We frequently get asked about how an assessment will change after an acquisition at a price higher than the assessed value. The answer of course is, it depends.
Assessors use sales ratio studies for the review and equalization of values. A sales ratio shows the relationship between the assessors Estimated Market Value (EMV) and the sales price of a property. The sales ratio formula is:
Sales Ratio = Assessor’s EMV/Sale Price
Assessors use sales ratio studies to plan an upcoming assessment, to evaluate an existing assessment, and to identify inequities. However, before the sales ratio study can be of any use an assessor must analyze the sale transaction. Assessors will verify the sale transaction to adjust the sale for non real estate components such as furniture, fixtures, and equipment, but they will also determine whether the sale should be rejected from the study. There are many reasons for a rejection, such as:
If the sale is rejected from the sales ratio study then the sale is unlikely to have a significant impact in the future assessment of the subject property. If the sale is a market transaction, good for the study, it may have some impact in the future valuation, but there is still a good chance that the sale will not result in the value being set at or near the sale price in the immediate future.
The Minnesota Department of Revenue defines sales chasing as “[t]he practice of making any substantive change in the value of a recently sold property, while not also reviewing and applying the same criteria to properties that have not sold.” The practice of sales chasing can cause invalid findings in ratio studies. For example, if assessors chase sales then the ratio studies will show that the assessments are generally in line with the sales, and those that are unsold will not be adjusted to be in line with the market.
In a rising market, sales chasing can cause the study to arrive at an inaccurately low value, and in a declining market sales chasing can cause the study to arrive at erroneously high values. Accordingly, sales chasing causes issues when applying mass appraisal techniques and is harmful to equal and fair assessment practices and is discouraged. Therefore, it is unlikely that assessors will immediately adjust the assessed value to a value at or near a sale price that is higher than the assessed value.
If there are many sales occurring at prices higher than the assessed values then the sales ratio study will show that the assessed values are below market. To illustrate, if the sales of a specific class of property in a specific area in a given year have a median sale price 30% higher than the assessed value then the ratio would be 0.7692 (i.e,. $1,000,000 EMV ÷ $1,300,000 Sale Price) or 77%. In Minnesota, assessors are to aim for ratios within 90% of the sales. Based on this illustration, instead of sales chasing, the assessors would put the sales in the study and likely increase all properties in that group by 13% the following year (13% + 76% = 90% sales ratio target).
In a rising market, like we have experienced over the last few years, we generally see assessors increase values year over year rather than chase the sale. As a result, the assessment may eventually reach the sale price, but it can take a few years. While it is possible that an assessor could decide to chase a sale, our experience evaluating these types of sales supports the methodology described above. Nonetheless, we always recommend taking a close look at the market activity, assessment patterns, ratio studies, and property specific factors to evaluate the risk of increasing assessments following a sale.