The Pennsylvania real property assessment process is in flux, leading to confusion and difficulty estimating future real property taxes, particularly in connection with the acquisition of commercial property. Nowhere is this lack of certainty more apparent than in the city of Philadelphia. It is the result of a recent Pennsylvania Supreme Court decision, the subsequent reversal of 2017 school district assessment appeals, and a partial revaluation in 2018.
The Philadelphia Office of Property Assessment (OPA) is authorized to reassess properties every year. Historically, it has left assessed values flat, with only occasional and irregular adjustments to individual values. The millage rate also remained flat, so increasing revenue was a function of growth in the aggregate assessment base. The Common Level Ratio (CLR) was constant at 32%.
Philadelphia adopted the Actual Value Initiative (AVI) in 2014 and began to reassess all properties at 100% of their market value. This was the first major reassessment in the jurisdiction for decades. In practice, values mostly lagged actual market values as indicated by sale prices.
The OPA reset land values in 2017 for residential properties (single-family and condominiums). As improvement values are substantially abated for new construction, increasing land values impacts the taxable portion and increases revenue. For 2018, commercial properties have been reassessed with, in many cases, significant increases. The city intends a full city-wide reassessment for 2019, and frequent—if not annual—reassessments in the future.
In September 2016, for the first time, the Philadelphia school district filed what are known as “reverse appeals” for the 2017 tax year. In a reverse appeal, the appellant (usually the school district) contends the proposed assessment issued by the assessor is too low and argues for an increase. In July 2017, the Pennsylvania Supreme Court, in Valley Forge Towers Apartments v. Upper Merion School District, affirmed that all property in a taxing jurisdiction constitutes a single class, and sub-classifications may not be treated in a disparate manner. The plaintiff property owners had argued that the school district violated the Uniformity Clause of the Constitution in selectively appealing certain properties to enhance revenue. This is a significant win for taxpayers, and it casts doubt on the legality of other jurisdictions’ reverse appeal programs. In September 2017, the Philadelphia Court of Common Pleas granted motions to quash the Philadelphia cases, citing the Valley Forge ruling. The school district has appealed these decisions to Commonwealth Court. For 2018, several suits have been filed, arguing that the partial reassessment violates the Uniformity Clause.
Philadelphia has historically relied more on wage and business taxes, and has been less dependent on property taxes to fund operations. This is one of the factors cited for lagging job growth over the years, and government and business leaders agree that it should be corrected, and the wage tax rate has been slowly declining. A bill is now pending in the Pennsylvania State Legislature, which would permit a 15% surcharge on taxes affecting commercial properties in the city of Philadelphia. Additional revenue generated would be off-set by reductions in wage and business taxes.
Frequent reassessment and reverse appeals are new in Philadelphia, so there is no useful precedent for predicting near-term trends. It will likely take years to resolve the questions raised by the Valley Forge decision. School districts still have the right to appeal, and while reverse appeals for the 2018 tax year appear to be down sharply in the region, the jurisdictions are expected to revise their processes and continue to appeal, pending further court rulings. The Philadelphia district has reportedly filed 450 appeals for 2018.
The OPA has historically been conservative in its valuations relative to actual market values. But the gap is closing, and future assessments may approach actual market levels. In prior years, commercial property acquisitions were underwritten, assuming no or minimal change in the assessment. This may no longer be appropriate, and there is a great deal of confusion as to how to underwrite future property taxes when a property changes hands.
Many in the brokerage community are ignoring these historic and fundamental changes to the assessment process and are indicating that future property taxes will continue to be set in the traditional manner. This may be wishful thinking; significantly higher future property taxes will have a negative impact on purchase prices, if in fact, a new valuation model and assessment practice is going to be consistently applied going forward. On the other hand, there may be political pressure to reduce the impact of such full market-value driven assessments, and that might lead to a more phased-in approach. In either event, purchasers of new commercial property in Philadelphia should exercise caution in the underwriting assumptions used for estimating their post-closing property taxes during their future holding period. With better market data as a result of an active sales market, more frequent reassessments, and pressure to increase property tax revenue as a share of total city revenue, it seems likely that assessed values will continue to increase in the near term.
The worse-case scenario is assessments increase to 100% of actual market. The best case scenario is increases trend in line with the general real estate cycle. The millage rate is expected to remain flat. Whether the OPA is restrained or aggressive, for the time being the school district can affect taxes through the appeal process.
Until we have more guidance on these issues, and a few years of assessment history using the new model, it will be very difficult to advise purchasers exactly how their new taxes will be determined.
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