Texas property taxes are the single most frequently underestimated operating expense item in development pro formas prepared by developers entering Texas from other states. The combination of high effective tax rates, an annual reassessment process that can produce dramatic value increases in rising markets, and a protest process that requires active management creates a property tax environment that is materially more burdensome than most states with income taxes but lower property taxes.
Understanding how Texas property taxes work, and specifically how they affect development feasibility and permanent loan underwriting, is essential knowledge for any developer building or acquiring multifamily or commercial real estate in Texas.
Texas Property Tax Basics
Texas has no state income tax and no state property tax. All property taxes in Texas are levied by local taxing units, counties, cities, school districts, special purpose districts, and municipal utility districts, each with their own tax rate applied to the same appraised value.
The combined tax rates from all taxing units that apply to a specific property are expressed as an effective rate per $100 of assessed value. In most DFW and Houston submarkets, the combined effective rate for a multifamily property runs 2.0% to 2.5% of assessed value per year. In some suburban areas with multiple overlapping taxing districts, particularly areas with Municipal Utility Districts (MUDs), the combined rate can reach 2.8% to 3.2%.
By comparison, Seattle’s combined property tax rate for commercial property in King County runs approximately 1.0% to 1.2% of assessed value. Denver’s effective rate for commercial property runs approximately 0.5% to 0.7% (Colorado uses an assessment ratio that reduces the taxable value). The Texas rate is not modestly higher, it is two to four times higher than the comparable rate in Innergy Integral’s Pacific Northwest and Colorado markets.
How Assessed Value Is Set
Texas county appraisal districts (CADs) are responsible for appraising all property in their county for property tax purposes. Each county has a central appraisal district, the Dallas Central Appraisal District (DCAD), the Harris Central Appraisal District (HCAD), the Bexar Appraisal District (BCAD), and so on. The CAD appraises every property annually and sets an assessed value that is supposed to reflect the property’s market value as of January 1 of each year.
For newly constructed multifamily and commercial properties, the initial assessed value is typically set at the completed project’s cost or market value, which, in a rising construction cost environment, can produce an assessed value that reflects the actual development cost rather than the project’s income-based value. A multifamily project that cost $20 million to build and that generates NOI supporting a market value of $17 million may be assessed at $20 million in its first year of operation, producing a tax liability that exceeds what the income-based value would justify.
The Protest Process: Annual Management Required
Texas property owners have the right to protest their assessed value annually to the Appraisal Review Board (ARB), an independent body that hears evidence from the property owner and the CAD and determines the correct assessed value. The protest deadline is typically May 15 or 30 days after the notice of appraised value is mailed, whichever is later.
For multifamily and commercial property owners, the annual protest process is not optional, it is a required element of active property management. Appraisal districts typically appraise based on mass appraisal techniques that produce systemically high values in rising markets. Owners who do not protest, or who protest without adequate income and expense documentation, often pay more tax than a properly protested assessment would require.
Property tax consultants who specialize in Texas multifamily and commercial property protests regularly achieve 10% to 25% reductions in assessed values, reductions that translate directly to tax savings. On a 150-unit multifamily property with a $15 million assessed value and a 2.3% effective tax rate, a 15% assessment reduction saves approximately $51,750 per year. The cost of professional representation, typically a contingency fee of 30% to 40% of the first year’s savings, is well justified.
Property Tax Impact on Development Pro Formas
The most important implication of Texas property taxes for development pro formas is that the tax line item must be calculated using Texas-specific effective rates, not the developer’s home state rates, not national averages, and not estimates that understate the combined rate by failing to account for all applicable taxing units.
A developer from Washington or Colorado who builds a $20 million multifamily project in Dallas and models property taxes at 1.2% of assessed value, the approximate King County rate, will understate property tax expense by approximately $160,000 per year compared to a 2.2% effective DFW rate. That $160,000 of underestimated annual expense reduces NOI by $160,000, reduces the stabilized property value at a 5.5% cap rate by approximately $2.9 million, and reduces the achievable permanent loan amount accordingly.
The error is large enough to turn a feasible project into an infeasible one, or to produce a permanent loan that cannot repay the construction loan at stabilization.
MUDs and Special Districts
Municipal Utility Districts and other special purpose districts are common in Texas’s suburban growth corridors, the outer DFW suburbs, the Houston suburban ring, and the San Antonio outer growth areas. MUDs finance the water, sewer, and drainage infrastructure for new development areas and repay that financing through additional property tax levies.
In areas with active MUDs, the total effective property tax rate can include a MUD levy of 0.5% to 1.5% on top of the county, city, and school district rates, producing combined effective rates that exceed 3.0% in some locations. Developers and lenders underwriting projects in MUD territories should verify the total combined tax rate from all applicable taxing units.
Innergy Integral provides these services in Dallas, TX and across our six-state footprint.
Related: Multifamily Development, Texas · Multifamily Operating Expenses · Multifamily Pro Forma Construction Costs · Development Advisory Guide