## 11.2 Property Value Determination

The goal of property value assessment is to provide an accurate and up-to-date estimate of the market value for each property. The accuracy of these assessments directly impacts the (perceived) fairness of property taxes. Achieving higher accuracy typically involves more frequent and regular assessments, ideally on an annual basis. There are three types of property values:

**Market value**assumes full information and properly functioning markets.**Appraised value**, determined by a professional appraiser, is relevant in the sale process and for mortgage lending purposes.**Assessed value**, used for property tax purposes, is often set by policy as a fraction (i.e., between 0 and 1) of the market value and may differ significantly from both market and appraised values. Property value assessments are typically conducted at the local level, rarely at the state level.

While market and appraised values are defensible due to their basis in actual transactions, assessed values are primarily determined by tax policy.

There are three main methods used to assess property values: (1) Comparable sales approach, (2) Cost approach, and (3) Income approach. The comparable sales approach is frequently used for residential properties by leveraging market transaction data. Since there is a sufficient number of transactions per year, statistical methods insure a fairly accurate property value determination. The cost approach, more suitable for industrial and utility properties, involves determining either the reproduction cost (the cost to construct an identical property) or the replacement cost (the cost to build a similar property using modern technology). Of course, this may be more difficult if you consider for example the value of a unique facility such as an ethanol plant. The income approach is commonly used for income-generating properties, such as apartment complexes. The approach determines the annual profit from the property and uses the net present value (NPV) to determine its current value. The present value of the property is then found by dividing the net income by the discount rate. This assumes the revenue is received in perpetuity. Let us consider the following example:

- A 10-unit apartment complex that rents for $1,500 per month.
- The expense rate as a percent of income is 54%.
- The vacancy rate is 6%.
- The discount rate used for the NPV calculation is 5%.

Given those information, the calculations are as follows:

- Gross income: \(\$1,500 \cdot 10 \cdot 12 \cdot (1-0.06)=\$169,200\)
- Expenses: \(\$169,200 \cdot 0.54= \$91,368\)
- Net income per year: \(\$169,200-\$91,368= \$71,832\)
- Present value: \(\$71,832/0.05= \$1,436,640\)

The assessment ratio is the assessed value as percentage of the market value. The ratio is set by state finance laws to differentiate classes of property, i.e., residential, agricultural, commercial, and industrial. There are lower rates for residential properties than for commercial and industrial property. The assessed value equals assessment ratio (\(AR\)) times market value (\(MV\)), i.e., \[AV = AR \cdot MV\]

The rationales for property classifications are the perception of fairness and slow urban sprawl by taxing farm property at lower rates.

The final remaining questions is with regard to the frequency of property value assessment. There are four primary types of assessment cycles used for property taxes. In the cyclical assessment approach, all properties are assessed during the designated assessment year. Once a property is assessed, its value remains unchanged until the next scheduled assessment, unless significant changes are made to the property that would warrant a reassessment. In a segmental assessment, only a fraction of all properties are reassessed each year. For example, one-third of all properties might be assessed every three years. In the annual assessment, the process is made possible by advancements in technology. In this approach, each characteristic of a property is assigned a value, and these values are adjusted based on market trends in the jurisdiction. Finally, under assessment on sale, a property is reassessed when it is sold. This method can lead to significant inequities, both horizontally (between similar properties) and vertically (across different property values), as properties that do not change ownership may not be reassessed for many years.