Valuation: The stakes are high affecting state aid to education, revenue
sharing, general assistance reimbursements and county taxes
(from Maine Townsman, February 1993)
by Geoffrey Herman, MMA paralegal
The process of adjusting the municipal valuation to the state valuation and the ultimate purposes for which such an adjustment is annually accomplished have always been the subject of some controversy. More municipalities are appealing their state valuation. The role of the state valuation in the education funding formula is currently a matter of intense debate. There is no shortage of published academic and legislative reports in the state's Law and Legislative Reference Library that attempt to address the essential issue constantly nipping at the heels of the state valuation process--the issue of fairness.
The stakes are high. After all, the greater a municipality's state valuation relative to its population and local property tax effort, the smaller the municipality's per capita Revenue Sharing rate. An additional liability associated with a high state valuation is the blunt assessment of a higher county tax apportionment. Beyond the 50% minimum reimbursement to which all municipalities are entitled, the amount of additional General Assistance reimbursement allocated to each municipality is based on the 1981 state valuation. A high state valuation has a direct influence on a municipality's overall assessment ratio which must be at least 70% as a matter of law, and a drop below the 70% minimum has the immediate effect of blocking Tree Growth reimbursement and the longer term effect of requiring across-the-board reassessments.
And it goes without saying that a primary influence if not the primary purpose of the state valuation is to determine the local share of the three components of school funding; operational costs, program costs and debt service.
Taken by itself, the calculation of state valuation is nothing more than a series of rather clean mathematical computations. For every property type or class that is given value by the municipal assessors, there is a rule-driven adjustment made to that aggregate valuation in an attempt to correct for any influences that cause the municipal valuation to deviate from "full value" or "just value" or "equalized value" terms that are essentially the equivalent of market value. As has been suggested, just beneath the straightforward mathematical calculations one can without much trouble find a host of unrelenting controversies. Before giving space to those controversies, it may be useful to first describe the benign mathematics involved.
The state valuation is a dollar figure that should represent the amount of money you would need if you were going to buy all the taxable property within the municipal limits. This gross, bottom line figure, however, is derived by means of a number of ratios that are applied to the municipal valuation base. In order to understand how the state valuation is calculated, there must first be an understanding of the different ratios that are used to adjust the municipal valuation.
Average ratio. An average ratio, discussed in further detail below, is an average of sales ratios which are themselves calculated by dividing a property's assessed value by its actual selling price. In other words, the average ratio is a percentage of full value based on sales data.
Segregated ratio. A segregated ratio is an average ratio for a particular, segregated type of properties. The most often segregated property type is waterfront residential.
Certified ratio. A certified ratio is the level of total municipal valuation relative to full market value as declared by the municipal assessors on the municipal valuation return; in other words, a percentage of full value based on sell-declaration. For a variety of reasons, certified ratios do not enjoy a reputation of absolute and inviolate accuracy.
Adjusted certified ratio. This ratio is an average of the certified ratio and the average ratio, to be used in place of the certified ratio when the certified ratio is shown to be a somewhat optimistic representation of the percentage of full value (i.e., over 110% of the average ratio).
Variant ratio. A variant ratio is 120% of the average ratio.
Adjusted variant ratio. This ratio is an average of the variant ratio and the average ratio, to be used in place of the self declared certified ratio when the certified ratio is shown to be an overly optimistic representation of the percentage of full value.
Assessment ratio. The assessment ratio for any year is a percentage that is determined by dividing the municipal valuation for the preceding year by the state valuation for the current year. 36 MRSA §327 requires that this percentage be at least 70%.
CALCULATING STATE VALUATION
With these ratios in hand, and beginning with the municipal valuation, the state valuation is calculated as follows:
Residential Property. The aggregate municipal valuation of all residential property is divided by the average ratio. If the average is low, the effect will be to very significantly jump the municipal valuation in this equalization effort. As the average ratio moves toward 100%, the jump from municipal valuation to state valuation for residential property will be proportionately smaller.
Sometimes the Bureau of Taxation personnel will apply specially derived average ratios--called segregated ratios-- to different types of properties. The importance of segregated ratios is discussed in greater detail below. Most typically, a segregated ratio study is accomplished for waterfront residential properties. Sometimes condominium properties are segregated as well. When segregated ratios studies are accomplished, the state valuation for the residential properties is calculated by dividing the total municipal valuation for each property class by the sales ratio appropriate for that property class.
Commercial, Industrial and Personal Property. Adjustments from municipal valuation to state valuation for commercial, industrial, and personal property are not quite as directly influenced by sales ratio data. In a very few municipalities, there will be enough sales of commercial properties to allow for a segregated sales ratio study, but this is the exception to the rule. In other isolated instances, Bureau personnel will conduct onsite appraisals of particularly large or complex industrial properties. In either circumstance, that sales data or on-site experience will be used to adjust the municipal valuation of this class of property to the state valuation.
It is much more often the case, however, that the state valuation for commercial, industrial and personal properties is derived by dividing the aggregate municipal valuation of these properties by the certified ratio. The certified ratio, as was pointed out above, is a number over which the municipal assessors have considerable control. One might think that the municipal assessors could therefore control the state valuation in this area, but that is not entirely true.
In the absence of a commercial sales ratio study, residential sales ratio studies influence the adjustment made to commercial and industrial property valuations when the certified ratio is deter-mined to be more than 110% of the average ratio. In this circumstance of an overly optimistic certified ratio, the lower, "adjusted certified ratio" is used.
When the certified ratio is more than 120% of the average ratio, the certified ratio is discarded entirely and Bureau personnel use the adjusted variant ratio (which is essentially the average sales ratio moderated slightly upwards) for the purpose of marking up the valuation of commercial, industrial and personal properties.
Electrical Utility Property. The correct value to place on regulated utility property for the purposes of taxation particularly electricity generation facilities is a matter of considerable dispute. Generally, the Bureau is extremely sensitive to the regulatory controls that allegedly limit the marketability and income earning capacity of a regulated power plant. The municipal tendency, on the other hand, is to assess power generation facilities in much the same manner as all heavy industrial property is assessed.
This disparity in assessing methodology was brought to the attention of the State Board of Property Tax Review in the mid-1980's when the Town of Madison sought a reduction in its state valuation because an unregulated hydropower facility in Madison was given a Bureau-assessed value much greater than similarly situated (but utility-owned) hydropower facilities just upstream. Although the Board ruled in Madison's favor by bringing the value of the unregulated facility located in Madison into line with the regulated facilities located in other municipalities, the Maine Supreme Court ultimately held that the Board lacked the authority to remedy differential valuations of hydroelectric facilities in other municipalities by reducing the Madison facility's value below market. (Bureau of Taxation v. Town of Madison, 541 A.2d 939.) It should be noted that the Law Court did not reach the issue of the proper assessing method to apply toward regulated facilities. The Bureau, nonetheless, cites the Madison decision for its practice of assessing regulated facilities as though their regulated status makes traditional industrial assessing methodologies inapplicable.
Aside from this ongoing dispute, for the purposes of understanding the calculation of state valuation, it is enough to say that the Property Tax Division places a value on electrical utility property both transmission/distribution properties as well as power generation facilities according to schedules and assessments that treat the regulatory limitations on this type of property with a great deal of respect. By rule, electrical utility properties are given a state valuation based on "appraisals approved annually by the Agency."
For the purpose of contributing to the state valuation, the Bureau's tendency to approve utility property appraisals that use low-yield methodologies is a decided benefit to the host municipality. Whether it is too much of a benefit to the host municipality is a matter of debate.
As was just discussed, a related problem of equity arises to the extent regulated utility properties are given one value, and similarly situated, non-regulated power generation properties are assessed at substantially higher values.
A third problem pops up when the Bureau's assessment is compared to the municipal assessment in the occasion the power company's appeal from the municipal valuation.
"Current Use" Properties. The "current use" properties are all the acres classified in the Tree Growth, Farmland or Open Space programs. These programs are unable to avoid controversy, but little of that controversy concerns the state valuation process, particularly with regard to Tree Growth and Farmland classification, because the municipal and state valuations of these properties are so similar and so similarly modest as a matter of law and regulation.
Acreage under the Tree Growth classification is state-valued at 100% of the Tree Growth values as derived and scheduled by the State Tax Assessor. Acreage under the Farmland classification is state valued at full value farmland rates as derived by the Bureau. Acreage falling in the Open Space category is given a state valuation at the full value for open space as determined by the municipal assessors. In the absence of municipal open space values, open space is valued at the countywide or regional per acre rates for undeveloped acreage.
Bureau personnel place a state valuation on Undeveloped and Waste Acre age, according to per acre rates developed on a countywide or regional basis from sales data covering the preceding three-year period. Also in accordance with region-wide data, the Bureau may assess the undeveloped-but-otherwise-developable properties according to a "base lot" system whereby the first developable lot on undeveloped properties is accorded a special value.
After performing these adjustments to each of the property classes within the municipal valuation, the state valuation is achieved as simply the sum of the various component adjustments.
STATE VALUATION APPEALS
If the calculation of state valuation is so straightforward, one would wonder why it remains the subject of some dispute. A look at state valuation appeals provides some insight into the confusions and controversies associated with the process. During the last half of the1980's, appeals of state valuation were rare, averaging only two per year. In 1990, there were five appeals. In 1991, the State Board heard seven such appeals and granted three reductions in state valuation for a total value of just over $6 million. In 1992, the State Board heard nine state valuation appeals and granted four reductions for a total value of $11million. As of January 15 of this year (which is the last possible day for a state or valuation to be adjusted barring a special legislative act authorizing an after-the-fact appeal), the State Board had issued decisions regarding 14 appeals of state evaluation and granted ten reductions for a total value of $100 million.
Beyond the growing number of appeals, it would also appear that the larger municipalities are finding reason to seek adjustments to their state valuation. Of the seven towns bringing an appeal in 1991, the average state valuation was $116 million. Of the 14 municipalities appealing in 1993, the average state valuation was $348 million. A substantive review of recently-decided state valuation appeals reveals that the vast majority of the appeals that resulted in a reduction of state valuation were granted with the concurrence of the Bureau of Taxation. Typically, Bureau personnel are able to identify an error of fact or an error in computation which, when corrected during the appeal hearing before the State Board, results in a reduction. An error of fact might be a failure to adjust for locally granted abatements, a recognition of the need to increase the mix of waste acreage and/or reduce the number of base lots within the municipality, or the recognition of the need to exclude from the ratio study certain property transfers that were driving down the average ratio and thus driving up the state valuation.
In only three cases over the last three years did the State Board grant a reduction in state valuation without the express concurrence of the Bureau personnel. In one case, the State Board sided with the town with regard to some sales that should have been excluded from the sales ratio studies. In another case, the State Board found that the Bureau had failed to recognize the degree to which the town was valued over 100% of market.
It is not, however, the successful appeals of state valuation that tend to illuminate the problems that are perceived to exist with the state valuation calculation process. Those problems are better articulated in the unsuccessful appeal.
Two arguments are most often used by municipalities in the appeal of their state valuation.
The inflated sales argument. One argument is that the property sales used to develop the sales ratios which drive the adjustment from municipal valuation to state valuation are disproportionately the choicest and priciest properties in town. As will be discussed below, the state valuation process tries to minimize the influence of the exceptional, "outlier" sales by trimming the top 15% and bottom 15% off the sales sample. Nonetheless, the "exceptional sales" phenomenon can seem to be especially disadvantageous in a depressed real estate market. It is not uncommon for high-value, typically waterfront properties within a municipality to command the attention of a broader, more affluent, non-resident market. When the sales of those properties are projected out to an "average ratio" for the purpose of calculating the state valuation there develops a statistical assumption that the local real estate market is considerably more robust and uniformly robust than is actually the case.
High sales prices which lead to low average ratios are one driving force behind high state valuations; the inflationary force. Unlike the introduction of real property into the community, which is the other force driving an increase in state valuation, the inflationary increases in state valuation are intangible and, as such, difficult to appreciate and difficult to assess locally without expending the considerable political and administrative effort necessary to factor or revalue the entire community.
The stale data argument. The other argument often raised in a state valuation appeal focuses on the staleness of the market data used to develop the adjusting ratios. It is perhaps easiest to under-stand why any given state valuation is based on stale, two-year old data by working through the state valuation timetable backwards from the final result.
The state valuation, upon which the various state subsidy formulas and county taxes are based, must be certified to the Secretary of State by February 1. As a matter of law, the Bureau of Taxation must report to each municipality its proposed state valuation, which is subject to appeal, by the preceding September 1. Therefore, the 1993 state valuations just certified o the Secretary of State were developed and proposed to each municipality before September 1,1992. At the same time that the 1993 state valuation was being developed, the municipal assessors were preparing the municipal valuation return for the 1992 tax year based on property conditions on April 1, 1992. As a matter of law, the 1992 municipal valuation return had to be sent to the Bureau by November 1, 1992 (or within 30 days of commitment, whichever is later), which was fully two months after the 1993 state valuation was developed. It would be impossible, therefore, for the Bureau to utilize the municipal 1992 valuation to calculate the 1993 state valuation; instead, the 1991 municipal valuation is the base of the 1993 state valuation. For any state valuation year, the Bureau must use the municipal valuation as of the April 1 two years prior.
A factor that drives the process even further into the past concerns the "current sales period", which is the one-year window within which actual property sales are analyzed to develop the ratios used to adjust the municipal valuation to market value. In order to avoid reviewing property transfers that were not available to the municipal assessors at the time the l municipal valuation was being developed, the "current sales period" is defined by regulation as the period beginning on the July 1 preceding the tax year under review and running through the following June 30.
Given a distinct possibility that a municipality's 1993 state valuation has been influenced by a local sale occurring in 1990, it is small wonder that during the first few years of a depressed real estate market municipalities are quick to argue at appeal hearings that their state valuation is not reflective of actual current value.
In truth, a state valuation may not be reflective of current market value in rapidly changing real estate markets. It is only fair to point out, however, that in a different economy, the stale data used to calculate the state valuation could be as advantageous to a municipality as it may be disadvantageous today.
Perhaps much of the confusion that surrounds the issue of state valuations could be eliminated by simply subtracting two years from the name of the state valuation that is certified to the Secretary of State each January. If the 1993 state valuation was called what it is--the 1991 state valuation--then the accuracy of the state valuation would not be called into question as often at appeal.
As was pointed out at the beginning of this article, there has been no shortage of studies in years past on the state valuation. The primary conclusions and recommendations of three such studies, published in 1969, 1977, and 1988, are listed in the accompanying sidebar. As will be noted, the problem of time lag between the municipal and state valuation is an issue that is raised in study after study. In the most recent 1988 report, a legislative study that is remarkable for its nearsightedness, the time lag is considered only in terms of creating a financial "windfall" to the municipality; a "windfall", the study alleges, that is poorly managed on the local level.
The other issue that crops up with a decided resilience in study after study concerns the propriety of segregating properties according to certain classes so that the sales trend peculiar to one class of property will not disproportionately influence the entire state valuation.
THE NEW RULES
Both of these issues have been constructively addressed in the most recent rewrite of the Bureau's regulation governing the state valuation process. These amended rules, with an effective date of December 16, 1992, are found at chapter 201 of the Bureau of Taxation's regulations. With some notable exceptions, these new rules serve the primary purpose of clarifying and providing detail to the existing state valuation procedures that were established in the last promulgation of the rules in 1989. The 1989 rules were written in a somewhat disorganized, rambling narrative format. These new six pages of rules are given a tighter, more conventional regulatory structure.
The rules begin with a comprehensive definition section that rather elegantly gives meaning to all the various terms that are brought into the computation of the state valuation. For example, six different types of ratios are distinguished the average ratio, certified ratio, sales ratio, variant ratio, state valuation ratio, and weighted average. In addition, no less than fourteen types of property are defined.
The rules go on to describe in a central section the manner in which ratio studies are conducted.
The regulations conclude with a no-nonsense, two-page section entitled "Computation of state valuation", which establishes as a matter of regulation the precise manner by which each class of property is adjusted from municipal value to market value.
As might be expected, the softness in the rules is found in their midsection, where some effort is made to describe the ratio study process. It is where the rules attempt to articulate when a segregated ratio study rather than overall ratio study should be accomplished that the concept of Reasonableness" begins inserting itself into the rules with enough frequency to suggest that common sense shall apply rather than any hard and fast standard.
What the rules do say is that the sampling of sales used in a ratio study should "reasonably correspond to the proportion of various developed property classes" in the municipality. This was also the case with the earlier rules, and segregated sales studies were authorized when the sales sample appeared unbalanced to Bureau personnel. In real life, the actual sales that may occur over a one or two-year period rarely have the courtesy of weighing themselves in perfect proportion to the property classes that exist within the municipality, and where the line is drawn between balanced and unbalanced correspondence between actual sales and property class distributions would often be a judgment call in the absence of any standard.
By elaborating on the issue, however, the new rules go beyond the replaced regulation by suggesting that the Bureau should conduct segregated sales ratio studies when the sales sample is not "reasonably" weighted or the valuational difference between property classes deviates by more than 10%. That 10% deviation factor should be understood as a 10% or greater spread in municipal valuation between residential properties in different classes (e.g., waterfront residential, non-waterfront, condominium, etc.) after equalizing for all factors other than property class.
The trigger that requires a segregated ratio study is critical to the issue of targeting and controlling inflationary adjustments to the overall state valuation. With the addition of this new quasi-standard in the Bureau's rules, more segregated ratio studies will have to be con-ducted, and municipalities will have some regulation behind them if a segregated ratio study was not conducted and it should have been.
Ratio studies: The representative sample. The new state valuation rules do not change the minimum number of "good" property sales that must have occurred for a sales ratio study to be accomplished. A property sale can be wed in the sales sample only if it was an arms length transaction as validated by the municipal assessors along with Bureau personnel. For all property classes except those which have been segregated or for which a sales ratio study does not apply, the "overall" ratio study requires 12 good sales. If it is determined that a segregated ratio study is called for, a minimum of eight good sales within the segregated property class is required.
It is the matter of some debate as to whether 12 sales sampled is enough of a statistical base to support an average ratio that so positively drives the state valuation. The Bureau has conducted statistical studies that show a reasonable tightness of fit with 12 samples, and in a small municipality, the 12-sales minimum may represent as much as 2% of total proper-ties. In a municipality of any size, however, 12 property sales would represent only a fractional percentage of total properties.
A 1977 study of state valuation methodology recommended an average ratio based on a sales or appraisal sample of 4% of total properties. To abide by a 4% standard, the Bureau would have to annually analyze or appraise over 500 properties in Portland alone. Even if it is agreed that a requirement to sample 4% of total properties would place too great a burden on the Bureau, there may be some merit to the suggestion that the representative sales sample be based on a percentage of total properties rather than a fixed minimum.
Ratio studies: The extended sales period. The first window of time within which the Bureau personnel look to find at least the minimum number of good sales to make up a legitimate sample is the state fiscal year (July 1 -June 30) that includes the April 1 of the tax year being studied. The Bureau's new rules do improve on the old rules, however, with regard to the extended sales period. Under the old rules, if the required number of arms-length sales had not occurred, the Bureau was allowed to include sales occurring during the 12 month period previous to the state fiscal year corresponding to the tax year under review. This expansion of the relevant sales period even further into the past had the potential effect of establishing current year state valuations on the basis of sales occurring as much as three years earlier.
The new rules move up the ex tended sales period window by allowing the Bureau to expand the sales period backward in time only to the extent that the sales period is also extended forward in time. In addition, the sales period expansion is accomplished in two steps. If the requisite number of good sales is not available, the sales period is first expanded three months backwards and three months forward, from the April 1 preceding the municipal valuation year under review through the September 30 of the tax year under review. If there are still too few good sales to accomplish the ratio study, the sales period can be ex-tended one more time by another three months before and after the 18 month sales period to cover a two-year period from the January 1 of the year prior to the municipal valuation year through the December 31 of the year of the municipal valuation.
The more current sales data should yield state valuations that more accurately reflect current value. This is the clear benefit of the change in the rules, especially in a recessionary economy. The disadvantage is that some of the sales that could be used under the rules will be sales that were not available to the municipal assessors during their preparation of the municipal valuation return. While from the Bureau's perspective this allows for an unbiased sales sample, it could prove unnerving to the municipal assessors for the state valuation and, to some extent, the town's quality rating to be influenced by sales of which they had no knowledge.
Ratio studies: Bureau appraisals. In the event there is an inadequate number of sales even after the one-year sales window has been opened up to become a two-year window, Bureau personnel are required to accomplish enough on-site appraisals of randomly selected proper-ties to fill out the minimum number of property transactions required to accomplish a ratio study (12 for overall ratio studies, eight for segregated ratio studies). The Bureau appraisals are accomplished by using standards in the Bureau's assessing manual, and the price schedules are factored to April 1 of the relevant tax year to prevent the Bureau appraisal from reflecting more current conditions than the period of the sales sample.
Ratio studies: Finding the average ratio. Once the validated sales and, if necessary, onsite appraisals are accumulated, they are arranged in ascending ratio order.
At the top of the list are those property transactions where the selling price was most out of line with the assessed value, yielding sales ratios that are either far under or over 100%. At the bottom of the list are the property sales where the selling price was the closest to the assessed value, yielding sales ratios approaching 100%.
Before determining the average ratio, some of the highest ratio and lowest ratio sales are excluded from the averaging calculation for the purpose of preventing a skewing of the average that might occur by including abnormal and outlier sales.
Under the old rules, the first 25% of the lowest ratios from the top of the list were excluded, as well as the bottom 25% of the highest ratios from the bottom of the list, and the average was calculated on the basis of the middle 50% of the sales sample.
The new rules expand the middle section of the sales sample that is used to calculate the average ratio by excluding only the first 15% of the low-ratio sales and the bottom 15% of the high-ratio sales, leaving the middle 70% of the sales sample open to the averaging calculation.
According to the Bureau, using a larger interior piece of the sales sample for the purpose of calculating the average ratio has been carefully researched and is expected to result in more accurate adjusting ratios without allowing undue influence from the outlier sales.
Without disputing the statistical propriety of expanding the working portion of the sales sample, the change will necessarily jiggle any town's average ratio one way or another. Assessors may find it an interesting exercise to recalculate the average ratio used in the municipality's 1993 state valuation by allowing an extra 20% of the outlier sales into the study. While some average ratios will go up and some will go down, the cumulative effect of this changes on the overall state valuation, if any, will not be known until the 1994 state valuations are released.
The average ratio is the factor that articulates inflationary increases and decreases in real estate value in a community, and consequently drives changes in state valuation. Two substantive changes to the rules that guide the state valuation calculation should improve the currency and accuracy of the average ratio. When properties deviate in value by 10% or more solely on the basis of their property classification (i.e., waterfront, condominium, mobile home, etc.), over-represented property classes in the sales sample will have to be segregated from the calculation of the average ratio. This segregation should act to limit sharp reductions in the average ratio caused by specialty real estate markets. Further-more, the sales sample wed to determine the average ratio will be drawn from a more current sales period than in the past, which should act to make current year state valuations a little more reflective of current year actual conditions. The jury is still out with regard to the third rule change expanding the us-able portion of the sales sample from the middle 50% of sales to the middle 70% of sales, although the Bureau is obviously comfortable with the change on the basis of the extensive research that was done prior to in implementation.
There are, no doubt, other modifications that could be made to the state valuation process to further improve in accuracy, and with these new rules the Bureau has shown a willingness to consider and deliver improvements to the regulations.
Perhaps the sales sample should be based on a percentage of total properties rather than a fixed minimum.
Perhaps some thought should be given to limiting the degree to which residential sales ratios effect the equalized value of commercial and industrial property on the theory that commercial, industrial and particularly personal property is bought and sold in a different market than residential real estate.
Perhaps the extreme disparity between the assessed value of regulated and unregulated power plant properties should be mitigated.
Beyond this kind of tinkering with the state valuation procedure, there should be considerable thought given to the way the state valuation is used as a basis for state subsidies, but care should be taken to separate the two issues. One set of concerns has to do with the use to which state valuation is put, or in implementation. The other set of concerns has to do with the way state valuation is calculated, or in methodology. On balance it would appear that the concerns regarding state valuation methodology run nowhere near as deep as the concerns regarding its implementation.