Real Estate Taxes: Calculation, Methodology and Trends

By Wendy S. Cell and Robert J. Strachota, MAI, MCBA, CRE^®

Real estate taxes vary widely throughout the Twin Cities area for many reasons. The primary factors that determine property taxes are the tax levies of the district the property is in, the value of the property relative to the value of all other properties in the district, and the use of the property. Real estate taxes are calculated based upon the market value of the property. Market value is the probable price a property should sell for assuming the buyer and seller are well informed and neither is under duress. There is no direct relationship between estimated market value and property tax liability. Instead, the property’s taxable market value is used to determine how much property tax is due. If your property’s value increased or decreased, it may affect the amount of property taxes you owe.

Rising property values increase the proportion of your property’s value that is subject to tax and decreasing property values lower the taxable amount of your property. While property taxes are supposed to rise and fall with property values, it is common that even when the economy is down, property taxes may rise. If governmental spending is reduced, less money is needed from taxpayers, and property taxes might be reduced. Conversely, if spending is increased, taxes may increase. Other factors include voter-approved referenda, local government aid, value of other properties in the city, and value of properties within tax increment financing districts. Shown below is a summary of the taxable market value in Minneapolis from 2008 through 2016 and the effective tax rate for commercial properties from 2011 through 2016.

One could presume that values will continue to increase as new construction continues and new projects enter the market, and thus tax rates are likely to decline. However, the overall proposed Minneapolis property tax levy for 2016 will increase 3.4 percent over 2015. Property taxpayers in Hennepin County will see an increase of 4.48 percent in 2016 over 2015. These increases reflect demands for quality services provided to residents. Yet, not everyone’s property tax bill will increase by the same rate. As shown in the chart in the next column, prepared by the Minnesota Department of Revenue, the effective tax rate is usually between 3 percent and 4 percent for commercial property.

Building owners often compare their real estate taxes to their competitors’ real estate taxes. They do this using a particular unit of comparison used by participants in the market, such as real estate taxes per unit, per door, or per square foot. While on the surface this practice seems reasonable, real estate
taxation is complicated, and as a result, this comparison should not be an owner’s primary benchmark. The assessor sets a market value on every property each year.

The assessor uses a mass appraisal process. As a result, assessors rely on general market data. Even though Minnesota statute requires the assessor to value each property on a fee simple basis (unencumbered with existing leases or assuming leases in place are at market levels), providing specific building information to the assessor may be useful in valuing a specific building. The actual performance of an income-producing property is typically more indicative of the property’s submarket. However, without the owner’s proprietary information, assessors have a diminished ability to account for differences within market sectors.