Tax Adjust in Sale NOI?

I'm curious how all your firms do it. Do you adjust your 'sale NOI' to have the next buyers real estate taxes included, therefore lowering the NOI and sale price? Or do you sell on your proforma NOI, not adjusting for next buyer taxes?

I've done it both ways at the firms I've worked for. Curious how everyone else does it. 

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Comments (12)

Sep 22, 2021 - 10:44am

Hate to give this answer, but it depends.

States with more amorphous/lax tax resets and shorter-term holds, we won't adjust. On the other hand, we always assumed a reset on exit when working on product in cities with more stringent policies (SF, LA). We build in conservatism by assuming a reset to our underwritten tax basis if the seller has held for a while (mostly sleepy endowments/UHNW, etc.) based on rough guidance (we shell this out during DD via tax consultants and would rather bill a higher tax number to tenants and true up to a lower tax number if we don't reset). As we all know, resetting taxes on exit for the next buyer would be a sizeable hit to underwritten returns so under the onus of why beat yourself up if you don't have to. 

What are your thoughts pudding? Any insight that you can share over your time? 

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Sep 22, 2021 - 7:03pm

I go back and forth on this issue. On the one the one hand, if you buy an opportunistic heavy turnaround and your next buyers taxes are going to increase significantly, it makes sense to adjust taxes. With that said, you can also run your own analysis and see the next buyers ROC with adjust taxes. 

Here's where I struggle. If I assume I'm selling at a 7% exit cap rate (without adjust taxes) and the next buyer going in cap rate is a 6% (with adjusting taxes). If I were to adjust my taxes on sale, I would be selling at a true 7% exit cap. I am taking too much of a hit on my sale to sell on 'true' taxes. Additionally, you need to understand the comps you look at. If all the comps print a 7% cap - well is that a 7% cap on current or next buyer taxes? I think a lot of it really comes down to chatting with the capital markets community in that market. Sale caps may be 7% and buyers know they are really buying a 6% cap. If you were to adjust your exit price with next buyer taxes, you're selling at a true 7%, which is great but you're leaving money on the table. 

I think the prudent thing is to always look at your next buyer entry cap and make sure that makes sense. And than talk to the investment sales community and make sure the market is currently buying based on, for example, 7% on in place and 6% post tax adjustment. 

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Sep 23, 2021 - 9:07am

Are you killing the deal because they didn't actually adjust taxes on exit, or because the returns got crushed? And have you dug into the next buyer cap rate and asked, does this make sense in this market? If so, can I do this? Curious how you and your firm dig into it. Because if you're selling at an adjusted 7% cap, and they are selling on an unadjusted 7% cap, you're actually selling at two different cap rates, in a sense. 

Sep 24, 2021 - 11:21am

Yes. If you have any level of sophistication in your underwriting or you're dealing with institutional groups you have to underwrite tax resets on the buy and on exit. Any next buyer is going to underwrite the tax burden so it should be included to make sure your returns are accurate.

Sep 24, 2021 - 11:39am

Is this for an abatement expiring during the hold period?  

I think the easiest way to look at it is model it with full non-abated taxes, and then factor the PV of the tax savings into the purchase price.

Sep 24, 2021 - 11:50am

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