During the recent recession and downturn in the commercial real estate market there has been increased vacancy across many commercial real estate sectors through higher rates of default by tenants, higher concessions required to maintain occupancy, and reduced demand. Logic suggests that when there are fewer tenants paying rent, there is less revenue and less income for the landlord. Usually when income declines so does the value of the income producing property.^[1] So does this mean that an income producing property with elevated vacancy will be able to obtain an estimated market value reduction on its property taxes as a result of the vacancy? Not usually, the actual vacancy will generally be given little weight in determining the market value for property tax purposes.

Recently the tax court adopted a 10% vacancy rate for an income-producing property that had actual vacancy rates of 27%, 34%, and 38% for the years under appeal. Continental Retail, LLC v. County of Hennepin, File Nos. 27-CV-07-06549, 27-CV-08-09497, 27-CV-09-11161 (Minn. Tax Ct. Dec. 21, 2010). A vacancy rate of 5% to 10% was reasonable for a property that was 100% occupied by a state agency for 20 years. Meritex Enter’s., Inc., v. County of Ramsey, File No. CX-06-4506 (Minn. Tax Ct. July 24, 2009). The tax court applied a 17% vacancy rate for an apartment building that operated with a vacancy of 25%. Nordlie v. County of Hennepin, File No. TC-23227 (Minn. Tax Ct. Dec. 21, 1995). The tax court rejected a historical vacancy rate of 3% for a church-based senior living property and instead applied a 7% vacancy rate. Colonial Acres Home, Inc. v. County of Hennepin, File Nos. TC-10613, TC-11575, TC-14676 (Minn. Tax Ct. Jan. 8, 1993).

In the cases above, none of the actual vacancy rates were used in the valuations, but that does not mean the actual vacancy rate does not have an impact.

In valuing an income-producing property, an expert must look at the actual rent, expenses, and vacancy rates of the property and make a determination as to whether these factors are market for that particular property. If they are market for the property, they should be used in valuing the property. If they are below or above market, they should not be used to value the property. 

444 Lafayette, LLC, et al. v. County of Ramsey, File Nos. 62-CV-08-4369, 62-CV-09-4709, 62-CV-10-166 (Minn. Tax Ct. April 7, 2011) (emphasis added).

So what happened in the cases cited above? In Continental Retail, the court decided that the actual vacancy rates were not market because retail market reports showed lower vacancy rates. The court in Meritex dismissed the historical vacancy rate because market data showed a higher level of vacancy for properties similar to the subject in the same market. The apartment in Nordliehad higher-than-market vacancy, because the landlord operated the property with higher standards than the general apartment market which resulted in higher vacancy. The court stated that a buyer would consider the market vacancy rather than the higher vacancy because the cause of the higher vacancy would be cured by an alternative management style. The senior living property received a higher vacancy because the court felt that the relationship with the church created a lower-than-market vacancy that would not exist if the property became owned by another entity.

While the actual vacancy rate must be considered, based on these cases and the history of the tax court it is more likely that the market vacancy rate will be applied to the valuation. As a result, a property with high vacancy is not guaranteed a reduction in value due to the vacancy, but it can be a relevant factor if the subject’s high vacancy can be tied to the market.  

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^[1]   Vacancy and collection loss is the “allowance for reductions in potential gross income attributable to vacancies, tenant turnover, and nonpayment of rent or other income.” Appraisal of Real Estate, 512 (12th ed. 2001).