Real Estate Taxes

Definition of Real Estate Taxes

In the context of commercial real estate and finance, Real Estate Taxes are mandatory charges levied by local government jurisdictions—such as counties, cities, and school districts—on the owners of commercial property. These are primarily ad valorem taxes, meaning the amount owed is calculated based on the assessed value of the property, including the land and any permanent improvements or structures built upon it.

Detailed Description of Real Estate Taxes in Commercial Mortgages

Real estate taxes represent one of the most significant operating expenses for commercial property owners and play a critical role in the underwriting, servicing, and ongoing management of a commercial mortgage. Below is a detailed breakdown of how these taxes interact with commercial financing:

• Tax Assessments and Millage Rates: Local municipalities employ tax assessors to determine the fair market value of a commercial property. Once the value is assessed, a "millage rate" (tax rate per thousand dollars of value) is applied to determine the annual tax liability. Because commercial properties can fluctuate in value based on income and market conditions, these assessments are subject to periodic updates or appeals.
• Lender Priority and Tax Liens: For commercial mortgage lenders, real estate taxes are a primary concern because tax liens almost always take first priority over a mortgage lien. If a property owner fails to pay their taxes, the local government can seize and sell the property to recover the debt, effectively wiping out the lender’s security interest.
• Tax Escrow/Impound Accounts: To mitigate the risk of non-payment, most commercial lenders require the borrower to maintain a tax escrow account. Each month, the borrower pays 1/12th of the estimated annual property tax bill into this account along with their mortgage payment. The lender then pays the tax bill directly to the municipality when it becomes due.
• Impact on Net Operating Income (NOI): Real estate taxes are a "line item" expense that directly impacts a property’s Net Operating Income. Since commercial mortgage sizing is typically based on the property’s ability to generate cash flow, higher taxes result in lower NOI, which may reduce the total loan amount a borrower can qualify for under a specific Debt Service Coverage Ratio (DSCR).
• Triple Net (NNN) Leases: In many commercial property types, such as retail or industrial, tenants operate under Triple Net leases. In these scenarios, the tenant is responsible for paying the real estate taxes. However, the mortgage lender still monitors these payments closely, as the property owner remains ultimately liable to the government if the tenant defaults on their tax obligations.
• Tax Abatements: Some commercial properties benefit from tax abatements or incentives offered by local governments to encourage economic development. Lenders must carefully analyze the expiration dates of these abatements, as the sudden "step-up" to full tax rates can significantly impact the borrower’s ability to service the debt in the future.

Ultimately, Real Estate Taxes are a foundational element of commercial mortgage risk management. Lenders require proof of payment annually and often perform "tax searches" to ensure no delinquent ad valorem obligations exist that could jeopardize the mortgage's collateral position.