Ad Valorem Taxes and Loading the Cap Rate
Assessors often are required to add an additional factor to the Capitalization Rate to account for Ad Valorem real estate taxes.   Appraisers also use this method to estimate the real estate taxes for new commercial construction. When the Cap Rate is developed in this manner, real estate taxes are removed from the Income Statement and from the Net Income that will be capitalized.  Many jurisdictions require that the Assessed Value of the subject be established in this way.  The theory is based upon the premise that Ad Valorem taxes are determined by the value of the property.  Therefore, it would not be proper to include an estimate of taxes in the Net Income that we use to estimate the subject's value.

The method used to estimate value by excluding certain items from Net Income is often called loading the Cap Rate.  This method assumes a direct relationship between the excluded item (usually real estate taxes) and value. For example, if the real estate tax expense is 3% of the subject's value, then we could add 3% to the Capitalization Rate and exclude this expense from Net Income. Investment Analyst has this capability.

This example shows that both methods produce the same value and taxes.  They are mathematically equivalent.