Property Classification

Which Properties are Classified in Category F1, Real Property – Commercial?

Category F1 property includes land and improvements associated with businesses that sell goods or services to the general public. Some examples of commercial businesses are: wholesale and retail stores, shopping centers, office buildings, restaurants, hotels and motels, gas stations, parking garages and lots, auto dealers, repair shops, finance companies, insurance companies, savings and loan associations, banks, credit unions, clinics, nursing homes, hospitals, marinas, bowling alleys, golf courses and mobile home parks.

Warehouses present a unique classification challenge because of the difficulty some appraisers have experienced in distinguishing between commercial real property (Category F1) and industrial real property (Category F2). The primary consideration is whether the warehouse is used as a part of the manufacturing process.

Warehouses that receive goods from more than one manufacturer or distributor to sell wholesale or retail should be classified as Category F1, commercial real property. The personal property should be classified as Category L1, commercial personal property.

Examples of warehouses that should be classified as Category F1, commercial real property, include:

• A warehouse that buys finished clothing from several manufacturers and sells it to wholesale or retail outlets.
• A warehouse that operates primarily as a retail outlet.

Warehouses that provide storage as part of a manufacturing process should be classified as industrial real property (Category F2). Industrial warehouses are normally owned by the manufacturer and are usually on or near the site of the manufacturing plant.

Examples of warehouses that should be classified as Category F2, industrial real property, include:

• A warehouse that stores various kinds of cloth, materials and supplies used by a manufacturing plant to manufacture clothing. The warehouse containing these items ensures the efficient operations of the manufacturing business by providing an uninterrupted supply of vital resources.
• A warehouse that only functions to receive the finished clothing from a manufacturing plant as it is manufactured, and then distributes it to wholesale or retail outlets. This warehouse enables the factory to maintain a regular and efficient production schedule by producing clothing even when there is no immediate buyer.

It cannot be overemphasized that personal property associated with either industrial real or commercial real properties should not be categorized as either Category F1 or Category F2, but should instead be categorized as either Category L1  (commercial personal property) or Category L2 (industrial and manufacturing personal property).

Important Notes in Classifying Commercial Real Property

• Include both the land and improvement value. The land may be appraised by the CAD and the improvement by an appraisal firm. The total land and improvement value, however, is classified as F1 property.
• Do not include commercial personal property as Category F1 property.

Category F1 Classification Questions

Q. A development company owns a 360-unit time-share condominium complex. How should this property be classified?
A. This property is operated as a commercial business. The real property value is classified as Category F1 property. The personal property should be classified as Category L1.

Q. One of our citizens owns a business and an adjacent lot. Both the business and lot are used for commercial purposes. Should the appraisal district classify the adjacent lot as a vacant lot under Category C or as commercial real property under Category F1?
A. The classification of any property depends on its use. Since the adjacent lot is used in conjunction with a commercial business, it should be classified as Category F1.

Q. A telephone store is owned and operated as an independent operation by AT&T. The store sells and repairs telephones. How is this property classified?
A. Even though a utility company owns this store, it is operated as a commercial business and is not a necessary component of utility operations. Classify the property as Category F1 property.

Q. If a motel suite establishment, such as a motor inn, rents by the month, is it classified as Category B property or F1 property?
A. The motor inn rents the units on a short-term basis. The property is classified as Category F1 property.

Q. A discount store chain purchases merchandise from several manufacturers for distribution to their company stores. Should their warehouse be classified as Category F1 property?
A. Yes. The warehouse is not part of the manufacturing process. When property is used for storing merchandise purchased from more than one manufacturer, which will be distributed to retail outlets, it should be considered commercial property.

 Information taken, in part, from the 2013 Property Classification Guide published by the Property Tax Assistance Division (PTAD) of the Texas Comptroller of Public Accounts.

Overview of Commercial Approaches to Establishing Property Value

Sales Comparison Approach

• Analyze sales of comparable properties compared to subject property
• Sales data: Sale surveys, Market research companies, Third party appraisals, Local media, Appraisal Review Board process 
• Comparables adjusted for sale conditions, land size, improvement size, age, condition, and location
• Arrive at indicated Sales Approach to Value 

The sales comparison approach is used at property tax hearings for houses, land and owner-occupied buildings. It is sometimes used for income properties as a secondary method of valuation. To perform the sales comparison approach you need information on other sales of property similar to your property. You can obtain this information from a variety of sources including the appraisal district’s real estate appraisers, brokers and third party vendors. Inspect and photograph the comparable sales making detailed notes regarding differences between the comparable sales and your property. Then make adjustments for differences between the subject property and comparables. Adjust comparable sales to the subject property. Select sales as similar as possible to the subject property to minimize adjustments.

Income Approach

• Capitalization of Income 
• Direct Capitalization 
• Single year’s net operating divided by market cap rate 
• Market income data compared to subject property income data 
• BCAD collects and enters income data into database: Income and expense data, Rental data, Occupancy data, Secondary income data, Net operating Income data
• Capitalization rates estimated based on sale prices and net operating incomes 
• Outside sources: Market research companies, Real estate publication
• Capitalization rates used for IMA Income Models 
• Subject property income components compared to market indicators 
• Income Approach preferred method for income producing property (Office, Apartment, Retail, Industrial)

The income approach is typically used for income properties. The basic theory is that investors purchase income properties for the income stream they produce. This income stream can be converted to an indication of market value for the property. The primary steps in the income approach are to estimate the potential gross income using rent comparables and information regarding actual income at the subject property. An allowance for vacancy is estimated based on the performance of the subject property and average vacancy in the area. Operating expenses are estimated using actual expenses at the subject property and market expenses for similar properties. The net operating income is calculated by deducting vacancy and operating expenses from the potential gross income. Net operating income is converted to an indication of market value by dividing it by the capitalization rate.

Cost Approach

• Calculates Replacement Cost New (RCN) 
• Deducts Depreciation (LD) 
• Uses Age-Life Tables 
• National Cost Publication Service 
• Market Data 
• Cost tables generate price per square foot 
• Land value added to improvement value(RCNLD) 
• Preferred method for special use properties, new construction, limited sales data, or limited income data

The cost approach is not typically used at the ARB hearings except for new buildings. Appraisal districts often use the cost approach for properties up to two or three years old. After that, the sales comparison approach or income approach depending on the type of property is used. The appraisal district will apply the cost approach for a new property by adding the market value of the land (typically the purchase price) to the construction costs for the building. In addition, they may add an allowance for soft costs and for entrepreneurial profit.