WHITE PAPER: Examining New York City's 21/22 Tax Assessments7 Mar 2021
By Brandon Polakoff
With New York City facing a major budget deficit, and property taxes serving as a financial lifeline, investors have grown very wary of future increases that can eat away at cash flow, and ultimately, their equity.
Properties consisting of 10 residential units or less (Tax Class 2a and 2b) have not been as highly scrutinized since assessments are capped at 30% increases over 5 years with an 8% max increase in a given year. Consequently, these properties are experiencing an uptick in demand and sales velocity.
Unfortunately, commercial buildings and apartment buildings with over 10 residential units (Tax Class 2 and 4) are not offered equal protections. Investors quickly assume New York City will phase taxes in until they reach 30% of effective gross income, provided they are below this figure. This thesis has often widened the pricing gap between buyers, who are waiting for the hammer to fall for under-taxed or value add properties, and sellers who want to focus on their current tax bill.
When analyzing Tax Class 2 and 4 properties for a prospective client, I proactively determine if property taxes as a percentage of gross income or potential gross income are below the 30% figure a buyer will anticipate. There are two major drivers for low taxes. The first is the owner is not properly filing their Real Property Income and Expense (RPIE) statements. The second involves the impact value creation has on taxes, whether already completed or forthcoming, to achieve full income potential. As it relates to value creation, the former (already completed) can be easily observed through a major gap between transitional assessed value and actual assessed value. The latter (forthcoming) must be estimated.
Following a complete property analysis, if applicable, I am forced to explain to an owner how a tax projection was priced in. I can assure you it is always a difficult conversation. However, I strongly believe over promising and chipping away at pricing after the fact due to a poor analysis is not the proper way to do business.
...and then the 2021/2022 Notice of Property Values were released, and my eyes lit up. Tentative assessments were falling* almost everywhere. Sure enough, one owner I recently prepared a valuation for reached out to let me know their tax bill will drop $25,000 and their anticipated price went up $500,000. Another owner I am representing proclaimed I can present a better cap rate since his property taxes will drop $32,000. At first, I wondered if the city truly recognized the financial strain placed on owners due to COVID-19. Finally, a win for the owners.
Then it hit me. This is too good to be true. 2021/2022 assessments should be based on 2019 RPIE filings, which would not take COVID-19 into account.
I was eager to get to the bottom of this and decided to speak with a proficient property attorney, Tyng Patka of Duval & Stachenfeld LLP.
As Tyng explained to me, New York City did indeed cut assessments (tentative) throughout the city, leading to reduced property taxes commencing in July 2021. Furthermore, the uniformity and amount of the reductions was unprecedented. She also told me that she observed a multifamily property on the Upper East Side realize a 10% decline in future property taxes, while a comparable property in Clinton Hill, Brooklyn attained a 15% decline. Even more, there were hotels that had 30-40% reductions.
I asked her for the rational, because as mentioned, 2021 assessments are based off 2019 figures. While she confirmed this, what she also explained is that New York City is able to take into account the status of the property on January 5, 2021, and in turn, the assessors determined value based on both 2019 figures and the current status of the property.
From there I started to wonder if concerns raised by buyers surrounding rapidly increasing taxes I priced into my valuations were irrational. It was then I discovered the catch.
According to Tyng, it appears New York City decided they were going to drastically cut assessments, possibly to preemptively fend off public outcry over 21/22 property taxes that do not reflect reduced gross incomes. However, it is widely accepted that a looming rise in tax rates will offset these tax reductions. This is an even bigger problem, as tax rates cannot be challenged. It is indeed is too soon for owners to do a happy dance.
I wonder where we go from here. It seems like the job just became much harder. How do I now explain to owners that they are going to see their tax rate shoot up and they should not consider their reduced assessment a sustainable boost to their net operating income? How do I give zero credit for this? I do not believe buyers will attribute much value to these reductions, if any, and it is going to be another hard conversation as we try to narrow the gap between buyers and sellers so that we can finally begin to see sales velocity pick back up.
*Pay attention to the 2020 transitional value (“transitional”) compared to the 2021 actual value (“actual”) to see whether you can actually expect a lower tax bill (assuming no change to the tax rate). You are billed on the lower of the two types of assessments and most owners pay on transitional. However, there will be instances where you will still be paying higher taxes in 2021 because the reduced 2021 actual, while lower than the 2021 transitional, is still higher than 2020 transitional.