One of the most common mistakes in commercial real estate underwriting is relying on the current property tax bill when evaluating a deal.
On the surface, it seems logical. The tax bill is real. It’s documented. It’s part of the seller’s operating expenses.
But for lenders and experienced investors, using the existing tax number can create a major underwriting problem.
Because in many cases, that tax bill is about to change.
The Hidden Risk in Property Taxes
When a commercial property sells, the local tax authority may reassess the property value based on the new purchase price.
This means the tax bill the seller has been paying may no longer apply once the property changes hands.
For example:
- The seller bought the property 15 years ago for $1,000,000
- Today the property sells for $3,000,000
- The county reassesses the value closer to the new price
That reassessment can cause the property taxes to increase significantly.
If underwriting was based on the old tax bill, the projected expenses will be too low, which makes the deal appear stronger than it actually is.
How This Impacts the Deal
Property taxes are one of the largest operating expenses in commercial real estate.
When they increase, they directly reduce the property’s Net Operating Income (NOI).
Lower NOI affects several critical metrics:
Debt Service Coverage Ratio (DSCR)
Lenders require properties to produce enough income to cover loan payments. If taxes increase, the DSCR may fall below the lender’s requirement.
Loan Proceeds
Lower NOI means lenders may reduce the loan amount.
Cash Flow to Investors
Higher expenses reduce distributable income.
Refinancing Risk
If a property was underwritten with artificially low taxes, refinancing later may become difficult.
In short, using the seller’s tax bill can lead to overestimating the property’s performance.
How Experienced Underwriters Handle It
Instead of relying on the existing tax number, lenders typically estimate future taxes based on the new purchase price.
A quick method many underwriters use is:
Estimated Taxes = Purchase Price × Local Tax Rate
For example:
- Purchase price: $3,000,000
- Estimated tax rate: 1.2%
Estimated annual property taxes: $36,000
This approach provides a forward-looking estimate, which better reflects what the new owner will likely pay.
Why Lenders Care
Lenders aren’t trying to make deals harder. Their goal is to ensure the property can perform under realistic conditions.
Remember:
- The seller’s tax bill reflects yesterday’s value.
- The lender underwrites taxes based on tomorrow’s value.
If the numbers still work after adjusting for the new tax estimate, the deal is likely much stronger.
Small details in underwriting can have a big impact on a deal’s success.
Property taxes may seem straightforward, but failing to account for reassessment can dramatically change a property’s true performance.
In commercial real estate, good underwriting isn’t just about analyzing the past.
It’s about anticipating the future.
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