Investment Property Evaluations – Adjusting Your Price for Property Taxes
About ten years ago I set out to buy my first commercial investment property. I narrowed down the choices to a retail center that looked beautiful. I analyzed the financials, did the inspections, and everything looked great. This investment was going to be great, and I was excited. We closed on the property and life was good.
Everything was going exactly to plan until one day I opened my mail and found a letter from the county where I bought my new investment property. Inside the envelope was a letter with the new property tax bill for the year on the property we purchased a few months earlier. I looked at it and thought to myself, “This has to be a mistake. This can’t be right… can it?”
Unfortunately, the letter was correct, and suddenly my investment plan took a big hit. What the letter told me is that the property taxes were not going to be the $24,000 I had expected based on the property’s financials during our due diligence and last tax bill; instead they were $36,000. It was an increase of $12,000 per year and approximately fifty percent higher than I had expected. Ouch, that hurts.
A lot of things went through my mind: did the seller misrepresent the property taxes? Did they have the property’s address correct? What did I miss and how could I have been so far off?
What had happened is that the sale of the investment property had triggered a revaluation of the property taxes by the county. So even though the previous owner was only paying $24,000 in property taxes, we were going to have to pay a lot more. The county had adjusted the property taxes based on the new sale price and that caused them to be increased by $12,000 per year. Again – ouch!!
The truth is, it wasn’t the sellers fault. He gave us his property tax information on the property. It was mine. I analyzed the financials correctly, but forgot to account for one big thing. I forgot to account for the potential adjustment of the property taxes to the new purchase price. In this case, this simple overlook during my financial analysis cost me $12,000 in cash flow per year and over $120,000 in value on the property I just bought. For anyone who has had a similar experience, and that is a lot of investors, it is a painful lesson to learn and one that I will never forget.
So, how do you make sure you don’t make the same mistake I did when I bought one of my first investment properties? You do it by making sure you adjust your financial analysis of the investment property for any increases in property taxes after your purchase the property. Let me repeat, make sure you analyze the property’s financials with the potential increase in property taxes, not with the current property taxes. If during your financial analysis you have already calculated in the potential increases in property taxes and adjusted your purchase price accordingly, you won’t have the same issues as I did when I got that letter in the mail with the new property tax amount. You’ll be prepared.
This big mistake can be avoided very easily by knowing how the property taxes are going to be adjusted to your new sale price. Then, you must use the new adjusted property tax number in your financial evaluations to determine how much you will pay for the new property.
How do you determine what property taxes will be based on the new purchase price?
There are a few ways you can determine what property taxes will be at your purchase price, but the easiest way is to find out the property tax mill rate for the type of property you are purchasing in the county that it is located in. Once you have that, you need to determine how the property taxes are calculated in each county. Because each county and state are different in how they calculate property taxes, it’s important to check with your county tax assessor’s office to ask them how it is calculated in the county in which you are purchasing the investment property.
In most states, you can simply take the property tax mill rate and multiply it by the purchase price of the investment property to get the projected property tax amount. Some of the other variations I’ve run into out there include taking the purchase price by a percentage (given by the county) to get the fair market value and then multiplying it by the mill rate. It’s important that you know the county where the investment property is located. They will be able to tell you how it is calculated in that area. There are also property tax consultants that can help you that work on a national or regional basis. The important thing is that you determine how the property taxes will be adjusted and use that new number in your financial evaluations.
Failing to realize that the property taxes can adjust based on the new sales price can have a dramatic effect on your investment. It’s a mistake that can be easily avoided by talking with your local tax assessor’s office and determining what the property taxes could be before purchasing the property. Then, you need to use those numbers when doing the financial analysis of the investment property and adjusting your purchase price accordingly. By taking these simple steps during the evaluation, it will ensure that you don’t feel the same way I did when I received the letter from the county with the new property tax amounts due.