A winning game plan for industrial property tax appeals

Transcription

1 A winning game plan for industrial property tax appeals Wade E. Norwood, Esq. Principal Law Offices of Wade E. Norwood Pasadena, California (626) Tim M. Landolt, ASA, MBA President & CEO Vista Valuations, LLC Sacramento, California (916) Session Description: Large industrial facilities like process plants and factories are complex, unique and consequently, often over-assessed. Successfully appealing property taxes for such facilities requires strategic thinking and advanced appraisal techniques. This session will discuss specific methods for obtaining significant tax reductions for large industrial facilities and examples of when such methods have prevailed. This session will include a detailed discussion of the property tax appeal timeline, how your position within the process shapes the valuation analysis, settlement negotiations, hearing preparation and strategies needed to win your case. Learning Objectives: For participants to gain insights and specific strategies in seeking property tax reductions for industrial facilities, including: 1. Evaluating the merits of appealing your property taxes; 2. How to optimize your position to obtain maximum tax reductions; 3. How to designate the scope of the appraiser s work to address unique valuation and property issues based on a cost-benefit basis; 4. Successful strategies for negotiating and litigating industrial facility appeals. I. Pre-Season: Evaluating the merits of appealing your property taxes 1) Internal Analysis Key Player: Tax Manager The first step in any assessment review is to figure out your appeal timeline. While this may sound straight-forward and insignificant, missing a filing date or deadline will guarantee a negative outcome. 38 th Annual Conference Institute for Professionals in Taxation

2 Appeal filing dates and procedures can vary significantly based on a myriad of factors including, but not limited to: asset type (real vs. personal), jurisdiction (city, county, state), property type (commercial, industrial, utility), new construction, recent acquisition and, annual assessments and reassessments. Check your appeal deadlines with the County to ensure a timely appeal. It is critically important to understand the appeals process. Many taxing jurisdictions have multiple paths or venues in which to appeal your assessment, and selecting the wrong venue or appeal path can result in the dismissal of your case before it is even heard. Furthermore, creating an appeal timeline will also increase the likelihood that your preliminary analysis will be completed well before an appeal decision must be made. Having sufficient time to bring in outside expertise, whether it be a tax consultant, appraiser, or legal counsel, to review your case prior to filing is often critical to a successful outcome. Therefore, developing a detailed appeal timeline and understanding the appeals process are simple, but necessary first steps in any assessment review. Once the appeal timeline and process have been defined, the assessed value can be tested to determine if an appeal is warranted. Testing the property value for overassessment is often the most difficult step in the review process as it requires a commitment of time and resources at a point within the project where the results are highly uncertain. This fact is especially true for process plants and factories due to their unique design and potentially limited market. In such cases, testing the assessed value for reasonableness can prove a difficult task. If you understand the factors that drive value for complex properties, however, then you can confidently execute the second step of the game plan Preliminary Assessment Testing or ( PAT ). The following list is a sampling of PAT questions. Coming up with a questionnaire for PAT analysis helps standardize the process and make sure you are capturing all the issues that impact value for a specific facility or set of assets. Key questions to determine whether to file an assessment appeal: Do you have a recent appraisal or other valuation that indicates the assessed value is too high? What do recent sales of similar properties indicate? Does your property operate as efficiently as newer properties of the same type? Have general economic or specific market conditions adversely affected your profitability? Norwood, Landolt Page 2

3 Do you have any special issues affecting the efficiency or profitability of your facility? Is your property at the end of its physical or economic life? Does your facility suffer from significant deferred maintenance or excessive physical deterioration? Are new facilities that compete with your plant being built, and where are they located? Has there been a major technological advance or innovation in your industry? Is your facility operating at its designed capacity, if not, why? How was your property valued by the Assessor and does it make sense? Do you report assets to the Assessor that are no longer used or on site? If you conclude that your property is most likely over-assessed it s time to bring in additional help. 2) The Draft a) Choosing your team Picking the right attorney, consultant, and appraiser greatly increases your chances of success. Look for an attorney that specializes in property tax matters. Property tax is a very narrow focus of law, but there are many complexities in property tax law of which a generalist will be unaware. A good consultant is one who understands the issues affecting your industry and who will not hesitate to pull in an attorney and appraiser where needed. You should select an appraiser who is also familiar with the property tax process, is a persuasive witness, and is skilled in appraising your type of property. 3) Assisted Analysis a) Key players: 1. Tax Consultant 2. Tax Attorney 3. Appraiser Preliminary Assessment Testing PAT: The testing process begins with a review of significant factors and high-level data that signal your facility may be over-assessed. By answering the preceding questions and gathering related data, an appeal feasibility analysis can be created. The analysis should focus on the data gathered during the testing process and attempt to translate that information into an appeal framework or outline. Norwood, Landolt Page 3

4 Depending on the amount and quality of the data gathered, a preliminary range of value or potential settlement range can be estimated. However, in certain instances developing a range or other valuation metrics may require specialized expertise. In such instances, the testing data is a starting point for additional analysis by an appraiser or tax consultant. Whether you calculate a preliminary value range internally or bring in outside expertise, understanding the key metrics that impact value for processing plants and manufacturing facilities is critical to a successful appeal outcome. The testing process is based on the same fundamental valuation metrics and data used in a complete appraisal of a processing plant or manufacturing facility s real and personal property assets. The analysis incorporates review data from all three traditional approaches to value (Cost, Sales Comparison, and Income) to provide a broad base of appraisal information. However, most assessed values for similar facilities and asset classes are based on mass-appraisal techniques applied within a Cost Approach analysis. The cost approach methodologies applied by taxing jurisdictions are often based on a trended investment method ( TIM ) for personal property and published valuation guides (Marshall Valuations Service - MVS or similar) for real property. While the trended method and Marshall-based cost approaches are considered appropriate and credible methods for mass appraisal purposes, they are typically the method of last resort for appraisals of a single facility. Detecting and quantifying all forms of obsolescence especially functional and economic obsolescence is the primary downfall of trended and Marshall-based analyses. If any form of significant obsolescence impacts your processing plant, both the trended investment and Marshall-based cost approaches will likely result in an overassessment. Therefore, it is important to understand how the taxing jurisdiction valued your processing plant and what their methodologies can and can t capture. The difficulty of fully measuring all forms of obsolescence when using trended investment and Marshall-based analyses is a systemic issue for nearly all cost approach techniques and methodologies when valuing processing plants and manufacturing facilities. With regard to special-purpose properties, The Appraisal of Real Estate, 14 th Edition states: The highest and best use of a special-purpose property as improved is probably the continuation of its current use if that use remains viable and there is sufficient market demand for that use Using the cost approach to value a special-use property where no market exists will usually overstate the market value of the property unless a deduction is made to reflect the lack of a market. 1 In cases where an active or semi-active market exists for a special-use property, the cost approach typically represents the upper-end of the value bracket and sets the theoretical limit for which a willing buyer and seller would exchange a property. Thus, it is very important to understand the strengths and weaknesses of the valuation approach applied by the taxing jurisdiction. Norwood, Landolt Page 4

5 Trended Investment & Marshall Specific Testing Issues: If the assessed value of your industrial facility is based on a trended investment or Marshall-based cost approach, then reviewing and testing the approaches will help meet the burden of proof needed for a successful appeal. The appendix section of this paper includes detailed testing criteria for both trended investment and Marshall-based cost approach models. The following list is not meant to be all-inclusive and other valuation metrics and testing methods may be incorporated into your review process. Improper Development of the Reproduction Cost New Trending Issues & Errors Failure to Account for or Quantify Excess Capital Cost or Non-Value-Adding Costs Embedded in Historic Cost Record and/or your Asset Listing Not Developing an Estimate of Replacement Cost New or Assuming Reproduction Cost New and Replacement Cost New are Equivalent Not Accounting for or Measuring Deferred Maintenance or Excessive Physical Deterioration Failure to Quantify Functional Obsolescence Due to Changes in Technology and the Presence of Lower Cost Operating Facilities Not Fully Accounting for or Applying External Obsolescence Due to a Variety of Economic Issues and Factors External to the Property 4) Cost Benefit Analysis: Once the preliminary value analysis is complete, you must go over the cost/benefit of proceeding with an appeal. How much will the case cost to litigate? What are the chances of success? This final part of the analysis requires knowledge of the Assessor s position regarding your case and the history of any prior assessment appeals and negotiations. Your attorney/consultant and appraiser should assist you in this analysis. 5) Conclusion: File a timely appeal or let it go. II. Pre-Game Maneuvers: How to Optimize your Position A. Key players: 1. Tax Manager 2. Tax Consultant/Attorney 3. Appraiser B. Preliminary Negotiations Norwood, Landolt Page 5

6 1. Getting to know the Assessor rapport building i. What is the Assessor s attitude, knowledge, skill? ii. What is his analysis of your facility? Is it extensive or cursory? iii. Goals: keep it friendly, build a rapport, find out his weaknesses and strengths, determine if settlement is possible 2. Initial Presentation/Discussion i. Company Provide a brief description to aid the Assessor in understanding your corporate structure, reporting units, and general operations. ii. Facility Cover the basics of the plant and operations to set the stage for any subsequent issues you will be discussing with the Assessor. iii. Industry Discuss the industry in which you operate. Are your competitors local, regional, national, or international? How does your facility fit within the industry? Again, this section should lay the ground for discussing related valuation issues with the Assessor. iv. Issues Translate the previous discussion points into a handful of specific valuation issues. If the foundation has been laid properly, the impact on the assessed value should be fairly obvious and easy to follow. 3. Follow-up i. Informal Information Exchange (type of data, how much to share, timing) After the preliminary discussion/presentation, supporting documents and information are typically requested by the Assessor. At this point in the process, it is important to maintain a level of transparency. However simply complying with most data request without carefully reviewing and vetting the data exchanged can have long-run and unintended consequences. 1. Publicly Available often times much of the data requested may already be publically available, in which case supplying this information may be a matter of presenting it in a format that is easy to digest and understand by the Assessor. 2. External Sources you may have access to information from industry experts and studies completed by consulting companies that can significantly aide your case. While this data is often copyright protected and confidential, it is often beneficial to let the Assessor review this information at your facility. Norwood, Landolt Page 6

7 4. Negotiation strategies: 3. Internal Sources care should always be taken in providing confidential internal company data. As with external sources, providing access to this data on-site may be sufficient to make your case at this point in the process. However, the level of rapport building and transparency should be carefully weighed against the potential miss-use and miss-characterization of the data. i. Highlight the strengths of your appraisal and the experience of your appraiser. ii. Underscore your willingness to work with the Assessor, but also your willingness to take the case to the Board or Court if needed. iii. Show appreciation for the challenges the Assessor faces and that you want to provide him or her with additional information that will help him or her determine the fair market value of your property. iv. Seek to move the Assessor s value a little, then work on the disputed points one by one. 5. Settle the case? If not, then it s time to develop our game plan. C. The Game Plan: It s more like chess than bowling. 1. Analyze the Assessor s valuation and his strategy, and then, be responsive. 2. Find the flaws in each of the Assessor s approach to value, then determine the evidence you need to prove the flaws. 3. Tailor your presentation to your strategy. Your appraiser needs to be onboard with the case strategy. If you have two appraisers, they must be in sync. 4. Review the prior Board decisions for this property, if any. 5. Case study #1: Integrated Warehouse Distribution Facility: Highlight the Assessor s error A retailer s integrated distribution warehouse was assessed by the Assessor based on historical costs of the real and personal property. This led to an assessment that greatly exceeded the fair market value of the property for two reasons: (1) The historical costs were high due to the warehouse being built in two stages; (2) the efficiency of distribution warehouses built after the subject property was significantly improved by new technology, resulting in huge savings in employee expenses. This functional obsolescence had not been adjusted for by the Assessor. For several years, the taxpayer had challenged the assessments unsuccessfully. Each year, the Assessment Appeals Board ( AAB ) denied the appeals, despite the Norwood, Landolt Page 7

8 taxpayer presenting a solid case by competent appraisers. The taxpayer s case was based primarily on the sales comparison approach using sales of large industrial warehouses. However, the Assessor persuaded the AAB that this was a very specialized distribution warehouse and therefore the comparable sales were not truly comparable. This special use argument is commonly used by Assessors to persuade AABs that all of the historical costs related to the facility should be assessed. A review of the AAB s decisions revealed that the AAB sided with the Assessor and disregarded the taxpayer s presentations. Based on this, we prepared our appraisal as a special use property done correctly. That is, the functional obsolescence was quantified by the discounted value of the excess employee expenses inherent in this older facility. As a result, the Assessor reconsidered their position despite winning every year at the AAB. A significant tax reduction was agreed to and the case settled. III. Game Time: A. Case Study #2: Food Processing Plant: Use the Assessor s method against him/her A large plant producing dairy products was operating at nearly full capacity throughout the Great Recession. For this reason, the Assessor refused to recognize any economic obsolescence at the plant. Because of the economic downturn, however, nearly all industrial facilities decreased in market value. Many plants had been shuttered. Others sold at a fraction of their former value. Few manufacturers were looking to expand and financing for purchasing large industrial facilities was hard to find. The weakness of the Assessor s case was that he failed to recognize any of the effects of the downturn, arguing that since the plant was operating at full capacity, its value had not decreased. By taking such an extreme position, the strategy of the case was fairly straightforward get the Assessor to admit on cross-examination that this facility suffered from economic obsolescence and that he had failed to adequately investigate or quantify such obsolescence. This was combined with a strong appraisal based on comparable sales, and a cost approach with a proper obsolescence analysis. When he was asked if his house was fully occupied and whether it had nevertheless gone down in value, he answered Yes. When asked if the subject property was somehow immune to the decline in value experienced by all industrial and commercial properties, he finally admitted that the subject property had probably also been affected by economic obsolescence. The AAB enrolled our appraiser s value resulting is a reduction of over 50%. B. Case Study #3: Food Processing Plant: Point out the Assessor s inconsistencies One of the largest processed fruit and vegetable companies in the U.S. had recently converted a mixed-use cannery/frozen product plant to only produce frozen products. As part of this conversion, significant portions of the plant were either abandoned or repurposed to support the frozen production. The company spent millions of dollars on the conversion and renovating a dated and functionally obsolete facility. The costs incurred during this process resulted in a dramatic increase of their assessed value. However, the company knew the market for frozen processing plants and internal operating results wouldn t support their recent investment. The company and their tax consultant decided to move forward with an appeal of the property. Norwood, Landolt Page 8

9 The team approached the Assessor and secured a significant obsolescence adjustment of nearly 40% for pre-conversion assets. The Assessor, however, refused to budge on the recent additions and new construction. At that point, a property tax attorney was added to the team and refined their strategy. The team s new game plan focused on simply asking the local board to treat all the assets fairly and apply EO to all processingrelated improvements. The team also knew they could bring in an appraiser knowledgeable about the market for freezing plants and make their case based on financial performance and recent market transactions. The Assessor also engaged an expert who was unfamiliar with the subject s industry. At hearing, the Assessor s expert presented his analysis based on all three approaches to value; however, the sale and income data relied upon were of dissimilar types of properties. The company s expert provided unrefuted sales and income data directly from the frozen processing plant market. The Board s final decision substantially adopted the opinion of the company s expert. IV. Post-Game Analysis: After the appeal is over, it s time to evaluate whether a further appeal is warranted. In jurisdictions where a trial de novo is available, it is often worth trying again if the administrative board failed to provide adequate relief. The cost of having the appraiser and attorney reargue the case is much less than the initial cost of preparing for the presentation given to the administrative board. But in jurisdictions where the administrative board s decision will only be overturned if there is either no evidence that supports it, or if the board made a legal error, your attorney will have to review the board s findings to see if an appeal is warranted. Most of the time in such jurisdictions, the chances of success on appeal are poor. If the board made no legal errors, it will be highly unlikely that its decision will be overturned. It greatly increases your chance of a successful appeal if the case was originally presented with an eye to highlighting the legal issues in the case. Norwood, Landolt Page 9

10 Appendix: Trending Error Check List & Recent Decision The following is a list of common trending errors made by trended investment practitioners: 2 The use of indexes and trending can easily lead to erroneous results. The following cautions are offered: Indexes generally do not reflect technological advances that may actually reduce cost new; thus, trending does not indicate replacement cost new or provide a means to measure the difference between reproduction cost new and replacement cost new. Trending should not be applied to anything other than a historical cost, that is, the cost of a property when it was first placed into service by its first owner. The appraiser should be certain that the cost to which a trend factor is applied is actually the historical cost, and not a cost resulting from a prior allocation of purchase price or a used cost. The historical cost that one is attempting to trend may not be typical cost; that is, it may include extraordinary costs or exclude indirect costs, and so on. Cost indexes are based on average values, but specific cases (including the subject property) may differ from the average. Trending the costs of used equipment is improper because costs of used equipment are generally not impacted over time at the same rate as new costs. Caution should be exercised regarding the use of trending for periods in excess of ten years, unless the accuracy of the trended result can be independently confirmed by comparing it with the results of other methods of estimating cost new. This is especially true when using a broad-based index or in periods of relatively high inflation. The index factor should match the subject property; hence, the user should know at least the basics of how the index was developed. Trending can be a useful tool in developing an effective or average age of an investment in a complex property such as a petrochemical plant that has investments that span many decades. While the previous list is not exhaustive, it does provide a detailed understanding of several issues that impact the credibility of a trended investment analysis. If the assessed value is based on a trended analysis, then each of the common trending errors should be reviewed and analyzed. In a recent case before the Idaho Board of Tax Appeals a review of common trending errors proved to be a critical factor in the Board s decision. 3 Norwood, Landolt Page 10

11 Appellant challenged the validity of Respondent s trended investment technique with respect to how it was applied to the main processing facility. Citing excerpts from an appraisal manual published by the American Society of Appraisers, Appellant argued Respondent s model was improper. Specifically, [t]rending should not be applied to anything other than a historic cost, that is, the cost of a property when it was first placed in service by its first owner [t]rending the costs of used equipment is improper because cost of used equipment are generally not impacted over time at the same rate as new costs. Appellant noted Respondent used 1995, the date Appellant purchased the Plant, as the starting point for assessing the equipment. Because the equipment was not new at the time of the Plant s purchase, Appellant contended Respondent s trended investment cost model was inappropriate and should be disregarded. The Board s Conclusion: In determining the assessed values of the subject parcels, Respondent relied on the trended investment cost method. While the approach is a widely used and long accepted appraisal method, the model developed by Respondent was found to contain a material weakness as related to the Plant s main processing area Respondent used cost figures from 1995, the year Appellant purchased the Plant Consequently, the starting point of Respondent s cost approach model was found to be imprecise or at least problematic. Cost-Based Valuation Metrics & Review: After testing for common trending errors, the next step in the testing process is to review and analyze a broad base of valuation metrics. The metrics can be broken down by the three traditional appraisal methodologies Cost Approach, Sales Comparison Approach, and Income Approach. While an in-depth analysis of each approach is outside the scope of this paper and the PAT process, a focused review of a handful of valuation metrics and their application can prove critical to supporting your appeals decision and the overall strength of your case. The Cost Approach can be estimated using a variety of methods and techniques. The most common method for mass appraisal and assessment purposes is the trended investment method described above. However, other cost-based methods are typically used for valuing a stand-alone facility or group of assets. Regardless of the method used, the cost-based analysis begins by estimating the replacement or reproduction cost new ( RCN ) of the asset. While the development of a detailed RCN is well beyond the scope of analysis needed for the testing process, a quick review of historic costs, as well as, recent construction costs of similar facilities, can uncover critical errors in the development of the assessed value. Replacement vs. Reproduction Cost New: When applying the cost approach the appraiser/analyst must distinguish between two cost bases reproduction cost and replacement cost and consistently use one of the two throughout the analysis. 4 While reproduction cost new is often considered the classical starting point for the cost approach, replacement cost new is commonly used as it may be easier to obtain and can reduce the complexity of depreciation analysis. 5 Norwood, Landolt Page 11

12 For limited-market facilities like processing plants and industrial facilities, replacement cost new is generally considered the appropriate starting point of the cost approach analysis. 6 Reproduction cost new is not often particularly useful to an appraiser as it is only relevant to an estimate of market value if the property would actually be replaced by one that is identical in terms of design, materials, and workmanship. 7 Given the significant changes in technology and design of most industrial facilities, replacement cost new is typically the most appropriate bases for a cost approach analysis. Reproduction Cost Approach 8 The reproduction cost approach, as a variation of the cost approach, has limited usefulness because it uses reproduction cost (the cost to replace an existing property with an identical property, a replica) as a basis for estimating value. It is frequently not possible or desirable to duplicate an existing property, due either to the lack of certain materials or trade skills or the functional obsolescence of a property. The difficulty of using reproduction cost increases as a property ages. When a property would not be exactly duplicated, as is often the case, reproduction cost loses validity as an indicator of market. This lack of validity can be overcome if depreciation is accurately estimated, but this can be somewhat difficult to determine for an exact replica. Replacement Cost Approach 9 Replacement cost is the cost to replace an existing property with a property of equivalent utility 10 as of a particular date. The replacement cost concept is the most meaningful as far as the principle of substitution is concerned. In the replacement cost approach, elements of a property that would clearly not be included in a substitute of equal utility are excluded from the estimated replacement cost. For example, a buyer may not look for an identical new property to replace an older property. The buyer would look instead for the best way to perform the same function(s). The best way may be to use the latest state-of-the-art technology and materials, or may be another used piece of equipment able to perform to specifications of equivalent utility. In making this decision, a buyer would look at various aspects of available properties. These considerations include, but are not limited to, the cost to acquire each property, the age of the properties, the remaining expected lives of the properties, and the expected cost to operate each in comparison to the property being replaced and to each other. Based on the generally accepted definition above for replacement property, a new property would need to replace the current service or production. It is worth noting, as Professor James Bonbright states in The Valuation of Property, that: Most physical properties are not replaced by properties of the same size, design, and materials. They are replaced by materially different properties of a more modern type, better designed to meet the owner s present needs 11 Therefore, a replacement cost approach is often considered the preferable method for limiteduse properties and older facilities that have been constructed over time. Norwood, Landolt Page 12

13 1 The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, IL, 2013, pg Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets, 3rd Edition, 2011, pg Selco Seneca Consolidated v. Twin Falls County Assessor, 2013 ID, Appeal NOS , , 13- A-1181, and 13-A Final Decision and Order, April 21, The Appraisal of Real Estate, 14th Edition, The Appraisal Institute, Chicago, IL, 2013, pg Ibid. pg Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets, 3 rd Edition, 2011, pg Assessor s Handbook 502 Advanced Appraisal, California Board of Equalization, December 1998, pg Assessor s Handbook 504, California Board of Equalization, October 2002, pg Ibid. pg Rule 6(d) provides that the "replacement cost of a reproducible property may be estimated... by applying current prices to the labor and material components of a substitute property capable of yielding the same services and amenities, with appropriate additions. 11 Valuing Machinery and Equipment: The Fundamentals of Appraising Machinery and Technical Assets, 3 rd Edition, 2011, pg. 41. Norwood, Landolt Page 13