increases for 2015 and for future years.
General Commercial Property Tax Assessments
In the District of Columbia, the assessed value of property is the “estimated market value” of the property. Estimated market value is defined as:
100% of the most probable price at which a particular piece of real property, if exposed for sale in the open market with a reasonable time for the seller to find a purchaser, would be expected to transfer under prevailing market conditions between parties who have knowledge of the uses to which the property may be put, both seeking to maximize their gains and neither being in a position to take advantage of the exigencies of the other.
D.C. Code § 47-802(4).
According to District law, the District must “take into account any factor that may have a bearing on the market value of the real property, including, but not limited to, sales information on similar types of real property, mortgage, or other financial considerations, reproduction cost less accrued depreciation because of age, condition, and other factors, income-earning potential (if any), zoning, and government-imposed restrictions.” In determining the estimated market value, the District can apply any generally recognized approaches to valuation, including the comparable sales approach, the income approach, or the replacement cost approach.
The rate of property tax on commercial buildings ranges between $1.65 and $1.85 per $100 of assessed value, depending on the assessment amount. The property tax is payable in two installments—the first installment is due by March 31st, and the second installment is due by September 15th.
The New Tax Assessment Methodology
In 2012, the District commissioned a report from Almy, Gloudemans, Jacobs & Denne (AGJD), an outside consulting firm to, among other things, evaluate the District’s commercial property assessment process, organizational structure and hiring practices, and to make recommendations for improving the District’s commercial real property assessment functions. In November 2012, AGJD submitted its report to the District. The report included recommendations for improving the District’s commercial property assessment process, including the specific methods the District should use to calculate the assessed value of commercial properties.
AGJD noted in its report that the District utilizes the income approach in its assessment of many commercial properties. This method generally involves calculating the net operating income of the property (after taking into account many factors including rent, vacancy and expenses) and determining the assessed amount by applying a capitalization rate to the income. For example, if the assessor determines that net operating income for a property is $100,000 and the capitalization rate is 10 percent the assessment amount would be $1 million. AGJD noted that in using the income approach, assessors calculate the various factors by relying more on property-specific market data rather than relying on broader market data and market appraisal models across classes of property. Among other recommendations, AGJD recommended that the District rely more on broader market data and market appraisal models rather than performing a more property-specific analysis of relevant data. AGJD reasoned that performing a more property-specific analysis can lead to inconsistent valuations of similar properties and that relying on broader market data can reduce inconsistent assessments.
The District largely incorporated the recommendations contained in the AGJD report. The District first put into practice the new recommendations earlier in 2014 for assessment of properties for taxes first payable in 2015. In assessing commercial buildings, the District apparently is now utilizing a hybrid methodology, which includes, in part, the use of standards in place before the AGJD report, as well as the use, in part, of recommendations contained in the AGJD report.
Following the use of the new assessment methodology, commercial property owners, and particularly office building owners, voiced their concern to the District, arguing that the new methodology was inconsistent with District law, and that the new methodology would hurt landlords as well as tenants, since many tenants pay their share of property taxes through leases. Specifically, the owners argued that the new methodology is inconsistent with District law because, among other things, the Superior Court of the District of Columbia had ruled in 1992 (in a case involving the National Place Building) that assessors had to take into account the current earnings of the property, as opposed to more general market data, if the earnings might have a bearing on the market value of the property. The District responded that its modified assessment methodology complies with law.
This new assessment methodology has resulted in significant increases in property taxes in some instances. For example, the property tax of one office building on M Street NW initially increased by 42 percent year-over-year. The increase in the property tax alone was more than $500,000. This increase occurred despite the fact that the building was largely vacant at the time of the assessment, like many other buildings in the District, as a result of the federal government’s reduction in spending in the region and other factors. The increase likely resulted from greater reliance on general market data, including potentially lower capitalization rates from sales records, and less reliance on the condition of the specific subject property.
Actions Landlords Should Consider
If a commercial building in the District has been affected by a significant property tax increase, landlords should consider the following:
Consider Appealing the Assessment for Future Years
For taxes payable in 2015, the District mailed assessment notices by March 1, 2014, and landlords had 30 days to appeal the assessment. However, the District did not publish rules or guidelines on changes to its assessment methodology before implementing the changes. Therefore, many landlords were unaware of the new methodology and did not consider appealing the assessment. While the appeal period for taxes payable in 2015 has passed, landlords should carefully review the new assessment notices for taxes payable in 2016, which will be mailed by March 1, 2015. If landlords are concerned about the assessment methodology, they should appeal by April 1, 2015.
Review Tenant Leases to Pass Through Increases
For taxes payable in 2015, landlords should review each of their leases with tenants to determine whether the additional property tax can be passed through to tenants. In the office market, many leases in the District operate on a Base Year concept, where only taxes over the Base Year, which is often the year in which the lease was signed, can be passed through. Under these circumstances, landlords should be able to pass through each tenant’s share of the property tax increase. The “tenant share” calculation in each lease can vary. For buildings with higher vacancies, landlords should review each lease to determine the most beneficial way to calculate the tenant share.
Resist Property Tax Limits in New Leases
With the new assessment methodology in its first year, additional buildings may be impacted by the new methodology in the coming years, as the District continues to implement the new methodology. Therefore, with the risk that additional buildings will see steep increases in property taxes in future years, landlords should consider resisting any attempts by tenants to limit property tax increases in leases.
Actions Tenants Should Consider
If a building in the District has been affected by a significant property tax increase and tenants are responsible for paying their share of property taxes in these buildings, such tenants should consider the following:
Review Lease for Limitations on Property Tax Payments
Tenants should review their leases to determine what limitations, if any, exist with respect to increases in property taxes. During lease negotiations, limitations on increases in property taxes may have been negotiated. For example, there may be annual caps in increases in property taxes of 5 percent or 6 percent, and tenants should review their leases to determine what limitations they have. In addition, tenants should review how the tenant’s share of the increased property tax is being calculated to make sure they are not paying a higher share than they are obligated to pay under the lease.
Discuss an Appeal with the Landlord
Commercial leases, particularly those involving medium-sized or smaller tenants, often do not give tenants any right to appeal property taxes directly with the governmental authority. However, if the District’s assessment has resulted in a substantial increase in property taxes, such as the previous M Street example, where property taxes increased by more than $500,000, tenants should consider discussing with their landlord the possibility of appealing the tax assessment for future years. Generally, it is in the best interest of landlords to keep property taxes lower because lower property taxes will make the building more competitive for the landlord. Therefore, landlords should be inclined to appeal the assessments when the new assessment appears to be inconsistent with assessment requirements.
Insist on Property Tax Limits in New Leases
With the new assessment methodology in its first year, additional buildings will likely be impacted by the new methodology in the coming years, as the District continues to implement the new methodology. Therefore, with the risk that additional buildings will see steep increases in property taxes in future years, tenants should consider negotiating limits in property tax increases in new leases.
