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Federally subsidized housing requires unique Consideration in tax assessment valuation.

In evaluating the appraisal of federally subsidized housing in Racine, Wisconsin, for tax purposes, the court reviewed whether the City of Racine (City) employed the methodology required by Wis. Stat. [section] 70.32 (the statute) and the Wisconsin Property Assessment Manual (WPAM) to value federally subsidized property pursuant to US Code 26, Section 42 (Section 42) restrictions.

The property at issue, owned by Regency West, includes nine two-story buildings constructed in 2010-2011, consisting of 72 residential units federally regulated pursuant to Section 42. The federal regulations include income and rent restrictions to accommodate low-income family housing. The City had appraised the property for purposes of assessing real estate taxes, valuing the Regency West property at $4,425 million for 2012 and at $4,169 million for 2013. Regency West contested both tax assessments, claiming that the appraisals that underlie the tax assessments did not comply with Wisconsin law.

The City's assessor testified that for the 2012 valuation she had applied a direct capitalization of income approach using mass appraisal techniques. With a direct capitalization of income approach to valuation, an appraiser computes the property's net operating income (income less expenses or NOI) and divides it by the applicable capitalization rate (ratio between NOI of comparable properties and their sale prices).

One of Regency West's construction lenders provided estimates of potential gross income and expenses to the City for use in the 2012 valuation. However, the City's assessor stated that those expense projections were inflated. Accordingly, she applied a 40% estimated expense ratio, as reflective of other Section 42 properties, "to stabilize expenses." The assessor also used a 6% capitalization rate derived from market-rate properties, not from the market for Section 42 properties, to which she added a 2.5% adjustment for the property tax rate for a loaded capitalization rate of 8.5%. For the 2013 assessment, comparable sales were used rather than the income approach.

Regency West presented testimony from an appraiser who specialized in appraising subsidized housing. That appraiser testified that he had relied solely on the income approach, which he explained was consistent with WPAM, and which led to a $2.7 million appraised value for 2012 and $2.73 million for 2013.

The circuit court dismissed Regency West's complaint, finding that it had failed to overcome the presumption of correctness given to the assessments. The court of appeals affirmed the circuit court decision, and Regency West filed a petition for review with the state supreme court, which was granted.

The Wisconsin Supreme Court noted the statute specifies that "property shall be valued by the assessor in the manner specified in the [WPAM]." Wisconsin law also provides as follows:
   The goal of the assessor is to estimate the market value of a full
   interest in the property, subject only to governmental
   restrictions. All the rights, privileges, and benefits of the real
   estate are included in this value.

   In determining the value, the assessor shall consider recent
   arm's-length sales of the property to be assessed if according to
   professionally acceptable appraisal practices those sales conform
   to recent arm's-length sales of reasonably comparable property and
   all factors that, according to professionally acceptable appraisal
   practices, affect the value of the property to be assessed.

The court noted that because an appraiser must consider all aspects of the subject property that affect its value, appraisers must consider whether value is affected by classification as residential property subject to Section 42 restrictions.

The supreme court agreed with the WPAM statement, "The income approach may be the most useful method for valuing subsidized housing." It stated that the income approach is superior when applied to subsidized housing "due to the conditions of the agreement and the limited availability of data." The WPAM recognizes dissimilarities between subsidized properties and market-rate properties. It treats federally regulated properties "as a separate market and distinct from conventional projects." Specifically, federally regulated properties have "operational constraints (regulations) and risk factors that are different from a market-rate property." As such, appraisals must account for differences between those properties and market-rate properties per the WPAM and the state statute.

In calculating Regency West's NOI for 2012 under a mass appraisal technique, the City's appraiser had used market-rate vacancy and market-rate expenses instead of the vacancy and expense projections that were specific to the subject property or federally regulated housing. The court noted that this approach "fails to account for the vast differences in federally regulated housing and distorts the actual value of Regency West's property." The court said, "An appraiser must not value federally regulated housing as if it were market-rate property. Doing so causes the assessor to 'pretend' that the subject property is not hindered by federal restrictions."

The statute requires assessors to value property based on "the best information that the assessor can practicably obtain." However, the court criticized the City for not employing such information and for its approach that instead calculated the NOI through mass appraisal techniques that were not particularized to Regency West's property.

In contrast, Regency West used income and expenses specifically projected for the subject property when it calculated the NOI for its income-based valuation. The court characterized these projected expenses as "the best information that could practicably be obtained," and recognized that for a newly opened property such as Regency West, the use of projected expenses complied with the mandate of the statute.

In addition to calculating a NOI for the subject property, the supreme court considered whether appraisers when valuing federally regulated properties may derive the capitalization rate from market-rate properties. The court concluded that they may not. It said that when determining the applicable capitalization rate, assessors must consider factors that appreciably alter the value of the property if the capitalization rate is to truly represent the risk of investing in the property. Appraisers who fail to consider the nature of federally regulated housing and the restrictions attendant thereto when deriving capitalization rates overlook major characteristics of such property.

The state supreme court concluded that the valuation methodologies used by the City did not comply with Wisconsin law and reversed the appellate court decision and remanded the case to the circuit court for a determination of the refund due to Regency West.

Regency West Apartments, LLC v. City of Racine

Supreme Court of Wisconsin

December 22, 2016

2016 WL 7407487
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Title Annotation:Recent Court Decisions on Real Estate and Valuation
Publication:Appraisal Journal
Geographic Code:1U3WI
Date:Mar 22, 2017
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