housing market

Furor over MPAC multi-res cap rates predicted

Advance disclosure reveals significant spike in values with reassessment
Tuesday, October 11, 2016
By Barbara Carss

Assessment notices for nearly 16,000 Ontario multi-residential properties will be mailed out next week, delivering valuations determined for the first time with the newly adopted direct capitalization methodology. Property owners have been promised an advance look and non-adversarial opportunities to adjust values before the assessment roll is finalized, but that has occurred on a fairly limited scale as the Municipal Property Assessment Corporation (MPAC) pushes to reassess about 5.4 million properties province-wide ahead of the next four-year assessment cycle, which begins with the 2017 tax year.

“A select few of our clients were provided a two-week window to review the top-line numbers for their portfolios, but we’re still missing some pieces of the puzzle because we’re not privy to information for comparable buildings,” says David Gibson, a property tax consultant with Yeoman & Company Paralegal Professional Corporation. “What we do know is the assessors are being very aggressive on values.”

Looking across the broader spectrum of business properties, lawyer and property tax specialist Stephen Longo concurs that jumps in value have been most pervasive in the multi-residential and retail sectors. He attributes significant spikes in multi-residential values to the new valuation approach and, more specifically, the low capitalization (cap) rates MPAC has employed.

“I anticipate a lot of appeals,” says Longo, who is a partner with Walker West Longo LLP. “I’m sure this isn’t what the sector had in mind when it talked about getting away from the gross income multiplier approach.”

Indeed, the Federation of Rental-housing Providers of Ontario (FRPO) advocated for the switch to valuations calculated on net operating income (NOI) in place of the gross income multiplier — a methodology that most other North American assessment agencies had already abandoned. Applying the approach that the real estate industry conventionally uses in appraising, buying and selling apartment buildings is considered generally more reflective of actual market values.

“It is going to modernize how they determine the value and then make it more transparent,” submits Scott Andison, FRPO’s president and chief executive officer. “It will be a great benefit in terms of catching any data errors up front and reducing the need for appeals.”

The change aligns with FRPO’s campaign for property tax reform, which also focuses on the disproportionate share of the tax burden that multi-residential ratepayers and their tenants carry. Multi-residential tax rates continue to be at least two times greater than the residential rate in most Ontario municipalities, and industry advocates acknowledge that getting local governments to narrow that ratio is a formidable and likely to be ongoing challenge.

“We said: Let’s get the assessment system fixed in the meantime,” Andison explains.

Among the improvements, he cites the promised accompanying policy and procedures manual to clearly set out how the direct capitalization methodology will be applied. This is the first time MPAC has produced such a guidance document for multi-residential properties — stating rules that can be used to gauge whether assessors have properly determined values — and Andison maintains it will be a valuable tool for property owners making a case for a revised value and for Assessment Review Board adjudicators tasked with determining the appropriateness of a value.

In contrast to some negative reviews, he tells of FRPO members’ satisfaction with the values they’ve seen through the advance disclosure process.

“We’re hearing: Yes, they are in the ballpark,” Andison recounts. “My understanding is that multi-res values have increased proportionately to the average value increases across all classes in many geographic areas, suggesting that, while values have in fact gone up, the relative tax burdens are relatively similar.”

Valuation assumptions questioned

When used to gauge expected investment returns, a cap rate expresses the net revenue a single building will generate as a percentage of its overall value — factoring in its operating costs, looming requirements for capital expenditures and untapped potential to garner higher rents. When applied to property assessment, analysts warn that a standard cap rate across larger groupings of buildings makes it more difficult to capture building-level variables that influence value.

“You may have two buildings on a street that are almost identical, yet one has rents 20 per cent higher because it has renovated units. Using the same cap rate will undervalue the lower-rent building and overvalue the higher one,” observes Lorenzo DiGianfelice, a certified appraiser and broker with Commercial Focus Realty Inc.

Gibson voices concern that not enough details were collected to adequately differentiate buildings’ expenses. Similar to the protocol for assessment using the gross income multiplier methodology, property owners were required to submit information about revenue and operating costs, but he characterizes it as a “top line” survey with no breakdown of key building performance indictors like electricity and water costs. Perhaps more problematically, he contends that MPAC multi-res cap rates aren’t realistic.

“The cap rates we’re seeing (in advance disclosure) are in the range of 3.25 to 3.5,” Gibson reports. “There’s no question cap rates are at historic lows right now, but we don’t even see them that low in the marketplace. The institutional players building new buildings are running pro formas on an 18-month lease-up at a 4.5 cap rate because that’s what they need to get a stabilized income. For MPAC to apply a 3.25 cap is way too aggressive.”

“The question is: How did MPAC create these values? Where did they get these inputs from and where did they get these cap rates from?” Longo agrees.

Multi-Residential Cap Rates, Q2, 2016
National Toronto Ottawa Waterloo London/
High-Rise, Class A 4.2% 3.25—4% 3.75—4.5% 4.5—5% 5—5.50%
High-Rise, Class B 4.92% 4.25—5% 4.75—5.5% 4.75—5.25% 5.25—6.5%
Low-Rise, Class A 4.7% 3.25—4% 4—4.75% 5—5.75% 5.75—6.75%
Low-Rise, Class B 5.38% 4.25—5% 4.75—5.5% 5.5—6% 6—7.25%

Source: CBRE, Q2 2016, Canadian Cap Rates & Investment Insights

This is likely to be the substance of Requests for Reconsideration should the October 18 mass mail-out of assessment notices reveal the same trends seen in the advance disclosure. Property owners will have 120 days, or until February 15, 2017, to adjust their valuations through informal discussion and negotiation with MPAC. Beyond that, they can formally appeal to Ontario’s Assessment Review Board — a scenario far from rare for landlords given that previous reassessments have spurred appeals on up to 40 per cent of multi-residential properties.

“Smaller property owners have been left out of the advance disclosure and they are the ones who tend, for the most part, to drive the appeals,” Longo notes.

Regardless, this large share of apartment owners typically already senses what to expect.

“I haven’t seen any advance notification on anything, but I am about as certain as I can be that there will be an increase in the valuations,” reflects Arun Pathak, president of the Hamilton and District Apartment Association and a property manager with Smar Holdings Ltd. “My feeling is it’s probably going to be a little bit more than in other surrounding areas. Just from what we’re hearing, the market is hot and it has been for awhile now, and there has been a lot of interest and a lot of activity in the Hamilton market.”

Barbara Carss is editor-in-chief of Canadian Property Management.

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