Publications & Resources
July/August 2008
Focus: Lending & Credit
Distressed Real Estate Loans and Their Property Tax “Kicker”
By Theodore F. Bayer
If you are confronted with a distressed loan secured by a deed of trust or mortgage (“security instrument”) on real estate, it is time to get familiar with your state’s property tax framework. What you don’t know could cost you dearly – and timely action can enable you to avoid, or at least minimize, significant unanticipated expenses.
In most jurisdictions, property taxes provide funding for many vital local services; thus, it is not surprising that the lien for unpaid property taxes and penalties is superior to all other liens against a property, regardless of the time of their creation. A security instrument may have been recorded in 2005, when there were no tax delinquencies; however, upon foreclosure in late 2008, any unpaid property taxes from the 2006, 2007 and 2008 tax years, plus penalties, become the obligation of the entity that acquires title upon foreclosure.
Because of statutory multi-year waiting periods before a property can be sold for tax delinquencies, most borrowers in distress simply ignore property taxes. The ongoing penalties associated with an owner’s failure to make timely tax payments, which can run to 25% of the unpaid taxes, only exacerbates the obligation. As a result, by the time the property is in the foreclosing lender’s hands, the opportunity, both to eliminate or reduce penalties and to challenge the property’s previous assessed values, has been lost.
A lender that views a troubled loan only in terms of a principal write-down is shocked to learn the magnitude of this additional, inescapable out-of-pocket expense. Savvy lenders faced with this scenario are well-advised to initiate early action to minimize the resulting impact on their bottom line.
Protective Measures Available to Lenders
A lender dealing with a distressed loan has two primary proactive measures
available to it: payment of property taxes before delinquency and attempts to
lower the property’s assessed value. Each of these actions is extremely
time-sensitive.
Annual real property tax bills are typically payable in installments, with a clear deadline for payment. Most well-drafted security instruments give a lender the right to make payment of property taxes when it can demonstrate reasonable grounds to believe that the owner would not make timely payment. Because unpaid taxes become the obligation of the foreclosing lender (or purchaser at the foreclosure sale), a diligent lender will ensure that taxes are paid prior to delinquency to avoid penalties. Additionally, since most states prohibit the filing of an appeal challenging a property’s assessed value unless all taxes owing with respect to the challenged assessment have been paid – even when the property’s current market value clearly is lower than its assessed value – failure to pay also eliminates the ability to secure a lower assessed value.
In certain situations, the assessor will consider reducing a property’s assessed value before issuance of the annual tax bill if substantial, reliable evidence supports the reduction. If negotiations with the assessor prove unsuccessful, however, a timely valuation appeal must be filed. Loan documentation often provides a lender with the right to engage, or to force the borrower to engage, the assessor in these pre-bill discussions and to file an appeal.
Appeal filing periods vary from state to state; failure to file before the applicable deadline precludes any further challenge to the assessed value for the affected tax year. Once an appeal has been filed, the Assessor has little choice but to consider reliable evidence that demonstrates that a property’s assessed value exceeds its current market value. The evidence must be current, compelling and well-presented in order to achieve the desired reduction in assessed value – and the resulting tax refund.
A lender confronted with a distressed real estate loan is well-aware of the detriment of any resulting principal write-down. A savvy lender also recognizes the potential impact of unpaid property taxes and penalties – and understands that timely action is the only way to minimize this additional expense associated with almost every foreclosed property.
Theodore
F. Bayer is principal with Ad Valorem Solutions LLC in
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