By James P. Regan

As Published in Real Estate Chicago, July/August 2001

There is a widely held misconception that the actual price paid for a property will become the basis for an immediate increase in its real estate taxes. In almost every state, including Illinois, a property’s market value is the base upon which real estate taxes must be determined. But there are many situations in which the purchase price does not represent the property’s market value and, therefore, should not become the basis for its real estate taxes.

Many property purchases are not dictated by the marketplace but by their value to a particular investor based on his or her requirements. The appraisal community would regard these sales as indicative of investment value. Market value and investment value are very different concepts. Market value assumes no specific buyer or seller, but rather a typical buyer and a typical seller for the market in which the property is located. On the other hand, investment value is directly related to the interest of a specific buyer. The price paid reflects the advantages of a particular property to the buyer.

A typical example might be the price paid for a land parcel adjacent to the buyer’s truck terminal. The vacant parcel may have a market value of $200,000. On the other hand, the owner of the truck terminal may be willing to pay $300,000 for the land since it is crucial for him to expand and it would be far more costly for him to relocate his entire business to another site. In this instance, a purchase price of $300,000 would not reflect market value and should not be the basis for the property’s real estate taxes.

An analogous situation arises when residential rental buildings are purchased for conversion to residential condominiums. A condo converter may be willing to pay more for a rental building than an investor in rental properties since he will be able to turn the building over within a short time frame and the sale of the individual units will more than compensate for the higher price.

But, the buyer’s motivation is just one consideration in determining whether the price represents market value. The question of what is purchased must also be considered. Properties such as hotels, shopping malls, nursing homes and retirement centers contain many non-real estate assets and those assets are typically part of a sale. A hotel is a business which has a major real estate component, but in addition, it has other assets such as a work force in place, a management team, in most cases a brand name (franchise), and a reservation system. The price paid for the hotel represents compensation for all those assets and not just the real estate. The real estate assets of a full-service hotel will normally be valued at less than half its total purchase price. In today’s market, anchor department stores are owner occupied and so the purchase of a “shopping center” will be restricted to the in-line stores and possibly, some outlots.

he purchase of a shopping center will include a continuing relationship with the anchor stores which play such a significant role in drawing customers to the mall. When we recognize that rents for in-line stores are based on sales volume the relationship to the anchor is a major non-realty asset that is purchased. In many cases the purchase of a shopping center will also include the right to provide energy and air conditioning to tenants. The most important asset of a nursing home is not the real estate but the permission to operate under a license from the state. Assisted living facilities for seniors as well as comprehensive retirement centers provide a myriad of services none of which flow from the real estate.

In each of these cases, we must peel away the value of the non-real estate assets from the total purchase price. In Illinois, the Transfer Declarations that must be filed at the time a property is purchased makes provision for an allocation of value between real estate assets and non-real estate assets.

There are many other circumstances which challenge the myth that the price paid for a property represents the market value upon which its real estate taxes are based. Space does not allow us to consider portfolio purchases and the effect of public financing on the fundamental principles of real estate valuation. It should be clear that the “price equals value principle” is, at best, a half truth.