In Part 1 of this blog series, we covered some of the U.S.’s hottest office and industrial markets for 2016. In Part 2, we’ll discuss how to cut your occupancy costs as the office and industrial markets heat up.
Commercial property taxes represent a significant business cost, comprising more than 40 percent of occupancy costs and more than 40 percent of your state corporate tax liability.
In addition to commercial property taxes, other occupancy costs may include electricity, natural gas, water, security, landscaping, parking lot maintenance and other expenses. But typically, none of these other costs take such a large chunk out of your budget. Property taxes, on the other hand, are another story.
And, if your organization is considering an expansion or relocation to – or within – one of the hot U.S. property markets (or elsewhere), you’ll want to make sure you do your homework and spend time evaluating the impact of purchase on your property taxes, which should never be treated as another fixed-cost line item.
Here are four tips to employ after acquisition and that can also be utilized to go back and review your existing portfolio to manage your cost of occupancy:
1) Perform Due Diligence
Because of the increased pressure to reduce costs of occupancy and leverage any available money-saving incentives, corporate real estate executives are doing more due diligence than in the past. Part of the expanded due diligence process should include an historic analysis of how the taxing jurisdiction will respond to the acquisition price:
- Will they adopt the sale price as the new assessment, or will they do a proper market analysis first?
- Will they accept your purchase price allocation and segregate out the non-taxable items in the transaction?
- When do you need to file new applications for abatements or pollution controls?
- Do you know the requirements for annual Inventory Freeport Exemption filings?
California, New York, Texas and Georgia are among the states with hot commercial real estate markets, as they offer some form of Freeport Exemption. See a full run-down of state-by-state Freeport Exemption rules here.
Additionally, confirm whether your local taxing jurisdiction has any potential acquisitions improperly classified on their tax rolls. Misclassification could result in a building being taxed unfairly. For example, one taxing authority in Texas classified (and taxed) a commercial asset as a large R&D facility, when in reality, the asset was predominately office space with a small R&D lab. The property taxes levied on Texas office space are notably less than on R&D facilities, and if this error had not been caught during the due diligence process, the company could have been on the line for far more than its fair share of commercial property taxes.
2) Ensure Proper Purchase Price Allocation (PPA)
Getting a purchase price allocation (PPA) done by a professional during due diligence is crucial. The PPA sets the opening balances for your accounting and is the basis for a beginning balance sheet so you can track the depreciation of your assets.
A PPA will also determine an allocated value for all of the components of the acquired assets – including the value of the real estate, land, site improvements and personal property, as well as the value of the acquired inventory and (non-taxable) intangible assets.
Ensure that your PPA and all associated documentation are correct so that your occupancy costs for your real estate and personal property assets are based on accurate information.
3) Report Transactions Properly
Far too often, a corporate attorney or someone not intimately familiar with jurisdictional requirements will improperly document and over-value taxable components.
Let’s say you pay $5 million for a hotel. As part of the PPA, it’s determined that $3 million should be allocated for real estate, $1 million for personal property (furnishings and appliances that are part of the sale) and $1 million for intangibles. If your state doesn’t tax personal property and your commercial property tax value is recorded as $5 million instead of $3 million, you would overpay your taxes.
4) Think Ahead: Exit Strategies
Whether you’re buying commercial property during a growth period or acquiring your competition with the intent to eventually sell, it’s important to understand what you will have to sell.
For instance, say that your firm employs just as many remote workers as it does people that physically work in your office building. Parking was never an issue for you, but when you decide to sell, a similar sized firm that’s otherwise a great fit may balk because the building’s parking lot is too small for a company that doesn’t allow remote work.
While a small parking lot might not be an issue for you, it could pose a significant roadblock for potential new buyers. This example highlights the benefit of thinking about an exit strategy. If you know you're going to eventually sell, make sure you look for and eliminate any obstacles that could get in your way.
Ready To Expand?
You have an array of resources at your disposal to conduct due diligence, ensure proper PPA and more. So, before you make a move into a new commercial real estate market, take the time to do your research.
To streamline your effort and alleviate many of the complexities and challenges that may drain your resources along the way, consider working with a property tax advisor who can help pave the way. This is often the best option to ensure that you’re equipped with the necessary information and poised to take advantage of any potential tax savings available to you.
Learn more about how to alleviate the risk and cost associated with commercial real estate expansion in 4 Tips For Managing Corporate Real Estate Occupancy Costs.