More than $9 billion worth of commercial real estate assets in Canada are at risk of underperforming due to reactive property tax management, according to a new study from Altus Group.

Terry Bishop, Altus Group’s president of property tax for Canada. (Photo courtesy Altus Group)

“Many firms view their property tax expenses as a fixed cost and are therefore reluctant to invest the required resources to manage the expense unless they get into a crisis situation such as a property with really high vacancies where they’re not able to recover their taxes from tenants,” said Terry Bishop, Altus Group’s president of property tax for Canada.

“Those firms that are focused more on cost rather than return on investment, in our opinion, are leaving money on the table by not proactively reviewing the property tax assessments for their portfolio.”

As commercial real estate values have increased, so have property tax assessments and liabilities — to the point where property tax is the largest single operating expense for building owners.

However, the “Tax as the New Strategic Driver” report reveals investors can leverage tax planning more strategically to realize operational and transactional efficiencies and unlock greater asset value.

“Not managing your property tax expenses leads to downward pressure on net rents and results in reduced valuation,” said Bishop.

Survey included 200-plus executives

The report is based on a quantitative survey of more than 200 executives in property tax and finance roles who deal with real estate tax matters at firms in the United States and Canada. All participating firms had assets under management of at least US$200 million in the spring, representing an approximate aggregate total of more than US$350 billion.

Compared to the commercial real estate industry’s level of analysis typically applied to the review and control of property management costs, the limited attention paid to the tax line item becomes more pronounced.

Tax data needs to be collected from a variety of sources and can often be fragmented and incomplete, or it arrives as raw data that must be properly aggregated, vetted and analyzed to derive trends and growth factors that can assist decision-makers in budgeting real estate tax expenses across their portfolios.

More property tax analysis needed

Fifty-two per cent of survey respondents said they lack the tools to analyze property tax information, and 44 per cent said they lack the expertise and resources to identify property tax data sources. Many firms haven’t yet invested in the tools and resources needed to produce accurate forecasting at the transactional or operational levels.

The lack of analysis of historical or benchmarked tax data has led to an industry standard of applying a static growth rate to the property tax liability for budgeting and underwriting purposes. While a property tax growth factor of three per cent is typically applied, Bishop said each property should be considered individually to eliminate potential inaccuracies.

“Taxes don’t typically grow at consistent rates. There are many factors involved, starting with the requirements for local taxing authorities for their capital infrastructure and operations.” he said.

“Then it gets into the projected growth in value for the individual property compared to the general growth in value in the assessment phase. If your property is projected to go up in value more than the assessment base itself, then you’re looking at higher tax increases down the road, and vice-versa.

“There are always changes in legislation coming down the pipeline that need to be factored in.”

Overseeing property tax due diligence

Bishop estimates about three-quarters of real estate firms handle their property tax due diligence in-house, with the remainder employing companies such as Altus. It’s generally the larger companies and pension funds that go outside, while smaller firms and real estate investment trusts most concerned about bottom-line expenses are more inclined to take care of such matters themselves.

“A lot of them are into bidding situations on properties and they’re not sure that they’re going to be successful, so they’re cautious about how much they invest in the initial due diligence phase,” said Bishop.

Forty-one per cent of survey respondents said they only periodically review property tax assessments to identify appeal opportunities. Bishop said firms may not be aware how potentially lucrative successful appeals can be.

“Our experience is that the return on investment delivered to clients through reviews of commercial real estate portfolios is typically in the range of 500 to 1,000 per cent. Oftentimes it’s higher than that, so it’s definitely worth the expense that goes into it.”

Need for increased benchmarking

The study says it’s important for owners to know where their property stands in comparison to competing properties for leasing and disposition purposes. Remaining competitive and providing a “lower real estate tax cost” to potential tenants or buyers can drive real and tangible value.

“There’s a huge opportunity for much more robust use of benchmarking,” said Bishop. “It’s just a matter of capturing the data and analyzing it properly.”