Appraising Residential Rental Property

Published for Coates' Canons on August 15, 2022.

Rental units, be they long-term rentals owned by institutional investors or short-term rentals on platforms like Airbnb, represent a growing share of North Carolina’s housing stock.  This is true in big cities like Charlotte, where corporate landlords have purchased tens of thousands of houses and now own 5% of all residential properties.  It’s also true in rural areas like Transylvania County, where the number of short-term rental units has increased by over 50% in the past three years.

As rental units arise in more neighborhoods, more questions arise about how they should be treated for property tax purposes.  In some communities, both landlords and residents argue that rental housing should be appraised differently than owner-occupied housing.

Some large landlords claim that their rental units should be appraised using the income approach instead of the sales comparison approach normally used by tax assessors for residential property.  These corporate taxpayers believe that an income approach would result in lower tax appraisals for their properties.

In communities where short-term rentals (“STRs”) have become more common, some homeowners want county tax offices to slap higher appraisals on neighboring houses rented out on Airbnb, VRBO and similar websites due to their use as income-producing properties. They believe that houses producing substantial rental income should receive higher tax appraisals than owner-occupied houses.

The problem with these arguments is that the Machinery Act creates one standard for all tax appraisals. Regardless of the type of property involved, a tax appraisal must reflect the property’s “true value in money.”  In other words, property must be appraised at its market value, “that is, the price estimated in terms of money at which the property would change hands between a willing and financially able buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of all the uses to which the property is adapted and for which it is capable of being used.” GS 105-283.

This statutory requirement does not provide much comfort to critics arguing that a house used as a rental should be appraised differently from a similar house in the same neighborhood that is owner occupied.  Under GS 105-283, if both properties would attract similar sales prices then they should receive similar tax appraisals regardless of whether they are occupied by tenants or owners.

The statutory appraisal standard created by GS 105-283 is the reason why Airbnb properties should not be appraised at higher levels than similar neighboring properties based solely on their use as STRs.  Assuming all properties in a neighborhood could be used for STR purposes, then the tax appraisals for all of those properties should be similar if they are otherwise similar in size, construction quality, and finishes.  If a STR property has features that other properties lack (pool, hot tub, updated kitchen, finished basement, etc.), that property would likely receive a higher tax appraisal. But that increased appraisal would be based on those additional features and not on the fact that the property is being used as a STR.

The same reasoning would apply to corporate landlords who argue for lower appraisals on their rental houses based solely on the fact that they are investment properties and not owner-occupied residences.  Two recent Property Tax Commission (“PTC”) appeals illustrate this point.

One appeal, In re: Mingo Creek Investments II, LLC, involved 40 rental townhomes owned by a corporate landlord that Wake County had appraised individually using the sales comparison approach.  The landlord, Mingo Creek, argued that the townhomes should be collectively appraised as a single investment property using the income approach which (arguably) would have produced a lower tax value.

The second appeal, In re: American Homes 4 Rent Properties One, LLC, involved the appraisal of two rental homes in Charlotte owned by American Homes 4 Rent, which leases out several hundred houses across North Carolina. Similar to Mingo Creek, American Homes 4 Rent argued that Mecklenburg County erred when it used the sales comparison approach to appraise its rental property and should instead have used the income approach. Not surprisingly, the landlord claimed that the income approach would have produced lower appraisals for the rental properties.

The Property Tax Commission rejected both appeals, concluding that these residential properties should not receive different appraisal treatment simply because they are used as rental housing.

In the Mingo Creek case, the PTC found that the townhomes were “properly appraised as a collection of individual units that happen to held by the same owner, and not as a single property with multiple units. . . . The owner’s choices regarding the property, such as whether or not to sell individual units, how to operate the subject property, or what rental rates to charge are not significantly relevant to the market value of the subject property especially when . . . these properties are typically bought and sold on an individual basis.”

In the American Homes 4 Rent case, the PTC accepted the county’s arguments that ownership should not be a factor in the tax appraisal process. The end use of the rental properties was the same as that of owner-occupied properties; all were used for residential purposes by the occupants.  Because the properties were used similarly, they should also be appraised similarly.

These two Property Tax Commission decision affirm the generally accepted wisdom that all residential real property should generally be using the sales comparison approach.  The appraisal method for a house should not change just because the owners view it as an investment rather than as a home.

If a neighborhood becomes dominated by rental units, be they Airbnb properties or long-term rentals, that change might affect the overall market value of homes in that neighborhood and therefore affect neighborhood tax appraisals.  But an individual house should not receive different tax appraisal treatment than similar neighboring houses solely due to its use as a rental.

The post Appraising Residential Rental Property appeared first on Coates’ Canons NC Local Government Law.

Topics - Local and State Government