San Antonio has long been recognized for its affordability, but as property values continue to soar, an increasing number of businesses and landowners are reevaluating whether the city is as easy to do business in as it once was.

At an event hosted by Patel | Gaines and the San Antonio Business Journal, business leaders discussed the challenges that come with rising property tax bills, higher interest rates, rising construction costs and filling commercial space vacancies, local business leaders hashed out what San Antonio’s evolving business climate could look like if property values continue to climb.

It isn’t pretty.

Brad Parscale, the panel’s moderator and digital director for Donald J. Trump for President Inc., is a business owner as well as a commercial and residential landowner. He said that property values have increased so dramatically, he’s beginning to reassess whether the city is as affordable for his business as it once was.

“As a commercial property owner for land downtown and homes that I rent out, I’ve seen million-dollar increases,” he said. “It has a significant impact on our bottom line, and property tax increases will soon close the gap between San Antonio being more affordable than other cities.”

There are several pieces of legislation the state is considering to help mitigate the increases cities across Texas have seen in property tax bills, which Senator Paul Bettencourt said were rising by at least 15 percent for some businesses.

Rahul Patel, a managing partner for Patel | Gaines, said he’s seen those increases push businesses out, and that’s an issue that will only become more pronounced as values continue to climb.

“People are deciding twice about whether to buy properties in certain areas or establish their businesses,” Patel said. “Taxes are put on the table immediately, and it’s driving people away.

San Antonio city officials are attempting to mitigate the impact of rising property taxes with incentives or other resources to help cut down the total development costs. But as the City of San Antonio’s Director of Government and Public Affairs Jeff Coyle said, the city is a different market than it was five years ago.

“There’s no question we’ve been a low-value market for a long time, and now, values are going up,” Coyle said. “There’s a benefit to that, but it has it’s issues, too.”

With a legal battle looming that pits a big-box home improvement store against the Bexar County Appraisal District, Lowe’s Inc. is about to give a whole new meaning to the term “do-it-yourself.”

That’s because the lawsuit Lowe’s brought against the County to try to cut its property tax assessment by more than half could have an estimated statewide impact of $8.5 billion – lost tax revenue that could leave homeowners and small businesses shouldering the shortfall.

“That is the greatest injustice of all,” said the County’s Chief Appraiser Michael Amezquita.

A Bexar County arbitration panel last fall rejected Lowe’s argument that it should value some of its San Antonio stores as if they were empty, or “dark stores,” rather than a profitable business worthy of taxation. However, the judge’s decision is non-binding, and Lowe’s is likely to take the matter to court.

“The decision, while it was great for us, doesn’t bind them to anything,” Amezquita said. “At the time of the hearing, opposing counsel opened with a statement saying that he hoped the appraisal district would live with whatever the decision of the judges was.

“It turns out they [Lowe’s] are not going to do that. They’ve already told me they are going to proceed to trial, so apparently, if we lost we were supposed to live with it and fix it to their liking. But if they lose, they get to choose. This is likely going to go up to the Supreme Court.”

Lowe’s Corporate Public Relations Manager Karen Cobb declined the Rivard Report‘s request for comment, citing pending litigation.

Bexar County has already spent $250,000 on the legal fight, Amezquita said, and a loss in court would cost the County another $2 million in attorneys’ fees. Lowe’s already has fought for and won tax cuts in Michigan, Indiana, and Alabama, though they lost in their home state of North Carolina.

In San Antonio, the chain operates 10 stores, each about 137,000 sq. ft. and stocked with tools, hardware, appliances, building materials, and garden products. In 2016, the stores were appraised in the $70-per-sq.-ft. range, with a total tax bill of almost $93 million (not counting a data center, service station, and parking). If Lowe’s wins their dark-store case here, the per-sq.-ft. value would drop to $20 or $30, Amezquita said – a prospect he is fighting.

“We believe that a fully functioning and operating commercial establishment, regardless of who occupies the space, has a different and highest best-use than a building that has been shuttered,” he said. “And the judge agreed with us in our methodology.”

Commercial real estate appraisals are generally based on a business’ “highest and best use,” meaning the financially feasible use of a property that would produce the highest value for that property.

But there’s a fundamental problem with that methodology, said tax attorney Rahul Patel, a managing partner with Patel Gaines in San Antonio. Although he is not involved in representing Lowe’s, he works for more than 200 small-to-medium business owners and homeowners who he said “are getting pummeled” with property taxes. In 2010, he won a contentious battle with the County over tax exemptions for a nonprofit housing development.

“I represent a litany of business owners who are paying well in excess of the price-per-square-foot of what their real estate should be worth,” Patel said. “There are many business owners coming to the table with true profit-and-loss statements, true income statements, true vacancy issues, true deferred maintenance, and they are being valued based off a sale that happened down the road but [is] not truly reflective of their property.”

In short, commercial property should be valued differently, he said, and what Lowe’s is seeking is not a tax loophole as some have concluded, but a theory that should be looked at as an appraisal methodology.

“They fail to remove intangible components of a business – the person, the proprietor, the brand, the people who work there, the goodwill, the other items that help generate the business revenue that has nothing to do with the real estate – when they value the business,” Patel said. “If Lowe’s were to leave, would that space garner an equal tenant, of equal revenue, of equal national presence? History tells you no. In essence, the theory is you have to value the space as if it was dark, in order to get to the real value of the property. Then you have a property tax.”

Otherwise, it’s nothing more than an income tax, he said. “What if each house was valued based on the earnings of the family inside of it, not the value the house is worth?”

Amezquita countered that only tangibles figure into assessments.

“In terms of our valuation, we value the sticks, the bricks, and the dirt. That’s what we’re required to do,” he said. “The notion that Lowe’s thinks this should be based on some hypothetical sale of empty properties all over the country is silly.”

Lowe’s currently owns 141 Texas stores, more than in any other state, and 2,355 stores in the United States, Canada, and Mexico – representing 212.8 million sq. ft. of retail selling space. The company reported earnings of $2.5 billion for the 2015 fiscal year.

Patel also said the amount of potential lost tax revenue government officials have put forth is “grossly misleading,” comparing the concept to a personal income tax refund. “Is it a lost revenue if it never should have been assessed in the first place? My response is unequivocally no,” he said. “Second, the argument that homeowners pick up the slack has no factual support, merely one offered as the media’s – and often the counties’ and governmental agencies’ – attempt to mislead the public.”

Patel said he also believes there’s a real possibility that businesses like Lowe’s will “go dark,” pack up, and leave behind large, empty commercial spaces, plus jobs, if they continue to see increased tax bills based on “isolated sales and mass appraisal methodology.” They may reduce their footprint locally or choose not to invest in new projects, building rehabilitation, or capital improvements. They could choose more tax-friendly places to open shop. And he blamed the property tax issue for some of the commercial market slowdown already happening in the state.

But dark-store victories in some states, and suits filed in other counties in Texas, are paving the way for similar complaints from big-box stores across the nation, such as Target, Kohl’s, and Walmart.

And that’s one reason Amezquita said the County can’t afford not to fight back.

“The thing that makes it different for us is, in Texas, we have equal and uniform appeals,” Amezquita said. “You can sue me over market value or you can sue me over how your property relates to the value of comparably situated, similar, and adjusted properties. If you’re a big box [store], and Lowe’s gets knocked down to $20 a foot, what other big box is not going to come in and say, ‘I want to be just like Lowe’s stores’? That’s where the spiral starts.

“We already have spiraling-down values based on equal and uniform. No other state has an equal and uniform statute as liberal as we have, all of them tied to some limitation having to do with market value. We only have to lose this one time to have it spiral out of control.”

Patel said it is property tax increases that are spiraling out of control.

“What’s happening is we’re starting to take the easy road by valuing everything based on an income method, that what it generates in revenue is what it should be taxed at, and that’s not the case.”

Meanwhile, Amezquita intends to hold the line with Lowe’s, saying it’s ultimately not fair for the tax burden to be shifted, “forcing small businesses and everyday homeowners to pay the tax liability of gigantic commercial property owners just because they have the financial means to wrangle the law in ways to benefit their bottom line, no matter who they hurt in the process.”

There has been a widespread “how dare they” reaction to certain Bexar County businesses filing lawsuits to have their properties assessed as vacant buildings — rather than revenue-generating ones — in order to reduce their tax bills.

A provision in the state tax code — commonly referred to as the “dark store loophole” — allows a business of any size to have its real estate assets qualified as vacant so that its appraised value won’t be linked to the business’s profit.

But what if lower property tax bills turned out to be an economic generator, as opposed to the escape route for businesses that it has been made out to be?

I spoke recently with local attorney Rahul Patel, the managing partner with Patel | Gaines with a client roster ranging from large hotel developers to small apartment complex landlords, who is concerned that the way certain commercial property is appraised — while generating more tax revenue today — can lead to unwanted consequences for communities in the long run.

Lights off

Retailers such as Wal-Mart Stores Inc. (NYSE: WMT), Target Corp. (NYSE: TGT) and Lowe’s Companies Inc. (NYSE: LOW) have filed lawsuits across the country to reduce their annual property tax bills. In San Antonio, the city’s chief financial officer, Ben Gorzell, told Texas Public Radio that roughly $275 million in tax revenue will be lost over the next five years if big-box retailers are successful in getting a vacant classification for their real estate.

But Patel said the way such business actions have been portrayed is misleading. He said it’s unfair to categorize every lawsuit filed to lower one’s commercial property tax bill as an “attack” on a local community, which he said is the case in recent media reports. Rather, it’s often a survival method for small businesses facing massive tax bills due to their property being in transitioning areas.

Patel said such businesses often see increases in their properties’ appraisals that are not necessarily in line with their real values.

“Residential tax values have a cap, and they can only go up a certain amount,” Patel told me. “That isn’t necessarily the case for commercial real estate.”

By basing commercial property values — to a large degree — on the potential for generating profit, the resulting tax burden can be heavy for small businesses.

“There have been double-digit increases in commercial real estate values across the board, and that’s a number many of them haven’t factored in before,” Patel said. “What decisions would small, midsize and large businesses make if that’s a growing expense?”

The cycle of rising property value

For every $1 million added to a local property’s appraised value, the owner takes an immediate $27,000 hit to its capital improvements budget — or money it’s able to put back into the property. That means a landlord may have to forgo renovations, maintenance and structural upgrades, and Patel said that scenario has become more common in areas facing an increasing amount of buildings falling into disrepair, creating areas with significant blight.

“Nobody is able to put money back into the properties, say, around the Loop 410 and Highway 281 intersection,” Patel said. “The property tax increases are driving triple-net rental rates up, which pushes tenants out, which means landlords have no money to put back into improvements, which turns new tenants away. It has become a cycle that happens when the appraiser takes an income approach to valuing a business’ property rather than the raw value of the property itself.”

The income-based approach that the local appraisal district has taken in valuing commercial real estate properties not only has the potential to bruise land owners’ bottom lines, but it could also deter developers thinking about jumping in to San Antonio’s strengthening real estate market.

“Property tax bills are starting to become a concern for developers,” Patel said about the impact on proformas and development plans. San Antonio, so far, has managed to avoid pitfalls faced in metros such as Houston, where rents are dropping at a dramatic pace while property taxes continue to rise.

With any loophole, such as the “dark store” provision, it’s possible that a few properties will squeeze through that don’t warrant the exemption. Nevertheless, Patel asserts that the current appraisal method “cuts to the core for small and midsize businesses,” preventing them from hiring more employees, expanding their spaces or taking on risk that they otherwise would be willing to assume.

Those smaller — but just as important — economic generators should be considered when properties are appraised, Patel said. The local attorney said the city should take a business’s entire role in the local community into account, not merely its profits or the new developments sprouting up around it.

“Whether you’re ready or not, change is coming,” Patel said of the new presidential administration, imminent increases in interest rates and several pending legislative actions. “Are we equipped to find a solution for that change, or will it pummel us?”