How Assessment Administrators determine Value for Tax Purposes

      There are two common forms of property which Michigan Assessment Administrators (Assessors) are required to provide annual estimates of value for: personal property and real property. The regulations governing the assessment of these forms of property may be found in the state Assessor's Manual, Michigan's General Property Tax Laws (a/k/a Michigan Compiled Laws Section 211 and that which follows) and in various publications of the Michigan State Tax Commission.

      While there may be some variation, personal property (personalty) is generally assessed by taking the historical cost of the property being reported plus its installation costs and depreciating the total using standard depreciation tables based upon various classification of properties. Properties lose their usefulness or "depreciate" in value as a function of what they are. For example, the depreciation rate on an office desk is much slower than the depreciation rate of the computer which may sit on the desk. The depreciation rate of a utility pole may be much different than the depreciation rate of manufacturer's bench grinder. Experts determine depreciation schedules and those schedules are certified by the state of Michigan and used uniformly by all assessors in the state.

      Real Estate is appraised using three basic valuation methods. They are commonly known as the cost approach, the income approach and the market value approach.

      One fundamental requirement in Michigan's tax assessment procedures is that the method of determining value should reflect how buyer's and sellers typically determine the exchange price of a specific piece of real estate in a given market. For example, in some specific markets there is a great deal of new home construction and the typical buyer is someone looking for a newly constructed home with the amenities the buyer desires and can afford to acquire. In such a market, the cost approach (the cost of constructing a specific structure and of acquiring the land necessary for it) may very well be the best indicator of what the value of a piece of real estate is worth.

      In another market, one may find that homes were built a couple of generations ago (say forty years ago) and there is an influx of buyers who prefer to purchase these existing homes. These buyers may be motivated to buy used rather than new housing due to financial constraints or they like the large trees often found in established neighborhoods or for a variety of other reasons. The point is, this market is driven by factors other than the need to have a brand new home. In this market, the appraisal approach which might be most indicative of value would be the "market approach". The market approach uses the concept of substitution. That is, the typical buyer will have choices of which similar existing homes that are for sale and if one is priced too high or is not suitable for purchase, then a substitute property may be found and purchased. The market approach uses three or more sales of properties similar to the property for which a value is being determined, as "comparables".

      Properties which have recently sold and are comparable to a property being appraised, are analyzed individually and compared to the "subject" property. The selling price of each comparable sale, is adjusted to match conditions dictated by the "subject' property. For example, the selling price of a property larger than the subject property is adjusted lower to reflect what the comparable would have sold for if it was the same size as the subject property. Similar adjustments are made for any item which can be accurately quantified by an expert appraiser. Other examples of adjustments might be for differences in the number of bathrooms in each property, or lot size or the ages of the structures, or hot tubs or a variety of other factors. Once these adjustments for differences have been made, the appraiser selects the individual comparable with a value most indicative of the property being appraised. The appraiser does not average the comparables ... the appraiser uses the comparables to indicate a range of potential values and selects (a process known as reconciliation) that specific comparable which is the best indicator of the subject property's fair market value. Michigan statutes refer to "True Cash Value" as the value determined through an assessment. Michigan courts have ruled that True Cash Value is synonymous with the term Fair Market Value as used by professional real estate appraisers.

      In some markets, the value of real estate is driven not by the cost to construct the property new, nor by the sale of similar properties based upon amenities that are attractive to prospective occupants. In these markets, the key to a buyer purchasing a property is the cash flow or income which the property will generate for the buyer. We often think in terms of commercial properties when we think of cash generators, but there are residential properties which have a similar function. For example, in college towns, a former single family home may sell for much more if it is used to house college students. The point is, within almost every real estate market, there is a subset of properties that are bought and sold at a price driven by the cash flow or income stream the property will generate. In Michigan, assessors and others who appraise real estate will "capitalize" income streams from properties similar to the property being appraised and make an estimate of a subject property's fair market value based upon the indicated income stream and a capitalization rate.

      An income analysis can be a complex process, but like the market approach, the analysis must reflect the actions of "typical" buyers and sellers within the market. It is impossible to properly reflect the entirety of a well done appraisal using the "income" approach within a few paragraphs. However, the concept may be stated succinctly.       In the income approach a "net operating income" is determined and that income is divided by a "capitalization rate" to yield an indicated value for the property. Much in the same way you would select a credit union, or bank or savings bond to invest your money into, real estate investors analyze parcels of real estate in terms of their yield, safety as an investment and burdens (such as ease of getting your money out of the investment) to determine a capitalization rate. So, the income analysis is used to determine an estimate of the most likely income stream and the most likely capitalization rate. Once these are determined, the income stream is divided by the capitalization rate to yield the value of the property.

      An simplified example of the mathematical process can be illustrated in this way. Presume a property will generate $1,000 per month in net operating income and that after careful consideration, an appraiser determines typical investors buying in this market would expect an overall capitalization rate of 10 percent annually. Since $1,000 per month income becomes $12,000 per year; $12,000 is divided by the 10 percent rate and the value of the property to an invester would be One Hundred Twenty Thousand Dollars ($120,000.00). I caution you, that an income analysis is much more complicated than this example, because both the income stream and the overall rate must be very carefully determined and documented. However, the fundament process of an income stream divided by a rate is the foundation or end point of all the analysis and it is this one equation that is used to make the final estimate of value.

      In a well done appraisal with information sufficient to apply each of the three approaches to value, you will find that the individual estimates of value produced by the cost, income and market approaches to value will be reasonably close and that the appraiser will reconcile the three approaches and indicate to the reader which approach is the best indicator of the subject property's value.

      In making your appeal to either the local board of review or the Michigan Tax Tribunal (MTT), it is critical that the appellant or petitioner (the owner of the property being appealed) can demonstrate factually, that the State Equalized Value (SEV) of the property being appealed is improper. Once there is a demonstration of a discrepancy in value sufficient to convince the Board of Review or MTT representative(s) something is wrong, the taxing jurisdiction must then document and sustain their estimate of value. This means the taxpayer can win.

      Most local Boards of Review are much less formal than the MTT and you can quite easily appeal your property assessment if you've done some homework. A very nice thing about local Boards of Review is they are willing to listen to any issue taxpayers bring up - so long as the taxpayer is reasonable in his/her behavior. However, if you intend to pursue an appeal and win, you should have a little knowledge of the three approaches to value and be able to make factual arguments to explain why you feel your assessment is wrong.

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