A Deep Dive into Property Taxes

The single biggest line item expense on any of our assets is our property taxes. They usually represent 30%-35% of our total expenses. The largest bill we had on a single asset last year was over $1,700,000.

Given the sheer dollar value and impact property taxes can have on our asset performance, it’s probably not a surprise to you that we spend an inordinate amount of time and energy focused on understanding the details of our tax bill—and potential changes and impacts to those bills. Today, there seems to be a lot of volatility in the air that could impact how taxes are calculated going forward; so much so that we’re dedicating this month’s blog to the topic.

First, it’s important to understand what factors are used to set the property tax assessment. Since there is no state income tax in Texas, property taxes are the biggest revenue source for local and state governments (along with sales tax). Inherently, that makes the taxes a hot button of importance and conversation—and increasingly they are becoming a more political conversation. The taxes themselves are set by taking the property’s market value and multiplying that by the millage rate. The millage rate, which is usually around 2%-2.5%, is in essence who the taxes are paid to and support. Think local school district, police, fire, city, county, etc. Those rates are set by each local jurisdiction and can vary quite a bit by location. When we are underwriting deals, we pay a lot of attention to the jurisdiction of the asset as there can be huge swings in millage rate and tax value—which can make or break a deal. Here we try to use our local market knowledge to help drive smart investment decisions, knowing that certain counties are more aggressive or expensive than others. And while it may not be the most important factor in making a purchase decision, it can be very impactful.

We can’t impact or influence the millage rate—it’s set by the local municipalities. We can, however, impact or influence market value—at least to a point. Each year the county sends out an assessed value for the asset in the Spring; you have the right to agree or disagree with the value, and if you disagree you can protest the value. We typically protest the value for nearly all our assets every year, enlisting the help of a property tax consultant who reviews the posted values and our financials to provide a recommendation on what we believe the value should be. If we can’t agree with the county on what the value is (or should be), then we oftentimes have to file a lawsuit against the county.

With property values currently depressed from their peak, establishing a real market value for each asset is critical right now. And it can have a massive impact on current property performance and cash flowThe money that is left over each month or year from the property's income after paying for operating costs, mortgage, taxes, and other expenses. Positive cash flow occurs when the income exceeds the expenses, while negative cash flow indicates that the property's expenses are higher than the income it generates.. The challenge for multifamily investors and operators is to navigate the timeline around all of this, as it can take 12, 18, or even 24 months to settle a lawsuit with the county about the market value. So as we sit here in May of 2024, our property tax bill for 2024 is due to be paid by January 20, 2025—and yet our market value might still be in dispute and not settled until the fall of 2025 or even longer.

As a way of example, let’s say an asset had a market value in 2022 of $100mm. At a 2% millage rate, that is a $2,000,000 tax bill. Now let’s argue that the property value is 20% off from that peak, and today we think the value should be $80mm. That would equate to a $1,600,000 tax bill and a difference of $400,000. Every month, you’re talking about $33,000. But the county isn’t just going to agree to receive $400,000 less in taxes than last year. And our lender isn’t likely to agree to let us escrow $33,000 less each month while the value is in dispute, which could take 2 years to finalize. Therein lies the challenge for operators—and where understanding the nuance of the market value, property tax process, and the political landscape gets to be so incredibly important.

In looking across our portfolio, we are having ongoing and real-time discussions with our property tax team as we evaluate the assessed value of each asset, where we think the target value is, and how to approach our lenders to highlight the problems. In some cases, we’ve already been able to have productive conversations with lenders where they have agreed to lower our tax escrow some—and in one case, we’ve got a refund on our tax escrow released to us because we had so much already accrued.

What we haven’t touched on here—and frankly I don’t think anyone reading would have interest in diving deep on—is the political aspect of all of this. In the last legislative session at the Capital, Texas had a large budget surplus and the conversation about what to do with said surplus was the hottest topic debated. In fact, they had to go to two special sessions to get anything passed. What resulted was an agreement to send a large part of the surplus back to the residents and businesses of Texas. The way they did that was by buying down the millage rate on your property taxes. So the 2% rate referenced in our example went down in a one-time event. That lowered the taxes owned last year, but will the millage rate stay depressed as the legislature gets set to meet again next January?

And what about the new state law that allows for large counties to vote for who they want to represent them on the local appeal boards? In early May, every large county held elections for newly created positions that will be part of the appeal process when hearing protest cases. How will those (non-partisan) elected officials influence the process — and at the end of the day our values? There is a lot of talking and thought about that right now, which again will vary county by county based on who was elected.

The bottom line is that property taxes in Texas have always been important. And complicated. The fact that we don’t have a state income tax and that we don’t have to disclose the purchase price of a transaction has always created a bit of a cat-and-mouse game. A game that is played out on our single largest expense. Throw in some real-time shifts in market value and a new political component and the game has just had the stakes go up.

I’m grateful for the relationship we have with our Property Tax Consultancy and (when needed) our litigator. We rely on them more than ever and are using more and more of our local relationships to stay on top of the various components that make up our tax bill. For something this nuanced and critical to an asset’s success, it helps to be local.