On this episode of The Mobile Home Park Lawyer Podcast, Ferd explains to us how to underwrite property taxes. Ferd’s checklist shows us how to get the most, or should I say least, out of your tax bill. Enjoy!
“In today’s market, the cap rates are compressing and prices are going through the roof. So one of the things you’ve really got to do a good job with is doing your property tax projections.”
0:00 – Intro
0:58 – It’s very important to do a good job with property tax projections
1:53 – Property tax appraisers have values lower than the current market value
2:59 – Property tax assessors don’t want to raise the property value and annoy voters
3:33 – There’s a risk when you purchase a property that your taxes are increased
4:11 – Ferd looks at the current market value in accordance with what the assessor tells him
4:26 – Looking at the purchase price
6:19 – Ferd’s formula for calculating tax dollars
9:08 – Know your jurisdiction to calculate your paying
9:48 – How probable will a tax increase will be?
15:34 – You should underwrite some percentage of increase
15:54 – Strategies to mitigate the risk
16:51 – Allocate some of the purchase price to non real estate items
17:59 – Try to flag the sale as invalid by throwing something unusual into the contract
20:05 – Buy the LLC membership units
21:25 – Another risk is bankability
21:51 – Get mutual or buyer indemnification provision pre-closing
24:12 – There are going to be extra filings for tax returns
Welcome back mobile home park nation. Here again today with another episode of The Mobile Home Park Lawyer podcast. And today we’re going to talk about something that’s really near and dear to me, I’m talking about property tax projections, which is really part one of a two-part series here. And number two will be property tax appeals. Cause the two kind of go hand in glove.
I feel like in today’s market, the cap rates are compressing and prices are going through the roof. So one of the things you’ve really got to do a good job with is doing your property tax projections. For most of us professional investors and operators, we looked at either by a stabilized asset that probably has stabilized operations and property taxes or more in my case, I like to buy assets that are kind of bruised and broken and need to be improved. Well, whenever I do that, I hope to be more efficient for most areas of management, frankly, like lower management costs, so I’ve met her water, push the rents, cut the expenses. Just really try to negotiate trash contracts really anywhere I can to try to get better insurance bids, all kinds of stuff to try to increase my net operating income. But the one area that would likely going to lead to higher expenses for me is property taxes. And the reason for this is by and large property tax appraisers, property tax assessors nationwide have values that are lower than the current market value. And they typically do not increase the value over time with inflation in particular, mobile home parks are largely owned. Majority owned it’s still at this point by mom and Pa. Well, mom and Pa owned it for 40 years, there’s been no sale to like trigger the assessor to go do his or her job and go reassess the property. And I’ve got a lot of experience in appraisal as an assessment, I was previously the property tax assessor for Jackson County, Missouri here in Kansas City. So I had about $325,000 real estate parcels that I was responsible for. And I had a 70 person team and $6 million operating budget, an $8 million overall budget and lots of consultants. And it was a big job. But what I learned was most all of my predecessors had no stomach to increase property values and really statewide in the state of Missouri that was the case. And the reason was they didn’t really want to get the heat. They didn’t want to have to deal with appeals. They didn’t want to lose reelection. I was, I think there are 115 counties in Missouri. I was one of one that was appointed. The other 114 were elected. So I didn’t have to play the politics game to become a County official, but these other guys do. So they don’t want to Jack the values up and piss off their friends and family and piss off the people that have helped them get elected.
So that has all led to current market values being below what they really are in the real marketplace. And there’s a great risk when you sell a property, when you buy a property, excuse me, that the taxes can increase. Because if you’re buying a property for a million dollars and that’s what it’s really worth, but the assessor has it on the books for $250,000, it’s possible. He’s going to give you the, Hey, welcome to the neighborhood call, where they chase your sale and they increase your property taxes. So you have to really look into that before you buy and really during your underwriting. So you can properly account for that. So we kind of that being said, I’m going to jump into just kind of some of the techniques and tactics that I use when underwriting property taxes.
The first thing I do is I look at the current market value in accordance with what the assessor tells me. If the assessor says this property is worth 250,000, and I know I’m paying a million, like, okay, it’s possible I’m going to have a problem coming down the pipe. So I look at my purchase price, man, that’s the second step. The third thing is really to look at is, is this a disclosure state? So like in Missouri here. It’s not a disclosure state statewide, but Jackson County and St. Louis County do have, what’s called a certificate of value. That’s a disclosure document. What that does is, if I buy this property for a million dollars, the County assessor is going to get a notice of it. And he, or she may decide to get out in the field and take another look, dust off their paperwork and sharpen their pencil. And I might get a million dollar valuation. Obviously that’s going to impact my net operating income post-closing. So I need to take that into consideration. Other States like Kansas is a disclosure state, whole statewide.
So that’s another problem. State by state, you got to look at the code, look at the rules, look at your local jurisdiction and see if there’s a disclosure process. If there’s not, then it’s, you can be a lot more aggressive and underwriting, cause it’s a lot less likely that you’re going to get hit with an increase. Sure assessors could still find out about the sale. I typically put a confidentiality provision in my purchase contract that precludes and prevents the seller from being able to disclose it except as required by law, by a governmental agency. So when the case was not disclosure, they could still report the sale to the IRS, but that doesn’t get to the County assessor. I don’t want them to report it. I don’t want to go down to the bowling alley and be bragging all their friends. They sold their trailer park for a million bucks and they’re rich. Because it could come back to bite me. And typically the assessors don’t find out. I mean, I just, you know, being in the business, I didn’t find out sales. I was too busy doing my regular day job. I was not talking to every broker, especially, you know, mobile home park brokers were few and far between back then. And at least in my metropolitan area really didn’t, I didn’t even know about any sales going on in the mobile home park space.
So next, when you know the market value, you know what you’re paying, you know, you’ve got, it’s going to get disclosed. You got to start to calculate the impact of tax dollars. And this is a relatively simple formula and again, it’s going to depend on by state, but so I’m going to use my example here of a million dollar purchase. So I take a million and I multiply that by a fraction that is the assessment ratio and assessment ratio comes about because state legislatures or perhaps the state constitution determined a long time ago, or maybe recently that they want to have disparate in different burdens to pay the property tax bill for the government and in Missouri. There was the general will to have farmers pay less and have business owners pay more. So the assessment ratio is 12% for Ag 19% for residential and 32% for commercial. So, 32 is bigger than 19, right? So you want to be residential, mobile home parks in Missouri are considered residential. And so, or even apartment complexes and this is distinct and kind of irrespective of the zoning classification that this is an assessment classification, and this is kind of their state law on this, but there’s also can be some subjectivity at times of the assessor, but I take my million times 0.19 for 19%. And then I get, that equals $190,000. That is my assessed value. Then I take that number divided by a thousand to convert it into mills. Mills is a unit of measurement. It’s basically one, 1000th. So that gets me 190. Now I need to take at times my levy rate, and I’m going to use the levy rate of 92, which is kind of typical in this region. And the levy rate is comprised of all the individual tax levies that the certain government agencies are allowed to charge. For example, your school district, your fire district, or library your city, your County, your road district, etc. This is going to differ greatly from jurisdiction to jurisdictions. You got to look this up. Your County assessor will have all this information and so should your County collector. So I take my 190 times 92 that’s 17,480. That’s how much my property taxes could be, which is exactly four times higher than they are currently for mom and pop.
So to kind of compare that. I take that as a function into 17, 480 into my purchase price of 1 million, that’s 1.7%. So residential, Missouri, it’s about 1.7% tax burden, Illinois for example, mobile home parks in Illinois, It’s going to be higher. Some States, you know, Texas, Florida, they don’t have an income tax. You’re likely going to pay higher property taxes. And if you make income, if you’re a surgeon and you live in Texas, that’s great. But if you’re a landlord and you own real estate and you live out of state and you’re not saving on the income taxes as much, but you’re getting hit with the real estate taxes. You just got to know your jurisdiction to calculate your pain. Cause obviously if I do this 17,800, 17,480, if that’s an expense, that’s going to hurt me for my appraisal for a refinance or for a sale from evaluation. If I take that at a five cap, for example, that’s a $349,000 decrease in valuation versus if I was tax exempt and you’re never going to be tax exempt, but you still don’t want to pay more taxes than you really have to.
Let’s be honest. Taxes are, you know, necessary, death and taxes. Well, I don’t want to pay as many taxes and I don’t want that quite yet either. But anyway, back to this regular scheduled program, I started to look at what is the probability that this tax increase is going to happen. That is going to occur. So I have to look at a couple of things. I look at, when does the reassessment cycle and how frequent is the cycle. So for example, here, Missouri property is reassessed every odd numbered years. So 2015, 2017, 2019, 2021. In Kansas, it’s reassessed every year. In Illinois, it’s reset every four years. And then sometimes the reassessment has phases in the entire property records or all the properties are not assessed in a given cycle. So for example, when I was the County assessor, we had a two year requirement, but we were part of a state tax commission approved six year plan, which basically meant we only did one third or did a close review of one third of the properties in a two year cycle. So you’ve got potentially six years before somebody shines a flashlight on you. So in that example, if mobile home parks were last year and I’m buying this year, I might have up to five years of, ability to escape review. And at that point, maybe they’d forget to look for you at all. Versus like in Kansas, they look at it every year. They may catch it in Kansas is a disclosure state. So you’re much more likely to have an increase I think in property taxes, buying this million dollar park as assessed at 250 by the assessor, you’re much more likely to have a tax increase in the state of Kansas than you are in state Missouri or the state of Illinois. Now, again, it doesn’t mean your tax dollars won’t be impacted based on just one factor because like in Illinois, the property tax rates are typically higher. The assessment ratio is 33 and a third for residential as opposed to 19%.
So you got to look at all these factors, but I basically I just look at the risk of reassessment, and then here’s another great opportunity to assess your personal risk is look at, were there any other sales or similar sales? So, I mean, if there was another mom and pa park that sold last year for a million dollars and it was on the books for 250, go see what happened to the appraisal from the county. If the county increased at 2.2%, like the rest of the region, then you could probably have less risk. If the county chased that sale, now get into chasing sales or spot appraisals, which are kind of verboten in the industry, but happen all the time. I’ll get into that in the next episode, talking about tax appeals. But ultimately if something happened to the last guy it’s probably going to happen to you, it doesn’t mean you can’t win an appeal. We’ll get into that. But I look at the similar sales and then I also look at comps. There’s no sales, just look at comps and none of necessarily sales comps, but other valuation comps. And what are they valued at per pad? If this $1 million sale is a 10 lot mobile home park, okay, well, you’re paying a hundred thousand per pad. What are the other properties in the books for? The other properties are in the books for $5,000 a pad or $50,000 a pad. And you’re going to pay a 100, in the event they do increase you. You’re going to be setting yourself up for a future tax appeals, because tax appeals can be one based on a number of categories, but really it was the valuation not fair. And is it not accurate? So it’s currently accurate if you pay a million dollars and that’s the real value, but it may not be fair relative to your peers. So really just looking into all those factors will give you a feel for the probability, whether or not the pain is coming. And then you can, you can kind of blend that into how much you want to underwrite that pain.
Next. You could call the County assessor. Now, I would do this anonymously. And I would probably not start with a mobile home park. I would call and say hey, I’m thinking about buying an apartment, or I’m thinking about buying a multifamily property. It’s on the books for 250,000. I’m thinking about paying a million. Could you help me figure out what my property taxes are going to look like a year from now? And sometimes they’ll come out right out and tell you, Oh, we’re going to, well, we’ll put it on for $1 million. That’s what you payed. Sometimes they’ll say, well, I don’t know. I mean, how big is this one property? And we know we kind of do mass appraisal and assessors do mass appraisal in more sophisticated counties. They do computer assisted mass appraisal (CAMA), which is basically statistical analysis and regression analysis because they don’t have the manpower to go reassess 325,000 parcels. So we were, we only had, I don’t remember the number when I was an assessor, call it $20 of budget per parcel. Not very much compared to you get a fee appraisal for commercial properties, $3,000 or $4,000 for residential houses, $350. Well, those guys are doing a more detailed micro level analysis, which actually may not be more accurate than statistical analysis, but that’ll be a discussion for another day.
So you could call the assessor, you could call local appraisers or tax appeals specialists, and you could, there are generally tax reps for tax people in every jurisdiction and ask them their opinion and number seven you can just be subjective, okay, this is a little risky, but you can be like, okay, you know what? I’m not going to underwrite this at a 4X. Property tax increase, if I do this, it’s going to kill my deal. You know, do I just want to just do a straight increase 4X? Well, you could do that, but you might miss a lot of deals, but it seems better to miss a bad deal than buy a bad deal. So there’s definitely some trains of thought on that. But at the same time, is there some sort of blend of subjectivity when you factor all these things together? You know, I’ve done that sometimes be honest.
And I know there are people out there who can disagree with this, and say you have to go the straight increase or you’re going to be in trouble. I bought mobile home parks for the last six, seven years. That really only had happened I think once where my property taxes went up substantially. And that’s one that I paid double what the market value was in the appraiser and I’m in the process of a tax appeal on that. And I’m very confident to win the tax appeal. And well, then I will have zero nightmare scenarios, but again, for underwriting, you probably should underwrite some level of increase, maybe 20, 25%. I don’t know, about 400%, 300% relate to each their own. But what I do is like on everything I continually evaluate, okay, continually evaluate the risks. And just the fact pattern and getting gathered more data and the last kind of combination I said think for an underwriting. I think as I say, strategies to mitigate the risk, and there’s really kind of four ways to do this, the first would be you appeal the property taxes pre closing. This is pretty rare, but some States like in Missouri, for example, if I appeal and the assessor settles or I win that’ll lock in the rate and the amount for the next year, if it happens in a non-reassessment year, I get two years, or sometimes you can even get three years depending on how that’s set up with the assessor, which may or not be valid, but some assessors do it where you get a three year freeze. So you could negotiate for this in your purchase contract and then underwrite it pre closing. I’ve actually done that before, but I don’t know if I’ve ever seen you ever heard anybody else even mentioning it. So I don’t know that it’s like a best-in-class strategy versus a, keep it in your hip pocket, cause you may need to do it. And it may be of benefit to you.
So the second strategy mitigate your risk would be allocate some of the purchase price to non-real estate items. So this is one of the key provisions in my purchase and sales agreement is that I get the right as the buyer to allocate the purchase price. And I can allocate, let’s say I’m paying the million dollars. I could allocate 100,000 in mobile homes. I can allocate 300,000 to good will. Now this is in a non-reporting state, then that’s not necessary. Okay. You just do it exactly right down the fairway what makes the most sense. But sometimes there’s some subjectivity. If I’m paying a million, maybe I’m paying a million, but that’s worth a million, two or three or four to me. Okay well now I’ve got more pieces to add up than the total pie. So I can maybe say, Oh, I’m going to put some more here, some more there, it’s got to be reasonable. You’ve got also be ready to be subject to the IRS audit some point. And then we can get into this for purposes of the cost segregation and tax depreciation and amortization in a later episode. But ultimately you could do some of that and just recognize there’s an income tax impact down the road. But for purposes of, if we’re just looking at property taxes today, the lower amount on the real estate components, real estate land and real estate improvements and real estate buildings the better from a tax appraisal.
Okay. Number three, into this category of strategies to mitigate risk would be trying to flag the sale as an invalid. And by this, I mean, when I was using computer assisted mass appraisal, it was, you know, it was a big computer program, right. Data in data out. So garbage in, garbage out. So the assessors don’t want to put in non-valid sales. So we had on our certificate of value, which was our sales disclosure form. We had a checklist and that checklist basically give you like 10 or 12 options you could check that would deem this not a market sale. Things like it was sold to a related party or it was inherited, or it was bought at a foreclosure, or it was a partial sale. You only sold a partial interest. I sold a mobile home park in Illinois. I don’t know, three years ago. And I didn’t sell a hundred percent. I sold like 97% and I kept 3% and it was part of the deal. And then I also bought four other parks with these guys at the same time. So as a result, I was a business partner. It was a partial sale. I was left on as the manager. And that was part of the deal. So there was other compensation and incentives for me. So that’s not a normal transaction. Now the price they paid was a normal price, but the assessors doesn’t know that. So if I check that box, partial sale, or there was another option is distressed sale or personal property was included mobile homes, throwing the pool table just to, you know, maybe you seriously say hey, I’m going to throw in the pool table for an extra dollar. Then you get to check that box. And then, it could get thrown out of the computer program. Cause assessors have sometimes have too much work where they’re too lazy or they’re not going to go dig into these sales and they just throw it out. Well, that means your sales, not in the big algorithm, but it also means it’s not going to get specific scrutiny, which can let you kind of live another day. Now you can’t lie on this form either generally it’s under some form of affidavit at closing. And again, this is largely irrelevant if it’s a non-reporting state. Not reporting state, man, I would be really a lot more aggressive on underwriting my property taxes, in my deal.
The fourth strategy. And this was going to be controversial as heck. I can tell you that, it’s buy the LLC membership units and I’ve only done this once, but it was actually a related party. But it happens more in like retail and some other, you know, restaurant and build a suit type projects, by buying the membership units. So for example, I’m buying this for a million bucks instead of buying the real estate from John Smith, LLC, I’m going to talk to Mr. Smith and say, Hey, let me buy the membership rights to your company John Smith LLC. Now it doesn’t work very easily if John Smith has 50 properties in that, LLC. Okay, this is going to be, but most sophisticated people, with true ma and pa is not going to work, but if it’s a semi-professional or professional owner-operator, they probably only have one property in an LLC. You could buy the membership units, some people, some lawyers, but really the non-lawyers in particular would say, don’t ever do that. It’s a huge nightmare. Huge risk and there are some risks, okay. But I think there’s ways to mitigate the risk.
So one risk is environmental. If John Smith LLC did not get a phase one environmental, then you’re not going to have the rights to be the buyer in good faith and get the benefit of that. Now you can still get your own phase one environmental that will protect you to some degree, at least don’t know about it, but it’s not going to be the same as if you were protected as the name and title person. So that’s a risk.
Another risk is bankability. I mean, your lender has to understand, Hey, I’m not buying real estate. I’m buying membership units. Now the membership units of the LLC would have the rights and ownership of the real estate. So a quasi-sophisticated or sophisticated lenders should get that, but it could cause a little bit of challenge. And sometimes you’ve got programs that are just lending programs that are so rigid that they say you must fit in the box, you know and then if you don’t fit in the box, you don’t play. So that’s an issue. To get over some of the environmental stuff. And just in general, you want to have a mutual or at least for the buyer, you want to have an indemnification provision pre-closing. So if Mr. John Smith did not rent a mobile home to somebody because they were white, black or purple, that’s going to be a violation of the FHA. So in HUD housing laws and stuff. So I don’t want to, the day after closing gets sued, because somebody who was purple comes up and says I discriminated, or my company that I now own is discriminating. So you would need to have a mutual indemnification of the date of the membership interest transfer. And that’s one of the reasons that why I’m okay with the strategy, because if you put that in there, you’ve got some protection.
Now the protection has to have some teeth, which I would generally like to say to be personal liability in recourse to John Smith person, and if John Smith person didn’t have any money or he dies or he goes out of the town and you can’t ever find him that may not be worth it to wait. So it’s a risk, but it could be worth it to potentially save on property taxes. I know here in Kansas city was working on a retail deal and it was a multi-tenant restaurant building, a couple of national tenants who had good credit so that the cost of construction was way lower than the eventual investment sale price. So once we sold it, the price went through the roof on the property taxes who’s in Kansas, they chased the sale and the new owner was stuck with this huge property tax bill. And eventually the tenants started to go belly up and national tenants and they subleased the space cause they couldn’t afford the taxes, which in retail is typically pass through to tenants on a triple net basis. But that’s for a career of yesterday.
So anyway, indemnification bridges can work. The only downside I think for the seller is he or she can’t really do a 1031 exchange because the memberships are intangible personal property. And before 2017 tax law changes, you could do some 1031 with personal property, but now you can’t. So if Mr. Seller wants to not pay gain on his million bucks, you’re not really helping him because he can’t go buy like kind real estate. Cause he didn’t sell real estate. He sold shares of a company basically, which are membership units. So that’s something to take into consideration. And then also there’s going to be a little extra filings for like tax returns because John Smith LLC is going to have to file basically two returns. You know, one, let’s say you close on June 1st. Well one before June 1st with Mr. John Smith getting a K1 and then another tax turn from June 1st to the end of the year with Ferd and his investors on the K1. So it does make a little more complicated, but that is another strategy to mitigate risk.
So as you can tell, there’s a lot that goes into property tax projections, there can be lots of different opinions. I’d love to hear yours. You can get a list of this stuff. Go into my website, www.themobilehomelawyer.com. And this is episode one, stay tuned, or just let the tape roll. And we’re going to jump into property tax appeals, which can help solve your problem if these strategies didn’t work for one reason or another.