By James P. Regan, As published by Real Estate Chicago, July/August 2003
Under the triennial real estate reassessment process mandated by Cook County, all real estate in the City of Chicago will be reassessed in 2003. A century of change has taken place in the three years since the city was last reassessed in 2000, and these changes should have a chilling effect on the new assessed values of the city's commercial real estate.
The prescribed valuation date for all assessments is Jan. 1. Thus, the 2000 reassessment was based primarily upon data from 1999, as the 2003 assessment will rely upon 2002 data.
The boom days of the '90s have given way to a confluence of staggering events that have affected every phase of life, both public and private. In the midst of a weakening economy, we were confronted with the Sept. 11, 2001, attacks, then the invasion of Afghanistan, then uncertainties leading up to the invasion of Iraq and now the uncertainties concerning the aftermath of that war. Peter Korpacz, in his Real Estate Investor Survey, points out that the effects of these events are "increased property expenses and elevated occupancy costs which will ultimately lead to declines in rental rates, property values, sales volumes and development..."
For the most part, the value of commercial real estate is based on revenues derived from the real estate after accounting for operating expenses. While rents have, at best, remained flat, increased security costs, higher insurance premiums and rising energy costs have driven operating expenses way beyond the market derived expense ratios used for the 2000 reassessment.
A report published by the Council of Economic Advisors estimates that private business spent approximately $55 million per year on private security before Sept. 11. As a result of the World Trade Center and Pentagon attacks, the council projects costs have increased by 100%. Increased spending covered the cost of 300,000 new security guards, screening equipment, new ID systems and video surveillance.
Prior to Sept. 11, 2001, terrorism insurance coverage was a standard inclusion in practically every property casualty insurance policy. Afterward, it became an excluded risk that only a few insurers were willing to cover. Those carriers that do provide terrorism coverage do so at extremely high premiums, larger deductions and lower coverage. Aside from the issue of terrorism, premiums on property insurance coverage in general have jumped anywhere from 20% to 400%, according to the Real Estate Investors Survey.
These exploding costs are not restricted to any one segment of commercial real estate. Office buildings, high-rise apartments including senior housing facilities and shopping malls have all experienced those increased costs, and the 2003 assessments should take them into account.
For real estate tax purposes, in Illinois, assessed value is not based on the specific circumstances of each property. Appraisers, including assessors, are required to determine the condition of the market. For example, class A market rents will be determined by surveying the rents of similar properties in the Loop. By the same token, operating expenses have to be surveyed to determine market expenses for a specific class of property. Professional associations such as the Institute of Real Estate Management and Building Owners and Managers Association should be very helpful in factoring in the additional costs created by Sept. 11. Clearly, the operating expense costs for 2003 will be significantly higher and will thus affect properties' bottom lines.
Some may point out that many of these costs are passed on to tenants, and so there is no immediate impact on that income. However, a market value consideration must also take into account the quality and durability of a property's income stream. Tenants budget for total occupancy costs, which include both base rent and pass-throughs. If the occupancy costs exceed their budgets, they have two options; to negotiate rent reductions or refuse to renew their leases. In either case, the quality and durability of the income stream becomes problematic, thus affecting the value of the property.
Whether we look at the revenue side or the expense side, the only conclusion can be that values will have declined over the past three years. Property taxes ought to reflect that.
James P. Regan is the managing partner
of the
Chicago law firm Fisk Kart Katz and Regan, Ltd., the Illinois member of
American Property Tax Counsel.
jregan@proptax.com