Local Property Tax Authority

Local Tax Departments and conventional appraisal theory rely upon the comparables method to appraise Real Estate. Thought this method is considered adequate, it is often unreliable.

To breakout the components of the bundle of rights, called Real Estate, local Tax Departments try to partition the bundle into two components, the improvement and that which is left over, called the land residual. Having derived the land residual value for a particular area of town, Tax Departments try to reverse engineer the value of each individual property by then adding the improvement value.

The underlying assumption here is that total value of the bundle is equal to sum of its parts. This partitioning arrangement does not work well, because many of the component rights are mutually exclusive.

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In our example:
r(1) = Improvement = $100,000
r(2) + r(3) +... = Land Residual = $100,000
then: V = $100,000 + $100,000 = $200,000

Though the property is for sale for $100,000, the Local Taxing Authority, in the worst case, will mistakenly value it at $200,000.