The DCAD 2007 Retail
Revaluation

by Paul Pennington


 
www.pennin.com

In 2007 the Dallas
Central Appraisal District (DCAD) reappraised its retail properties, which
commonly resulted in valuation increases of 50% to 300%. Listed below is the
apparent reasoning behind such an aggressive reappraisal. 
We will also analyze the DCAD conclusions and compare them to independent
third party published studies.  Additionally,
we will address what the effects of such dramatic increases in the 2007 retail
valuations had on tenants and property owners.  Finally,
we will discuss the measures a property owner took to limit their tax liability
and to protect their tenants’ from excessive property tax “pass-throughs”.
 

The
Revaluation:

DCAD determined that
retail properties were under appraised and decided to reappraise them for tax
year 2007.  Based on data collected,
and summarized in the DCAD 2007 Shopping Center Sales/Cap Rate Study (the
study), property owners were notified of their 2007 proposed valuations.¹ 

The study, which was obtained through a formal open records request,
represents the source documentation of the Rates used by DCAD.

Chart
1

DCAD 2007 Shopping
Center Sales / Cap Rate Study

 (Assumed to be Class A Rates)

BC	Sale Date	Square Feet	Year Built	Sales Price	Cap Rate	Sale $ PSF	Comments
36	02/05	22.496	2003	$6,272,000	6.69	$278.81
35	06/06	26.418	1998	$6,500,000	5.71	$261.19
36	09/05	171.028	1985/65	$53,000,000	5.67	$309.89
36	04/05	133.088	1987	$19,000,000	4.995		Two Story
36	10/06	134.953	1987	$31,300,000	4.47	$231.93	Income is actual
35	12/05	38.788	1999	$14,000,000	7.1	$360.94
36	11/06	46.8	1999	$9,500,000		$202.99
35	09/05	32.114	1999	$7,100,000		$221.09
36	10/06	178.121	1983	$6,700,000	4.33		60% Vacant At Sale
36	12/06	324.569	1952	$42,400,000	4.92
36	06	43.885	2005	$13,600,000		$309.90
35	03/06	28.794	2005	$3,640,000	6.59		Two Story
				Average	5.608333	$272.09
				Median	5.67	$278.81

Chart
2

 Big Box Retail

BC	Sale Date	Square Ft	Year Built	Sales Price	Cap Rate	Sale $ PSF	Comments
36	05/05	233,667	1987	$22,785,202	6.29	$97.13	All Big Box
36	04/06	140,934	1985	$14,091,791	6.87	$100.00	80k + SF Big Box
36	02/06	121,369	1986	$11,500,000	5.9	$94.75	50% Big Box/Theater
36	09/05	92,270	2003	$16,232,750	4.995	$175.93	Mostly Big Box
36	04/06	69,090	1995	$8,265,856	4.47	$119.54	95% Big Box
				Average	6.353333	$117.49
				Median	6.29	$100.00

Chart
3

Small
Retail

BC	Sale Date	Square Ft	Year Built	Sales Price	Cap Rate	Sale $ PSF	Comments
35	02/05	14,820	2003	$3,325,000	4	$224.36
35	08/05	9,198	2001	$1,930,000	7.49	$209.83	Estimated Some Income Factors
35	06/05	11,879	1960	$3,887,700	5.72	$327.28	Estimated Some Income Factors
35	06/05	17,245	1995	$3,050,000	4.995	$176.86
				Average	5.736667	$253.82
				Median	5.72	$224.36

 Chart 4

Two


Story

Shopping Centers

BC	Sale Date	Square Ft	Year Built	Sales Price	Cap Rate	Sale $ PSF	Comments
36	04/05	133,088	1987	$19,000,000	4.995	$142.76	Two Story
36	08/05	78,283	1981	$12,000,000	7.49	$153.29	Two Story
35	03/06	28,794	2005	$3,640,000	6.59	$126.42	Two Story
36	11/05	124,607	1983	$12,500,000	4.995	$100.32	Two Story
				Average	5.7925	$130.70
				Median	5.7925	$134.59

 

Analysis
of the DCAD 2007 Shopping Center Sales/Cap Rate Study:
 

• The
  Appraisal District notes in the comments section that some of their Rates
  are based on actual and estimated income and expenses as well as profit and
  loss statements previously provided to DCAD presumably by the seller. 
  Depending on the date of the sale the financial information DCAD had
  on file could be somewhat dated by the time of the transaction. 
  This would have an effect on the indicated Rate.

• Additionally,
  one of the sales comparables was only 60% vacant at the time of sale.  

• Some
  of the sales appear to be mixed use.

• Two
  of the sales comparables are repeated initially in the first group of sales
  comparables and again in the “
  
  Two
  
  Story
  

  Shopping Center
  
  ’s” grouping.

• A
  large number of the sales used in the DCAD study were transactions which
  occurred in 2005.

Conclusions
of the DCAD 2007 Shopping Center Sales/Cap Rate Study:
 

• The
  Class A properties were selling on an average Capitalization Rate of 5.608%.

• Big
  Box Retail (Assumed to be Power Centers) were trading on an average Rate of
  6.3533%. 

• The
  average Rate on small retail averaged 5.736%.

• The
  
  
  Two
  
  Story
  
  Shopping Centers

  
  traded on an average Rate of 5.79%.

As a result of the DCAD
Retail Study the commercial property tax department of DCAD generally used Rates
of 6.0% for Class A, 6.5% for Class B and 8% for Class C properties. 

 

Analysis:

Comparing the results of the DCAD 2007 Shopping
Center Sales/Cap Rate Study with other published capitalization rate studies
they appear to differ in their conclusions. 

Some Real Estate Professionals state that

Dallas

more or less mirrors national Rates. With that in mind, examining national
Rates, using the First Quarter 2007 PriceWaterhouseCoopers Korpacz Real Investor
Survey,² the following observations, Rate ranges and averages were
concluded: 

Chart
5

First
Quarter 2007 

PriceWaterhouseCoopers
Korpacz Real Investor Survey

 National Regional Mall Market (First Quarter 2007)“…investors
note that cap rates as a whole are stabilizing – and even increasing for
certain lower-class quality assets.”
 

 

National

Power

Center

Market (First Quarter 2007)“…participants
indicate that they (on average) are increasing and/ or stabilizing in the
national power market.”
 

National

Strip

Shopping Center

Market (First Quarter 2007).many investors
note overall cap rates are increasing (or at least stabilizing) in this
market…”

The
Korpacz Survey concludes that nationally with exception of
California
,
Seattle
and

Phoenix

, overall cap rates are increasing or stabilizing. 
Additionally, the average rates for Malls,
Power

Centers
and

Strip

Centers

have increased from the fourth quarter of 2006. Additionally, the average Rates
from The Korpacz Survey are higher than the average rates used by DCAD on Class
A and B properties. 
 

In
comparing The DCAD Study with the Henry S. Miller Commercial 2006-2007 Miller
Mark (Miller Report),³ a

Texas

publication, we observe the following conclusions:

Chart
6

Henry
S. Miller Commercial 2006-2007 Miller Mark (Miller Report)
 

CAPITALIZATION RATES
PROPERTY TYPE	GOING-IN	STABILIZED	REVERSION
	Average       Range	Average         Range	Average        Range
RETAIL	7.1%          6.5-8.0%	8.0%        7.0-10.0%	8.4%       7.0-12.0%

 

The
Miller report notes that the Rates for class A, B, and C properties “Going-In
Rates” were 7.1% and “Stabilized Rates” were 8.0%. 
In addition, they note that their Rates “…are more reflective of
Class A type properties,” and are broken out as follows: 
“Class A-44.6%, Class B-37.4% and Class C-18.0%”. 
Miller also states that “…Approximately 76% of the respondents
indicated that they deduct a reserve within their stabilized pro-forma.” 
The DCAD study did not include recognition of reserves in determining
their Rates.
 

The Miller Report
acknowledges that property owners who reported their Rates (7.1% average), were
made up of 82% of Class A and B retail properties. 
It would then stand to reason that the DCAD Rates (Rates of 6.0% for
Class A, 6.5% for Class B, and 8% for Class C properties) would appear to be
low.  Thus both Korpacz and The
Miller reports differ with the DCAD conclusions.
 

Why
did the Korpacz Survey show an increase in Rates while the Miller report showed
Rates lower than the previous year? The answer may be that The Korpacz Survey is
reported on a quarterly basis and the Miller Report 
on an annual basis. Perhaps Korpacz was reflecting the beginning of the
credit crisis. In June of 2007 Holliday Fernogolio Fowler, LP reported a
dramatic downturn in the capital markets. In 2006 lenders were still bullish in
their loan underwriting. For example; aggressive underwriting and loan
structuring were still common. At the same time the subprime housing mortgage
defaults exploded, the ripple effects spilled over into commercial real estate
lending. By the first quarter of 2007 rating agencies began to scrutinize
commercial mortgage-backed securities (CMBS) by tightening lending practices as
protection against increasing loan defaults. As a result commercial lending
rates have risen over 100 basis points in the last twelve months. Rising
interests rates typically translate into higher capitalization rates.
 

The
Revaluation Effects:

To
determine the effects of the 2007 DCAD retail revaluation one must first
understand revenue recoveries also known as “pass-throughs.” This term
relates to an owner recovering expenses for common area maintenance (
CAM
) expenses, which include items such as utilities, security, cleaning, repairs,
management fees and maintenance, etc.  Additionally,
landlords typically charge tenants for insurance and property tax
reimbursements.  “Pass-throughs”
can vary based on the lease terms negotiated by the lessee. 
For example the terms could differ if the tenant is an anchor versus a
non-anchor tenant.⁴
 

“Tenants
are generally responsible to provide reimbursement for property taxes may
include the costs of any protests or assessment appeal”…. “The tenants
will probably be required to pay their tax shares in advance on a monthly basis,
adjusting for any differences at the end of the year”.⁴

 

“Real
estate taxes now make up about one-third of shopping center expenses…” The
tenants are typically required to pay their tax shares in advance on a monthly
basis, adjusting for any differences at the end of the year”.⁵   Therefore,
tenants have a vested interest in the amount of property taxes assessed due to
the fact that they are required to reimburse their pro-rata share to the
landlord. 
 

According
to Dollars & Cents of Shopping Centers/The Score 2006 ⁶ the
national averages of reimbursements are shown below as a comparison:

Chart
7
 

Number of Centers in Sample:244	Average	Median	Lower Decile	Upper Decile	Median		Lower Decile	Upper Decile	Number Reporting
OPERATING RESULTS	Dollars per Square Foot of GLA					Percent	of Total	Receipts
TOTAL OPERATING RECEIPTS	$12.78	$12.55	$6.02	$21.75		100.00%	100.00%	100.00%	244
Total rent	10.19	10.27	5.08	16.75		80.03	69.83	89.01	242
Rental income-minimum	10.01	1021	5	16.27		79.11	67.15	88.74	242
Renta income-overages	0.45	0.28	0.04	1.48		2.59	0.22	10.19	59
Total common area charges	1.21	1.01	0.36	3.01		8.69	4.73	17.06	200
CAM administration fee	0.18	0.14	0.03	0.53		0.98	0.35	3.56	74
CAM charges (excluding administraion fee)	1.13	0.96	0.35	2.8		7.97	4.48	16.98	196
Total other charges	1.32	1.25	0.44	2.73		9.80	5.28	16.32	165
Property taxes and insurance revenue	1.23	1.14	0.42	2.64		9.45	5.04	15.41	162
Property taxes revenue	1.03	0.94	0.29	2.16		7.86	3.49	13.71	195
Insurance revenue	0.17	0.15	0.04	0.34		1.25	0.40	2.48	157
Security revenue	0.14	0.11	0.02	0.32		0.59	0.22	3.65	14
Marketing/promotion fund (excluding merchants assn.)	0.28	0.22				1.20			8
Total HVAC energy revenue									3
Common area									3
Tenant space									2
Total other utilities	0.17	0.14	0.01	0.51		1.18	0.06	2.63	50
Common area	0.15	0.11	0.01	0.45		1.10	0.08	2.34	33
Tenant space	0.16	0.15	0	0.37		1.06	0.03	2.34	22
Other escalation charges									4
Total miscellaneous income	0.11	0.05	0.01	0.66		0.35	0.04	5.31	128

As
we see from viewing Chart 7 above, nationally

CAM
reimbursements rank number one followed by property taxes and insurance
respectfully.  When we look at an
actual Dallas neighborhood retail property after the 2006 revaluation and appeal
(see below) we again see that the recapture of CAM, Tax, Insurance follow the
national trends for neighborhood shopping centers.  

Chart
8
 

It
stands to reason that revenue and reimbursements fall within a definable range
however they can be skewed by a variety of factors including, but not limited
to, the property’s occupancy level, tenants being current in rental payments,
and lease terms of tenants.  Typically
we’d expect to see debt service being a property’s largest expense and
CAM
and Taxes being the second and third highest expenses, which is clearly denoted
in the two above mentioned examples (Chart 8 denotes a neighborhood retail
center).

 

The
next example below denotes the same

Dallas

property (Chart 8) after receiving their DCAD 2007 proposed valuation. As noted
below the revaluation caused Tax Revenue to become the highest expense category
even above CAM Revenue.

Chart
9

	Total	Per Sq.Ft	Percent
Rental Revenue	$492,552	$15.70	62%
CAM Revenue	$118,027	$3.76	15%
Tax Revenue	$160,302	$5.11	20%
Insurance Revenue	$11,178	$0.36	1%
Other Revenue	$13,310	$0.42	2%
Total Operating Revenue	$795,369	$25.35	100%

  

In the example above, the
increase in recoverable tax revenue rose from $2.78 to $5.11 per square foot
(p/s/f) which translates into an 83% increase.  
Typically, this increase would be paid by the tenant(s). 
The owner of this property is in a position of passing-through the large
increase in tax revenue to the tenant(s).  Although
it can be argued that such a large increase would affect the tenant’s future
decisions to renew their leases at the subject property. 

Taken a step further, if such large recoverable tax pass-throughs affect
tenant’s willingness to renew their leases, two scenarios develop. 
First, tenant(s) might relocate to another property with lower property
tax pass-throughs. Secondly, the landlord would have to make concessions in
their rental rates to offset the increased expense to the tenant(s). 
Both scenarios would have a negative affect on the property’s net
operating income (NOI).
 

Taxpayers Rights:

When
a property owner is faced with reappraisal of the magnitude described above they
must first understand their rights.
 

·       

A property owner is entitled to
be assessed at market value based on methods that comply with the Uniform
Standards of Professional Appraisal Practice and “… each property shall be
appraised based upon the individual characteristics that affect the property’s
market value.”⁷

·       
The taxpayer is entitled to a
fair and equitable appraisal based on the “…median level of appraisal must
be prepared to prove unequal appraisal.”⁸

·       
To prove unequal appraisal, “A
ratio study or a comparison of a representative sample of properties,
appropriately adjusted, for determining the median level of appraisal must be
prepared to prove unequal appraisal.”⁹

 

Appealing:

With
these rights in mind and facing a huge valuation increase, a property owner
should consider dividing the appeal into two segments. 
First quantify the market value of the subject property and then address
any issue relating to unequal appraisal. 
 

The
following is an example a Large Class A retail center initially assessed at
$48,000,000 in 2006 which was increased to $78,649,800 for tax year 2007. 
The initial informal “Administrative Remedy” settlement meeting
resulted in an offered reduction to $69,000,000. 

The offer was rejected based on the fact that the owner believed that the
property would still be appraised over market value. 
It was the decision of the property owner and their agent to commission a
narrative fee appraisal to determine the subject’s market value as of January
1, 2007.  The appraisal report
indicated a market value of $55,000,000, which the DCAD Appraisal Review Board
(ARB) certified as correct.  This
appeal effectively reduced the proposed 2007 appraised value from a potential
increase of 63% to 16.6%.
 

 The
tenants of this property had been informed of the increased valuation which
would affect their accruals for the property tax pass-throughs, they were also
advised of the successful market value appeal. 
Additionally, the property owner has left open the possibility of
appealing the ARB rulings if an unequal appraisal exists. 
If an unequal appraisal does exist a successful appeal would translate
into additional relief to the tenants.  

 

References:

1.      
The DCAD 2007
Shopping Center Sales/Cap Rate Study.

2.      
First Quarter
PriceWaterhouseCoopers Korpacz Real Investor Survey

3.      
Henry S. Miller
Commercial 2006-2007 Miller Mark

4.      
P. (203-206 and
214) Shopping Center Appraisal and Analysis; Vernor and Rabianski

5.      
P. 218 Shopping
Center Appraisal and Analysis; Vernor and Rabianski

6.      
Dollars &
Cents of Shopping Centers/The Score 2006, p 226.

7.      
Sec. 23.01 of
the

Texas

Property Tax Code

8.      
Sec 42.26 of the


Texas

Property Tax Code

9.      
Texas Property
Taxes, Taxpayer’s Rights, Remedies and Responsibilities, February 2007