By Steve Nowak, Esq.
Appraisal methodologies for financing seniors housing properties factor in more than real estate to produce amounts that exceed property-only value. That means seniors housing owners may be paying real-estate taxes on non-real-estate assets.
Everyone can agree that a senior living operation — whether independent living, assisted living, memory care, skilled nursing or some combination — consists of a variety of assets. There are real estate assets (the land and building); personal property assets like furniture and kitchen equipment; and intangible business assets such as the work force, tenants and operating licenses. These multiple assets and asset types present a challenge when developing an appropriate ad valorem tax valuation.
To appropriately value this asset type for property taxation, an owner must show the assessor the real estate’s standalone value. Most states acknowledge that business assets are not subject to property tax, so the intangible business assets and their respective values must be identified and excluded.
The International Association of Assessing Officers, in its guide, “Understanding Intangible Assets and Real Estate: A Guide for Real Property Valuation Professionals,” has developed a four-part test to help determine whether something intangible rises to the level of an asset. The IAAO test is as follows:
1. An intangible asset should be identifiable.
2. An intangible asset should have evidence of legal ownership, that is, documents that substantiate rights.
3. An intangible asset should be capable of being separate and divisible from the real estate.
4. An intangible asset should be legally transferrable.
The Appraisal Institute’s current 15th edition of “The Appraisal of Real Estate” recognizes the valuation methodology of separating the components of assets in a business or real estate transaction. Potential intangible business assets identified in the text include contracts for healthcare service, contracts for meals, and contracts for laundry assistance, all of which represent income streams or businesses. An assembled workforce is an intangible business asset with a quantifiable value. How long would it take an operator to staff up a property prior to opening? What are the carrying costs during that time?
Many seniors housing owners and investors believe that the entire value associated with senior living real estate is attributable to the business. While this may be a firm belief, the real estate must have some value. For fair taxation, the taxpayer must differentiate and value both the tangible and intangible components of the asset.
Multifamily comparisons
For 30 years, Ohio law has permitted appraisers to reference data obtained from traditional multifamily properties to value just the real estate in seniors housing.
The theory has been that traditional apartments are primarily real estate and lack much of the associated business value that comes with senior living assets. Therefore, an appraiser that takes the gross building area of a senior living property can select, analyze, adjust and apply multifamily data to determine fair market value.
This approach presents at least two issues. One, senior living designs differ from traditional apartments. For instance, senior living units are typically smaller, lack full kitchens and require wider hallways to accommodate wheelchairs. Two, the multifamily market has generally prospered in recent years while senior living properties have struggled to recover from pandemic-related losses.
This means Ohio appraisers are comparing senior living properties to multifamily assets selling at higher and higher dollars per unit. Multifamily properties generally experience lower vacancy, credit loss, expenses and capitalization rates than do seniors housing assets. In short, these two product types often move in opposite market directions.
Difficulties with financing data
More and more, county assessors and school board attorneys throughout Ohio rely on appraisers who value senior living properties as if done for lending purposes. While these going-concern valuations may satisfy lenders’ needs, these same techniques are not reliable or accurate enough to support a state’s constitutionally protected valuation and assessment process.
Going-concern appraisal reports back into a real estate value. After first developing a total value for all assets present, the appraiser attempts to extract the business value.
There are several techniques routinely used in appraisals for financing that are inappropriate for determining taxable value. These include the lease fee coverage ratio approach, a management fee capitalization approach and the cost residual approach. These appraisal techniques have been approved by banks, but they are largely untested in courts.
These approaches are tainted from the start because they look first to the total going-concern value. That inherently requires an evaluation of business income, which should not be considered when determining a fee-simple value of the real property.
Of the going concern methodologies, the cost residual method appears best suited to assess taxable property value. However, challenges and subjectivity abound when identifying and determining all aspects of depreciation that may impact market acceptance of the real estate asset, especially for an older property.
Starting with the business is problematic given the dollars involved in seniors housing resident services. Median asking rent for a conventional apartment was $1,000 per month in the Federal Reserve’s 2022 Survey of Household Economics and Decision Making. By comparison, the median monthly rate for assisted living is $4,000, according to the American Health Care Association and National Center for Assisted Living. Importantly, that $4,000 excludes fees for additional services like medication management and bathing assistance.
Service fees constitute significant revenue in most seniors housing operations. A 2019 CBRE Senior Housing Market Insight report found that 65 percent of the revenue in assisted living properties comes from services provided above and beyond pure rent. The 2023 JLL Valuation Index Survey found that the average majority assisted living asset class saw an expense ratio of 71 percent.
Owners and appraisers must closely examine operating statements to develop and support their opinions of value. Appraisers should consider looking at properties as having multiple income streams to verify whether their opinion of value for the real estate is reasonable and supportable. Operators and investors should be open and honest about return expectations.
Because the income generated by intangible business assets at senior living properties is taxed in other ways, assessors must continue to carefully review senior living real estate to ensure fair taxation.
Steve Nowak is a partner in the law firm Siegel Jennings Co. LPA, the Ohio, Illinois and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.