ADMINISTRATIVE NOTICE 93-02 SUBJECT: Property Tax -- State Tax Commissioner's Policy Statement for the Determination of the Capitalization Rates for Producing Coal, Oil and Gas, Other Mined Minerals, and Managed Timberland for Property Tax Purposes for Tax Year 1993, Pursuant to §110-1H-8, §
110-1I-4.1.9, §
110-1J-4.7 and §
110-1K-4.1.8.
On July1, 1992, the Department of Tax and Revenue filed valuation variables to be used in conjunction with legislative regulations for the appraisal of natural resource properties. (See: §§
110 CSR 1-H, 1-I, 1-J, and 1-K) These variables were amended and refiled on December
11, 1992.
This notice will address one of the variables, the capitalization rate, setting forth the generally accepted appraisal procedures used in developing the respective rates and in applying the rates to income streams generated by natural resource properties. To this end, this notice will discuss development of industry capitalization rates for producing coal, oil and gas, other mined minerals, and managed timberland. DISCUSSION The International Association of Assessing Officers text "Property Appraisal and Assessment Administration, 1990, defines a capitalization rate as: "Any rate used to convert an estimate of income to an estimate of market value; the ratio of net operating income to market value." In other words a rate used to convert an estimate of future income into an estimate of present value. Generally, there are three (3) components that must be considered and if appropriate developed and included in an overall capitalization rate. These components are: the discount component, the recapture component, and the property tax component. The development of each of these three(3) components will be discussed in the remainder of this Notice.
DISCOUNT COMPONENT Of the three (3) generally accepted methods of estimating a discount component, the bands-of-investment method has received primary consideration. Consideration was given to use of the summation and comparison methods; however, the Department is of the opinion that the bands-of-investment method is the more appropriate method to employ for producing coal, oil and gas, and other mined minerals properties as it lends itself more readily to the conversion of the equity rate portion of the discount component to a pre-tax rate. In this regard the first step in developing the bands-of-investment method is to construct a capital structure. The capital structure of an industry depicts typically the sources of capital financing (i.e.: what portion of the total capital financing is raised through debt and through equity financing). The Department developed an average industry capital structure based on mining, oil and gas, and timber industries as grouped in Moody's Industrial Manual, 1991, and Moody's Handbook on Common Stocks, Spring edition 1992. The capital structure was segregated into percentages of capital financing generated through debt and through equity financing in order to develop a profile for typical leveraging characteristics by type industry. (Equity financing represents capital acquired through sale of stock and earnings retention and debt financing represents capital acquired through issuance of instruments of debt.) Once the capital structure had been established a return on investment was developed for each financing band. The Department analyzed stock growth and dividend yield of companies grouped by industry in Moody's Handbook on Common Stocks in order to develop a return by type industry for common stocks. This "after-tax" return was then adjusted to a "pre-tax" return where applicable and used in developing the equity portion of the discount component. The debt return for the debt finance band was established, for each industry, through analysis of loan rates extracted from questionnaires received from lending institutions. A synthesis of these equity and debt rates (as illustrated in Attachment I) was then used to develop the discount component. RECAPTURE COMPONENT The discount component previously discussed provides an investor with a rate of return-on-investment (interest). The second capitalization rate component, recapture, provides the investor with a return-of-investment (principal i.e.: provides an estimate of return necessary for the investor to recovery the principal invested). Once a capitalization rate has been developed for coal, oil and gas, and other mined minerals properties, the income series is discounted to present worth through selection of a multiplier(s) from a standard mid-year life Inwood table (see Attachment II). The Inwood table has a factor for recapture built into the table coefficients thus removing the need to separately accommodate for recapture in the capitalization rate. PROPERTY TAX COMPONENT The third component, property taxes, was derived by multiplying the assessment rate by the statewide average of tax rates on Class III property. Department research indicates that in addition to royalty rates negotiated in producing coal property leases, property taxes are paid by the coal producer. Thus the capitalization rate for producing coal properties does not contain a property tax component as the income stream does not contain income to be used to pay property taxes. APPLICATION The summation of the previously discussed components (i.e.: discount, recapture, and property tax components) yields a reasonable estimate for the overall capitalization rate. The overall capitalization rate is used to select the factor(s) from a standard mid-year life Inwood table (i.e.: present worth of one(1) per period) that converts the income stream(s) into an estimate of present worth.
The Bands-of-Investment technique was employed when developing discount rates for producing coal, oil and gas, and other mined mineral properties. A combination of this technique and the summation technique was employed in developing a discount rate for managed timberland properties. An adjustment was then made to the managed timberland discount rate to remove the effects of inflation as the income stream developed for managed timberland is a noninflating perpetual (80 year) income series. For more information concerning the development of capitalization rates for producing natural resource and managed timberland properties see 110CSR
1-H, 1-I, 1-J, and 1-K, or contact the Department of Tax and Revenue at (304)
558-3940.
_____________________________ James H. Paige III Secretary Department of Tax and Revenue Issued: January 5, 1993 Department of Tax and Revenue Operator on Duty 8:30 am - 4:00 pm Property Tax Division Monday through Friday P. O. Box 2389 Phone: (304)558-3940
Charleston, WV 25328-2389 FAX: (304)558-2324
After Tax Pre-Tax Percentage Market Rate Rate of Capital Oil and Gas Industry Equity 14.00 ¸ (1-.38) = 22.58 X .45 = 10.161 Debt 10.416 ¸ (1-.05) = 10.96 X .55 = 6.028 Discount Component 16.189 Property Tax Component 2.51 X .60 = 1.506 ______ Capitalization Rate 17.695 = 17.75% Coal Industry Equity 14.50 ¸ (1-.30) = 20.71 X .60 = 12.426 Debt 1991 10.944 "NA" 10.944 X (.4 X .4) = 1.751 Debt 1990 12.445 "NA" 12.445 X (.4 X .3) = 1.493 Debt 1989 12.846 "NA" 12.846 X (.4 X .3) = 1.542 Capitalization Rate 17.212 = 17.25% Other Active Minerals Equity 14.50 ¸ (1-.30) = 20.71 X .60 = 12.426 Debt 1991 12.893% "NA" = 12.893 X (.4 X .4) = 2.063 Debt 1990 12.250% "NA" = 12.250 X (.4 X .3) = 1.470 Debt 1989 13.444% "NA" = 13.444 X (.4 X .3) = 1.613 Discount Component 17.572 Property Taxes 1991 2.51 X .6 = 1.506 X .4 .6024 Property Taxes 1990 2.47 X .6 = 1.482 X .3 .4446 Property Taxes 1989 2.47 X .6 = 1.482 X .3 .4446 Property Tax Component 1.4916 _______ Capitalization Rate 19.0636 = 19.00% Managed Timberland Safe Rate 8.464 Illiquidity Rate .127 Risk Rate 4.198 Management Rate .500 Property Tax Rate 1.480 Inflation Rate <4.594> Capitalization Rate 10.175 = 10.00% II. FACTORS FOR THE VALUATION OF GAS AND OIL PROPERTY (1991 Market Rates) A. Capitalization Rate = 17.75% Year Mid-Year Factor 1 0.921 2 0.782 3 0.664 4 0.564 5 0.479 6 0.407 7 0.345 8 0.293 9 0.249 10 0.211 11 0.179 12 0.152 13 0.129 14 0.110 15 0.093 16 0.079 17 0.067 18 0.057 19 0.048 20 0.041 21 0.035 22 0.029 23 0.025 24 0.021 25 0.018 26 0.015 27 0.013 28 0.011 29 0.009 30 0.008 31 0.006 32 0.005 33 0.004 34 0.004 35 0.003 36 0.003 37 0.002 38 0.002 39 0.001 40 0.001 Midyear Factors for Present Worth of 1 and Present Worth of 1 Per Annum Percent 17.25 Present Worth Present Worth Period of 1 of 1 Per Annum 1 0.924 0.924 2 0.788 1.711 3 0.672 2.383 4 0.573 2.956 5 0.489 3.445 6 0.417 3.861 7 0.355 4.217 8 0.303 4.520 9 0.259 4.778 10 0.221 4.999 11 0.188 5.187 12 0.160 5.347 13 0.137 5.484 14 0.117 5.601 15 0.100 5.700 Midyear Factors for Present Worth of 1 and Present Worth of 1 Per Annum Percent - 19.00 Present Worth Present Worth Period of 1 of 1 Per Annum 1 .917 .917 2 .770 1.687 3 .647 2.334 4 .544 2.878 5 .457 3.335 6 .384 3.719 7 .323 4.042 8 .271 4.313 9 .228 4.541 10 .192 4.733 11 .161 4.894 12 .135 5.029 13 .114 5.143 14 .096 5.239 15 .080 5.319 16 .067 5.386 17 .057 5.443 18 .048 5.491 19 .040 5.531 20 .034 5.565 21 .028 5.593 22 .024 5.617 23 .020 5.637 24 .017 5.654 25 .014 5.668