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In a number of states, depending on the locale, you can be granted anywhere from an 8-15 year abatement of property taxes. This is typically done in return for having a percentage of affordable units available for low income residents.How would you model that in your excel models? When I have encountered this issue in the past, I calculated the reversion value of the property by capitalizing the NOI as if the property taxes were in place and payable and then added to this value the present value of the remaining property taxes that are abated. Does this sound like a reasonable approach?
Ironically, I’m putting together a post on the blog side of the website on this very topic! I’ll share the link as a response to this thread when I’m done, but to quickly answer your question: yes, your method is correct.
With that said, allow me to offer some color on property tax incentives in both your DCF and Direct Cap valuation.
Direct Cap.
What’s the first rule of direct cap valuation? Only cap durable cash flows, right? A below market property tax line item is not durable. So the proper way to account for a property tax abatement when doing a direct cap valuation is to:
1) Mark the property taxes to market in your pro forma.
2) Calculate the present value of the future property tax abatement payments. Now what discount rate should you use though? Personally I use the cap rate but this is probably overly conservative and simplistic. Others use the yield on municipal bonds for the jurisdiction guaranteeing the abatement, which also makes sense but interest paid on municipal bonds are free from federal tax (in the U.S.) which means you’d need to calculate the tax yield equivalent for that bond to really get to the proper discount rate. Hence, using the cap rate is a safe and simple alternative.
3) Cap the adjusted NOI by the cap rate and then add the present value of the property tax abatement to the base value to arrive at an adjusted value including the property tax abatement.DCF
You already taught us the method for accounting for a property tax abatement in a DCF valuation. But to restate:
1) Run the DCF, projecting the actual cash flow inclusive of any property tax abatement payments.
2) Adjust the reversion pro forma to include market rate property taxes.
3) Take the present value of the future property tax abatement payments beyond the analysis period, and add that value to the reversion value to get an adjusted reversion value.Really glad you brought this up!
Additional Insights
Here is the link to the blog post mentioned above. The post includes a video and Excel workbook walking you through the logic.
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