Government & Politics  June 11, 2023

Up, up up

Commercial property valuation spikes threaten business operators

Commercial real estate brokerage CBRE lists a property in east Loveland like this:

“Conveniently located close to I-25 and Highway 34 in Loveland, the building provides its occupants with views of the mountains and is within one mile of more than 25 restaurants, shopping, hotels …”

Two units are available this summer at a base rent rate of between $16.50 and $17.50 per square foot. That would translate, at the lower end, for a 2,500-square-foot unit at $3,437 per month. Not bad for Class A office space.

But the property also requires participation in other expenses under the triple net, or NNN, lease agreement. 

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NNN leases, typical throughout the region, mean that tenants will share expenses with other tenants and the landlord. Usually, property taxes, insurance premiums and common area maintenance such as snow removal and similar expenses, are added to the base rent.

In the case of the property that CBRE lists, the estimate of NNN fees are $14.55 per square foot, or $3,021 per month for the same 2,500-square-foot unit. As is common, NNN fees are estimated before a year begins, then reconciled with actual expenses at year end. Tenants then receive a supplemental bill or a refund, depending on actual expenses. 

For the small business with thin margins, suddenly the impact of rent plus NNN becomes something to be reckoned with.

And the NNNs are about to get worse. New property valuations will cause the tax piece of the calculation to explode. Or at least that’s the fear among property owners and their tenants.

Valuations

As reported earlier, all categories of property rose substantially in the most-recent re-evaluation conducted by county assessors. Commercial property valuations increased from 12% more at the low end in Broomfield County to 41% higher in both Boulder and Larimer counties. Weld County saw a 35% increase in commercial property valuations. Industrial properties increased from 19% higher in Weld to 67% higher in Boulder, where available industrial properties are few and far between.

Assessors use sales of comparative properties when determining new valuations of residential and commercial properties and, in the case of commercial, also consider the income potential of the property. Comparative sales alone have likely resulted in the increased valuations of similar properties. A 1-million-square-foot portfolio in the Flatiron Park campus in Boulder, for example, sold in 2022 for $625 million, the richest deal in Colorado history.

The percentage increases in valuations don’t necessarily translate into the same percentage increases in property taxes but will result in substantial tax increases unless valuation protests are successful. Some are; others are not.

Flatiron Park
The entrance to the Flatiron Park development in Boulder. Christopher Wood/BizWest

Once the valuation is fixed in December, then the county applies the state assessment rates, which because of the Gallagher repeal in 2020 are set at 7.15% for residential properties and 29% for commercial properties.

Value multiplied by the assessment rate results in a taxable value for each property.

Then, mill levies are applied to the taxable value; mill levies vary by jurisdiction and can in some cases be adjusted. One mill equals $1 of property tax for every $1,000 of assessed value, so the taxable valuations are multiplied by the total mills then divided by 1,000 to get the taxes to be paid.

It’s complicated and varies by jurisdiction, which is why property owners fear the worst when taxes are due next year.

Protests

The increases in commercial valuations have sparked widespread, perhaps historic, numbers of protests.

Cynthia Braddock, assessor in Boulder County, called the protests “historic, eye popping.”

As of the day before the June 8 deadline for filing, Boulder County had more than 15,000 filings.

“It’s our job. It’s part of everyone’s due process” to be able to protest the violations as permitted under state law, Braddock said. “We’ll do whatever we can for them,” she said.

“Whatever we can” of course may not mean the same to assessors as it does to property owners. Property owners hope that the mere filing of an appeal will result in relief. However, by law, assessors have to see evidence that an assessment of a specific property was made in error in order to make a change. 

Errors do happen. Because every property in a county is reappraised based upon recent sales and other factors, conclusions can be drawn broadly that don’t necessarily apply to an individual parcel. 

Braddock, like other county assessors, will provide revised valuations to county commissioners Aug. 25 and again in December. Commissioners and other taxing authorities send their mill levies to assessors in late December, and by Dec. 22 commissioners will act on the mill levies. At that point, property owners will know what their taxes will be for 2023, payable in 2024.

Uncertainties

Property owners and government officials, while acknowledging that spikes in valuations will have impacts regardless of anything else, are living in a world of uncertainty. 

For commercial property owners like Spiro Palmer, Palmer Properties LLC in Fort Collins, the uncertainty stems from what will happen as a result of assessment protests. “They have this process. They ask us to make the cases. We don’t want to make comments. We’ll wait and see,” he said.

But in addition to the protests, at least two efforts are afoot to provide property-tax relief via the ballot.

The Colorado Legislature passed a bill, signed by Gov. Jared Polis, to place a statutory measure on the ballot, dubbed HH, that would lower property-tax rates — the 7.15% and 29% factors — for 10 years. This would decrease property-tax collections, which go to support local governments and school districts, by $1 billion a year for 10 years. The state would backfill some of the loss to local governments, but not all of it. 

The money to backfill would come from raising the so-called TABOR cap. The Taxpayer Bill of Rights limits how much money governments can collect and keep so that in times of prosperity, government does not grow beyond certain limits. In the state’s case, the cap is applied to income- and sales-tax collections. By raising the cap, the state could keep more of its collections and in turn would funnel money to local governments and schools to make up for the loss in local property-tax collections. 

TABOR refunds to taxpayers would still occur if collections continue at their current pace, but would not be as large. To make it more palatable to taxpayers, refunds would be uniform regardless of income, meaning higher-wage earners would get less and lower-wage earners more than would otherwise be the case.

HH may or may not make the ballot. A lawsuit has been filed challenging it under the constitutional one-subject rule. Opponents contend that the property tax rate change and the TABOR cap change are two distinct subjects, which would need to be voted on separately. A judge determined Friday that the ballot measure does meet the single-subject rule, but the plaintiffs in the case said they would appeal.

Also likely on the ballot this fall will be Inititative 21, a constitutional measure offered by an organization called Advance Colorado to reduce property taxes. It would limit revenue collected on a property to no more than a 3% increase annually, unless the property undergoes significant improvements such as adding 10% or more square feet or seeing its use change.

Whether either of those measures passes remains to be seen, and if they do or not, governments have some latitude to collect less than they otherwise might.

Limitations, imposed or voluntary

State law places a limitation on local governments to tax property at a level that results in no more than a 5.5% increase in revenue. So even if the new valuations would otherwise permit higher collections, county commissioners, for example, would need to set mill levies low enough to prevent collections that exceed that 5.5% limit. 

The limitation does not apply to all governments. Home rule cities and counties, for example, are exempt from it. Broomfield and Weld are home rule counties, as are many of the cities and towns in the Boulder Valley and Northern Colorado. School districts, fire districts, water districts and other special districts are also exempt.

John Kefalas, a Larimer County commissioner and former state legislator, opined that HH, while not guaranteed, also may bring with it unintended consequences. He said that in his experience, late-arriving bills as this one was at the Legislature often have issues. The two-subject issue may be one of those consequences that results in its failure to appear this fall, he said. Advance Colorado is behind the lawsuit, he said, and as many as 12 counties in the state have signed onto the lawsuit as plaintiffs. 

John Kefalas

“If either of those pass, we (Larimer County commissioners) are preparing three budget scenarios — one for HH, one for Initiative 21” and one without either of those measures, he said. Kefalas said that “from our perspective of providing services, 21 is in perpetuity. That would have serious implications for county operations and services. HH would also have implications but that’s for a 10-year period.

“If neither passes, and there won’t be any property-tax relief from the state, as commissioners, we would temporarily lower the mill levy.”

The county has done that in the past, the last time in 2020. “We’ve done it maybe five times in the past 20 years,” he said, although those situations may not have been as significant as what property taxpayers are facing now.

Kefalas said that the property-tax credit the county is considering is about an 18% reduction, but that would apply only to the county’s share of property-tax collections. Of the 94 mills applied by the eight taxing authorities in the county, only 22.7 mills are controlled by the county. School districts collect the lion’s share of property taxes.

When asked for information about discussions in the St. Vrain Valley School District, based in Longmont, about how it might respond to the spike in valuations, Superintendent Don Haddad declined to answer because of the uncertainty of the statewide ballot issues.

Larimer’s Kefalas said that while lowering mill levies is not new, it does raise issues. “We always have the ability to reduce, but the trick is bringing them back up. We can provide a mill-levy credit, then when warranted bring it back up,” he said.

In the meantime, the county is taking steps to reduce spending even though tax collections most likely will be up.

“It’s not our intention to cash in on a windfall of revenue,” he said.

Departments have been asked to submit two budgets, one that would be business as usual and one that shows a 5% reduction in spending. Kafalas also said the county will impose a hiring freeze “until the dust settles” on the statewide ballot issues.

Information about property-tax collections in Larimer County can be found on the county website. The site includes information about every address in the county, both residential and commercial.

Where the rubber meets the road

Commercial Realtors, for better or worse, operate where the rubber meets the road: Relationships with business owners who lease or buy properties. 

“The implications are wide-reaching. The increased assessments touch all sides,” said Nathan Klein, a partner in LC Real Estate Group LLC, a Loveland-based commercial brokerage that also has a residential division. 

“The average industrial triple net for the first 15 years of my career was $3 to $3.50 per square foot. In the assessment a few years ago, it went up a dollar, and now it looks like it’ll go up at least a dollar more.”

While a dollar doesn’t sound like much, that’s applied over thousands of square feet for industrial properties. “That’s 60% over four years,” Klein said.

He cited multiple examples, including the Foxtrail business condos in Centerra or the Rangeview buildings in Centerra. 

At 1605 Foxtrail C-1, a 3,200-square-foot business condo, property taxes in 2022 were $45,160 or more than $14 a square foot, which is similar to the CBRE listing at the start of this report. Those will increase with the new assessments. 

Both Klein and Ryan Schaefer, CEO of NAI Affinity commercial brokerage, said they encounter properties regularly that have seen no increases in base rent for 20 years because tax increases force up triple nets to the point that landlords can’t raise the base rent and still find or retain tenants.

“At Thompson Valley Towne Center (where King Soopers is located in south Loveland off of Taft Avenue), net rents are basically the same as they were when it was built in 1999,” Klein said.

Schaefer said Class A office spaces built in the early 2000s are renting on a base level for about the same. “Property taxes are twice what they were. Gross rents (base plus NNN) may be up, but the triple net has captured all the rental increase over time,” he said.

Thompson Valley Towne Center sign
Thompson Valley Towne Center is located at 1163 Eagle Drive in southwest Loveland. Christopher Wood/BizWest

“That’s a problem for property owners. People think of property owners as rich investors, but many times you have people who have their pensions invested in this real estate,” Schaefer said.

LC Real Estate, which serves as a broker for property owners seeking to sell or rent and also owns its own properties that it leases to small businesses, has tried to be transparent with tenants.

“We’re telling our tenants: ‘We’re not immune to the assessed valuation increases; that’s hit the entire market. We’re protesting in almost every case. They need to be prepared for an increase,’” Klein said.

He said LC nudged up rents a little over the past months in anticipation of what was coming, so tenants would not be hit with a big increase all at once. 

“We’ve heard that some landlords are fixing triple nets and eating some of it. Some of the big redevelopment projects in Denver, their triple net expenses are $25 or $30 a square foot. Tenants in those cases are saying they want to pay a gross amount” that includes the taxes, so they have more predictability.

Klein recounted the experience of a client in south Loveland who owns a Class C industrial property. 

The property was assessed previously at about $750,000. “The property is worth maybe $1.2 million or $1.3 million today. He got assessed $1.675 million. The property taxes were $16,000 a year, and they’ve gone to $37,000 a year,” Klein said.

As a Class C property, rents are low, and tenants occupy the space because their margins are low. Because the landlord issues gross leases, not triple net leases, he has to eat the tax increases or increase rents. When the landlord’s income drops by $20,000, that subsequently lowers the value of the property using the income method of property appraisal, which is one of the methods assessors use in determining value.

“If the assessor had assessed him at $1.1 million or $1.2 million, he wouldn’t have much of an argument. The implications are that he will have no choice but to increase his rents just to restore his income. He’ll have to withstand some vacancies,” Klein said.

“Most people understand that their values have gone up, and they’re willing to accept some increase. But when you get assessed way over what you can sell it for, somebody has to look at it with a more reasonable head,” Klein said.

Klein believes that commercial assessments are being based too much on the comparable sales approach appraisal instead of the income-based approach.  

He cited another property, a warehouse that doesn’t have an overhead door and with all access by a pedestrian door. Such a property has limited value in the marketplace because only a few tenants can make use of it.

“We’ve had to tell the assessor for the fourth time in four assessment cycles that this warehouse is not the same as others in that category,” which might have higher income values because they permit more access to the space.

Schaefer said he’s seen what he called a “stagnation in value” of office properties because of the outsized impact of taxes on triple nets. 

In addition to the issue of landlords being unable to increase base rents, “a second real spot of pain is among small retailers, franchisees, who operate small businesses in retail strip buildings. There may have been a sale in a neighboring center and values have increased 40% or 50%,” but the amount of retail business being done has not increased.

“I’ve seen small businesses such as restaurants that have had tens of thousands a year increases in their rental costs. And maybe they were just breaking even before,” Schaefer said.

He noted that commercial properties are particularly vulnerable to swings in valuations because they are taxed at 29% of actual value, four times the assessment rates applied to residential properties.

Schaefer said all categories of property have been affected by the spike in taxes, but newer industrial properties have been least affected. “Lease rates have increased so fast (in that category because of demand) that it’s keeping up with increases from the assessor,” he said.

Office properties have the best case to make for relief when they argue in front of the assessor, Schaefer said, because of lower rates of growth, low occupancy rates and factors that affect the income possible from the property.

Boulder commercial broker Geoffrey Keys, owner of Keys Commercial Real Estate LLC, described the situation as “kind of a mess.” 

“I represent one building where the property taxes went from $8 a square foot to $19, more than double. That pushed the total operating expenses (which make up the full triple net amount) to the high twenties,” he said. 

The situation is particularly acute in downtown Boulder, where operating expenses are more than $30 per square foot, he said.

He has not seen tenants moving out of Boulder as a result, but the impact of the new valuations has yet to be seen. Taxes applied to those valuations will be due and payable in 2024.

“It’s pretty early in the game to make that determination, but we will see some impact soon.”

Keys also said that in Boulder property owners and tenants have to deal with taxation on square footage on outdoor decks and patios, which is taxed at the same rate as indoor office space. 

“If you combine that feature with the fact that property taxes have gone up exponentially, it will cause a lot of concern for tenants,” he said.

Becky Gamble, CEO of Dean Callan & Co. Inc., concurred that the tax issue is affecting properties of all types. Her clients are protesting the valuations, but she noted that companies that handle protests for others in some cases aren’t taking on new clients because of the flood of potential cases.

She also noted that the issue is especially impactful for office properties.

“Landlords are trying to get these spaces leased out. When looking at this kind of tax increase, when you see inversions where base rent is lower than operating expenses, that’s a problem,” Gamble said.

Inversions, she said, are a relatively new phenomenon in the market.

“If it continues, there’s definitely going to be an uncomfortable conversation between landlords and tenants and between landlords and the city. There’s only so much small businesses can pay.”

She knows that some tenants would like to negotiate caps on what landlords can pass through, but landlords are reluctant to do that without knowing what’s coming, and that won’t be known until late this year.

“It’s kind of like the PGA and the LIV tour. No one knows what to expect,” she said.

Still, given the governor’s interest and that of the Legislature, “I generally feel like there’s enough momentum that something will happen to cap the increase. To what degree and how helpful that becomes, we don’t know.”

Commercial real estate brokerage CBRE lists a property in east Loveland like this:

“Conveniently located close to I-25 and Highway 34 in Loveland, the building provides its occupants with views of the mountains and is within one mile of more than 25 restaurants, shopping, hotels …”

Two units are available this summer at a base rent rate of between $16.50 and $17.50 per square foot. That would translate, at the lower end, for a 2,500-square-foot unit at $3,437 per month. Not bad for Class A office space.

But the property also requires participation in other expenses under the triple net, or NNN, lease…

Ken Amundson
Ken Amundson is managing editor of BizWest. He has lived in Loveland and reported on issues in the region since 1987. Prior to Colorado, he reported and edited for news organizations in Minnesota and Iowa. He's a parent of two and grandparent of four, all of whom make their homes on the Front Range. A news junkie at heart, he also enjoys competitive sports, especially the Rapids.
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