When valuing industrial, commercial or retail real estate, New Jersey tax assessors are required to value the “unencumbered fee simple interest” of the real estate. This concept often confuses property owners who capitalize the existing leases to show a property is overassessed. In layman terms, what does this all mean?
The cornerstone of New Jersey’s real property tax system is uniformity. Uniformity of assessment is achieved by assessing all property subject to tax at its full and fair value. By using the term “full” value, property is required to be assessed at its highest and best use, not its present use. For example, if a vacant lot is being used for parking but has a more valuable use (i.e., build a new office building), the property can be assessed at the higher value if the alternate use is legally permissible, physically possible, financially feasible and the most profitable use. These are the four criteria for determining the highest and best use of property.
For most industrial, commercial or retail real estate, the income approach to valuation is the most reliable and often given the most weight by tax court judges. To use the income approach, an appraiser must first determine the gross rent for the property at its highest and best use. For tax appeal purposes, the gross rents must be market rent or “economic rent,” which may differ from the actual rent generated from the property. Although actual rent may be a probative factor in determining economic rent, it is not controlling. For example, a lease may be above market because the landlord and tenant are related entities and structured the lease for business or tax reasons. A lease may be below market for the same reasons. However, if supported by other comparable leases, a lease for the property being appealed will often times be given great weight by the court.
The assessor or appraiser must obtain leases and other data from comparable properties in the surrounding area to make a final determination of economic rent. Although there is no hard and fast rule for the number of comparable leases required to opine to economic rent, a broad sampling of current leases is necessary.
Like every rule, there is an exception. The rent roll from a well managed apartment building can sometimes be capitalized to determine value. Going back many years, the New Jersey Supreme Court held “in the absence of convincing evidence to the contrary the current ongoing income scale of a large, well-managed apartment project like this, functioning as customary with leases of relatively short length, should be deemed prima facie to represent its fair rental value for purposes of the capitalized income method of property valuation.” Parkway Village Apartments Co. v. Township of Cranford, 108 N.J. 266, 528 A.2d 922 (N.J. 1987).
It is important to provide a copy of all leases to your appraiser at the outset of the appraisal process. However, your appraiser must also go out into the market and collect accurate information on comparable leases in order to avoid having his or her appraisal stricken by the court.
