The Proper Valuation of an Assisted Living Facility in a Property Tax Appeal: Liberty Manor v. Englishtown, New Jersey
Frank E. Ferruggia, Esq.
The proper valuation of an assisted living facility was the subject of the recently decided Ruck, DiRubbio, and McCauley (Liberty Manor) v. Borough of Englishtown, N.J., issued by the New Jersey Tax Court after a trial in 2008. The case involved the Liberty Manor assisted living facility, located in the Borough of Englishtown. In this case, the Tax Court unequivocally favored a cost approach to valuation advanced by the taxpayer, and rejected an income approach utilized by the municipality.
Liberty Manor was constructed in 1999, with a portion of the building that pre-existed the 1999 construction being preserved and renovated at that time. The facility had 70 living units and was licensed for a maximum of 110 residents. The improvements contained a total of 50,350 square feet, a number agreed to by both the taxpayer and the municipality. There were 39 double occupancy units and 31 single occupancy units. Each unit had a bath and kitchenette, but no cooking facilities. The common areas were located in a renovated older portion of the facility. Those common areas consisted of a dining room where residents took their meals, a commercial kitchen used for meal preparation, and other areas where residents could socialize. There was also a basement area below the renovated older portion of the building which contained the mechanical systems of the facility. The property sat on 3.14 acres.
The tax years in issue were 2005 and 2006. Under New Jersey law, the proper valuation date for each of the relevant tax years is October 1 of the pretax year. Therefore, the relevant valuation dates were October 1, 2004 and October 1, 2005.
For both tax years in issue, the total assessment being challenged was $5 million, broken down into $278,300 for land, and $4,721,700 for improvements. New Jersey publishes an equalization ratio (the “Chapter 123 ratio”) based upon usable sales in the relevant municipality. For 2005 that average ratio was 55.21%, while for 2006 the relevant average ratio was 49.83%. Utilizing those ratios, the equalized total fair market value reflected by the assessments for 2005 and 2006 was $9,056,330 and $10,034,115 respectively.
Plaintiff’s appraiser utilized only a cost approach and testified that this approach was the only valuation methodology that was probative for ad valorem tax valuation purposes. The cost approach isolates the value of the land and the bricks and mortar that make up the improvements. Because an assisted living facility offers more than just “housing”—it offers meals; nursing and medical care; recreation activities—it is difficult, if not impossible to utilize an income approach that would necessarily have to isolate the rental value of the facility alone. An income approach that utilized the fees paid to residents would have the effect of incorporating into a final value conclusion the value of benefits and services that have nothing to do with the land and improvements. In essence, the Plaintiff’s appraiser testified, an income approach suffers from the potential defect that it is actually providing a value for the “business” of the assisted living facility, and not just the value of the real estate itself, which obviously is the object of the valuation exercise in the ad valorem context.
Plaintiff’s appraiser further testified that the sale approach would suffer from the same infirmities as the income approach. Sales of assisted living facilities are rarely if ever for just the real estate. Purchasers are buying the cash flow, actual or potential, generated by the bundle of services offered by the facility pursuant to its state license. Plaintiff’s appraiser testified that it would be virtually impossible to take sales data and attempt to segregate that portion of the sale price that applied solely to the value of the real estate itself, as opposed to the value generated by non-real estate revenue sources.
Employing the cost approach alone, Plaintiff’s appraiser researched and proffered four (4) land sales in order to determine a value for the underlying acreage. The land sales were for uses that conformed with the appraiser’s highest and best use conclusion—continued use as an assisted living facility. The land sales were analyzed on a per bed basis. The appraiser opined that “[t]his is the typical common denominator for this property type” in the market. Adjustments were made to the sales for time, location, size, and whether the sales were with approvals already in place or were contingent upon receipt of approvals. He concluded a land value, after adjustments, of $10,000 per bed, for a total land value of $1,110,000 for each tax year in issue.
In order to determine the value of the improvements, Plaintiff’s appraiser utilized the Marshall and Swift cost estimator service. After deduction of 10% for all forms of depreciation, the addition of a 10% entrepreneurial profit factor, and consideration of the land value, Plaintiff’s appraiser concluded a total value for the subject property of $5,750,000 for 2005 and $5,990,000 for 2006.
Defendant’s appraiser rejected the use of a cost approach. He indicated that his research produced no “recent land sales that were purchased for improvement with Assisted Living facilities or were zoned for that usage.” (Defendant’s Appraisal, p.26). Further, he opined that a replacement cost estimate could not be derived because he “was not provided an as built plan for the Facility, showing accurate dimensions with which to use in a replacement cost estimation of the improvements.” (Id.)
Defendant’s appraiser also rejected the use of the sales approach, since his research disclosed no sales of assisted living facilities which took place “during the past three years.” (Id. at p. 27).
Defendant’s appraiser relied solely upon the income approach. He utilized the total revenue from the operation of the facility, but made deductions for “the depreciation of personalty” and a “return on personal property”. He also made a deduction for “Business Value” and equated that factor with a management fee of 5% of operating income. He otherwise made no effort to segregate what portion of the revenue was strictly attributable to a rental of the physical premises, and what portion of the revenue was attributable to goods and services that had nothing to do with real estate.
Although the municipality’s appraiser used the facility’s reported income in his income approach, he rejected the actual expenses reported by the taxpayer. Instead he utilized the expense ratios of an industry consultant survey of seven (7) anonymous assisted living facilities located in New Jersey. He opined that “[w]ith this quality of research available, it is the appraiser’s opinion that it is reasonable to apply the expense percentages of the regional industry ‘norms’ as reflected in the survey…” (Defendant’s Appraisal, p.34).
Defendant’s appraiser concluded a fair market value, using only the income approach, of $8,644,707 for tax year 2005, and $8,644,700 for tax year 2006.
The Tax Court, in deciding for Plaintiff and awarding a substantial reduction in assessment for both years in issue, cast significant doubt on the use of the income approach in the assisted living context. The use of the survey data to develop an expense ratio was fraught with imprecision. “Defendant’s appraiser had very little knowledge of how the survey data had been obtained and no knowledge at all of the facilities participating in the survey other than their location.” (Court’s decision, Transcript at p.25, lines 8-11). The Judge also cited to a previous New Jersey Tax Court decision, Twin Oaks v. Morristown, 9 N.J. Tax 386 (Tax 1987), aff’d o.b. per curiam, 11 N.J. Tax 94 (App. Div. 1989), certif.. denied, 117 N.J. 155 (1989) in holding that a cost approach was the most appropriate valuation methodology in the context of a tax appeal involving a nursing home.
Using Plaintiff’s cost approach, the Court came to certain value conclusions. With respect to land value, the Court placed more emphasis on land Sale One. That comparable sale was of a 6.13 acre parcel in Wall Township in Monmouth County, New Jersey. It had approvals in place as of the time of the sale for development of a 110-bed assisted living residence. The sale occurred in November 2001 for a price of $1,950,000 reflecting a price per approved bed of $17,727 before any adjustments. Plaintiff’s appraiser had made adjustments of negative 5% for location (the sale was on a more visible location than the subject); negative 5% for size (the subject was half the size of the comparable; and negative 5% for approvals being in place at the time the comparable sold. As adjusted, the indicated sale price for Sale One was $15,068 per bed. The Judge concluded a land value for the subject property of $15,000 per bed for a total of $1,650,000.
Finally, the Court approved of the Plaintiff’s use of the Marshall and Swift cost methodology, and particularly Plaintiff’s use of the “good” class of construction costs. Although the property was located in Monmouth County, the Court felt that the proper local multiplier to use was the Middlesex County multiplier of 1.24, rather than the Monmouth one of 1.12, given that the subject was very close to the Middlesex border and appeared to be part of the Middlesex “market”. Given the age of the construction, and that the older portion of the subject constituted only 20% of the overall improvements, the Court allowed only 7% and 8% depreciation respectively for each of the tax years in issue. Finally, the Court accepted Plaintiff’s use of a 10% entrepreneurial profit factor.
Based on these calculations, The Court concluded a full fair market value for the subject property of $6,890,000 for tax year 2005 and $7,180,000 for tax year 2006. Applying the average ratios published by the State of New Jersey for each tax year in question, the Court concluded an appropriate assessment for tax years 2005 and 2006 of $3,804,000 and $3,578,000 respectively.
The Liberty Manor case clearly stands for the proposition that in a property tax appeal case involving an assisted living facility, the cost approach is the more probative approach to ad valorem value. The cost approach, if researched and executed properly, clearly isolates the value of land and improvements and does not fall prey to incorporating “business value” into the calculation. The income approach, on the other hand, is fraught with peril. Utilizing the revenue stream from an assisted living facility to do an income approach to value will necessarily include revenue from activities unrelated to real estate, and will produce a value that is not reflective of the value of the pure real estate. Although the income approach has been successfully used in other contexts (e.g. hotels) where “business value” can be isolated and subtracted from the calculation, assisted living facilities may be quite different, dependent as they are in part upon government –subsidized daily fees and because their expense profile is a complex mix of health care, nutrition and recreation. Merely deducting a management fee and some factor attributable to FF&E (furniture, fixtures and equipment) may not be sufficient to clearly isolate the real estate of an assisted living facility from the other services provided to residents which produce a portion of the revenue. As Liberty Manor makes clear, the better approach is to utilize a cost approach if possible when valuing an assisted living facility for property tax purposes.
Frank E. Ferruggia is a partner in the Newark office of McCarter & English. He practices nationally in the field of property tax appeals and was the trial lawyer for the Plaintiff in the Liberty Manor case that is the subject of this article. The author would like to gratefully acknowledge the research assistance of University of Pittsburgh pre-law student Frank E. Ferruggia, Jr.