Assessor Methodology for 2022

The Cook County Assessor began publishing Commercial “Revaluation Methodology Worksheets” in 2022.   This was intended to show “transparency” in their approach to commercial valuations, particularly with regards to their use of the income approach for commercial property valuation.  Analysis of their valuation methods demonstrates that they are not conforming to the methodology practiced by other members of the real estate valuation community.   This article looks at the Assessor’s 2022 methodology in the North Tri.  Their 2023 methodology appears to be substantially revised and will be examined in our next article.

Typically, any professional valuation of a potential income-producing commercial property will consider the subject’s potential gross income, vacancy & collection losses and stabilized expenses in order to conclude a stabilized net operating income.  That net operating income (NOI) is then divided by a capitalization rate to yield an indication of market value.  When considering real estate tax as an expense, there are two methods available.   For valuations that are not related to property tax assessment, real estate taxes are typically estimated and applied as an expense before capitalization.  However, when the valuation of the property is intended to establish the basis for a property tax assessment, the methodology applied by the overwhelming consensus of valuation professionals is to account for the property tax expense by excluding that expense in the calculation of NOI and applying a tax load to the capitalization rate.  The tax load is equal to the tax expense as a fraction of the market value of the property.  For a given level of actual real estate tax expense, the two methods are mathematically identical; however, when the tax expense is unknown, i.e. when the assessed value is in question, the tax load method is considered superior and almost universally adopted by the appraisal community.

In order to understand the Assessor’s analysis we have selected three industrial properties as examples.  All three are similar in size, (9,973 sf to 10,000 sf), year built (1970 to 1980), have similar ceiling heights from 14 to 16 feet, and similar land-to-building ratios between 1.91:1 and 2.67:1.  As a result they should have similar total expenses, aside from their real estate tax liability.  The three properties chosen are summarized below and reflect the 2022 assessment period:

The Assessor used the following metrics in analyzing these properties, as reported on the Assessor’s website:

The Assessor’s indicated rents are at a level that can only indicate that they are concluded on a gross basis.  The vacancy allowances ranging from 3% to 5% are lower than most real estate professionals would stabilize at and even if vacancies are currently at low ebb, few market participants assume that those vacancy levels will persist over the long term. This category should also reflect collection loss. The reported capitalization rates are applied without a tax load; implying that real estate taxes are treated as an expense and included within the projected expense ratio. 

The following table compares the Assessor’s expense allocation, on a $ per square foot basis, with the tax expense based on the assessed value, and with the average and median industrial expenses taken from our Industrial Expense Survey for 2021 which includes hundreds of reported industrial property annual operating expenses.  Our survey breaks down industrial building expenses for above and below 50,000 square foot properties.  The expense data reported below reflect our surveys estimate of below 50,000 square foot industrial buildings. The median and average lines indicate the range of expenses anticipated for properties similar to these examples.  The average and median expenses vary slightly based on using 4% of EGI as management and 3.5% of EGI for commission expense.  Our projected expenses do not include real estate tax, which would be accounted for in a tax load.  The final two lines combine the projected real estate tax expense with the median and average expenses from our survey to show a projection for total owner’s expense for a given property.

The Assessor’s allowance for total expenses must include property taxes as an expense in that the Assessor is not using a loaded capitalization rate.  The Assessor’s projected total expenses for these properties range from $0.93 to $1.24 per square foot to cover all of the properties expenses, including real estate tax.  The Assessor’s expense allowance is, in each case, insufficient to cover even the projected taxes based on the property’s assessed value.  Adding real estate taxes to our median and average expenses indicates a range for total property owner’s expense of $3.66 to $4.13 per square foot.   In each case the allowance for expenses is approximately $3.50 per square foot less than a reasonable range of expenses that include property taxes.  

The methods used by the Cook County Assessor for commercial valuations in 2022 are clearly incorrect.  They understate the expenses associated with ownership of income producing real estate and apparently completely disregard property tax by failing to account for it in either the calculation of the NOI or by applying a tax load to their capitalization rates.