One Property: Two Appeals
For triple net (or NNN) commercial leases, it is not unusual to give the tenant the contractual right to appeal any future real estate tax assessment of the leased property, because the tenant bears the responsibility under such lease to pay the taxes levied on any assessment of the real estate. This can cause huge headaches if the lease is not drafted to take into account (i) situations where both the owner and tenant, or two separate tenants, lodge separate appeals on the same property and (ii) all stages of the tax appeal process. Let’s look at a hypothetical example.
For instance, imagine a parcel that covers an area of 100,000 square feet (the “Subject Property”), which has a commercial improvement built on only a portion of the Subject Property’s total area. The owner leases out the building to a commercial tenant under a triple net lease but plans, eventually, to construct another building on a portion the Subject Property’s unimproved footprint. Several years later, in 2016, the commercial tenant has several sub-lessees that pay their pro rata share of real estate taxes. However, three entire floors of the building are vacant, leaving the tenant responsible for a proportionate share of real estate taxes, when the tenant receives a notice of change of assessment for tax year 2017 (probably in April or May of 2016, possibly not until August). Because the new 2017 assessment is $1 million more than the assessment for 2016, which the tenant believes is incorrect due to the aforementioned vacancy issues, the tenant appeals the 2017 assessment to the Philadelphia Board of Revision of Taxes (“BRT”). Pursuant to the lease, the tenant informs the owner, which has no objection.
Note that under the General County Assessment Law, any tenant or subtenant responsible to pay real estate taxes on a property is an “owner” and has a statutory right to appeal the value of that property. See West Mifflin Area Sch. Dist. v. Bd. of Prop. Assessment, 802 A.2d 687, 692 (Pa. Commw. Ct. 2002). In other words, there is no statute to prohibit a tenant (or subtenant) from appealing a property’s value instead of, and without joining or even notifying, an owner or other responsible tenants.
Over a year after filing its BRT appeal, in July of 2017, the tenant doesn’t receive the reduction it hoped for and has lost another subtenant. Consequently, the tenant appeals the BRT’s decision to the Philadelphia Court of Common Pleas (“CCP”). The Subject Property’s 2018 assessment was certified by the Office of Property Assessment on March 31st, see 53 Pa. C.S. § 8565, which means that the 2018 assessment is ripe for appeal and automatically incorporated into the tenant’s pending CCP case. See Kmart Corp. v. Washington Cnty. Bd. of Assessment Appeals, 950 A. 2d 1089 (Pa. Commw. Ct. 2008); 72 P.S. § 5020-518.1(b).
The primary lease on the Subject Property does not oblige the tenant to notify the owner of its subsequent appeal of the BRT’s decision. In addition, the CCP rules do not require that all entities with an ownership interest in an appealed property be notified of the appeal. Accordingly, the owner is not aware that the original appeal to the BRT has been continued to the CCP. This is important, because, in our hypothetical scenario, in early 2017 the owner has begun to construct a $100 million hotel on the unimproved portion of the Subject Property. The Philadelphia School District learns of this and intervenes in the tenant’s appeal to request that the Subject Property’s assessment be increased in proportion to how much construction is complete.
While the tenant’s appeal proceeds at the Court of Common Pleas, the owner, unaware of the CCP appeal, files an appeal of the Subject Property’s 2018 assessed value with the BRT, because the OPA increased the assessment assuming 30% completion of construction for 2018. The owner’s appeal, filed in August of 2018, contests the OPA’s reliance on the total cost of construction as a basis for the property’s assessed value, because the owner argues that the Subject Property would not actually sell for $30 million mid-way through construction, even if construction was partially complete.
However, while the owner’s BRT appeal is pending, the tenant’s appeal, now in CCP, is scheduled to be tried in October of 2018. By that time, the owner’s hotel is 70% complete, and the tenant has now filled the subtenant vacancies. Moreover, pursuant to the Kmart case, as explained above, 2019 is now also incorporated into this case. However, the tenant does not introduce an appraisal report for either 2018 or 2019, as its attorney was only authorized to contest the 2017 assessed value and isn’t aware that the owner is contesting tax year 2018. The School District, however, has prepared appraisal reports for 2017, 2018 and 2019.
Keep in mind that this situation, where the appellant taxpayer fails to enter an appraisal report for a later tax year that was automatically incorporated into an assessment appeal, is not just a relatively unlikely hypothetical—it happens. There are numerous Commonwealth Court decisions that describe this exact fact set, and I myself, while working for the City of Philadelphia, went to trial in an assessment appeal case where the owner did not introduce an assessment appeal for a subsequently incorporated tax year’s assessment. In such situations, the taxing authority’s proposed value is likely to be adopted in full.
Because in our hypothetical, only the School District’s appraiser presented evidence for the Subject Property’s 2018 valuation, the Court accepts its unrebutted evidence as determinative of the Subject Property’s tax year 2018 value. This increases the 2018 value of the Subject Property over $50 million, which is equivalent to an additional $700,000 in real estate taxes that is not subject to abatement. See 72 P.S. § 4727 (abatement effective only once construction is complete). The Philadelphia Revenue Department then issues a revised tax bill for the property to the owner. At this point, the owner realizes (too late) that full and final trial on the 2018 valuation for the Subject Property may preclude the owner from contesting the 2018 value before the BRT, even though the owner timely filed for tax year 2018 and got an appraisal with a much lower value. Moreover, the owner hasn’t budgeted for this additional expense, and the hotel project is now at risk.
The foregoing scenario, or something quite like it, is entirely possible if a commercial lease doesn’t adequately address all potential issues if a lessee, sublessee or owner appeals a property’s tax assessment. Specifically, it is essential that if a commercial lease allows a tenant to appeal a property’s assessment, that same lease require notice to the owner at all stages of an assessment appeal, not just when an appeal is first filed at the administrative level. It is also vital that a commercial lease clarify the responsibilities for all parties if an appeal incorporates later years’ assessments.
(NOTE: the foregoing article has been edited and updated from the original which was published in early 2019 by the same author in a different blog that was discontinued.)