Donald Bouchard, CRE

In real estate tax cases, the issue of market value is the central factor that establishes the “fairness” of the tax burden on a given property. Sounds simple and in many cases it is, but recently, some courts have begun to adopt what has been called the “dark store theory” of property value.

This concept is predicated on applying strict interpretations to what constitutes the actual real estate and actual market value. For example, a new “name brand” big-box store is built and leased to the tenant for a rent that reflects the need for a developer to cover the costs associated with the acquisition of land, the costs of construction and an adequate return (profit). This is commonly known as feasibility rent. The value of this type of store sold subject to a long term lease can be very high because capitalization rates reflect the creditworthiness of the tenant. Most long term net leases will trade in the low single digits when leased to certain national tenants.

Property owners are fighting back, however, with valuations that they believe reflect figures more appropriate to the value of the land and the bricks and mortar. They argue that the higher assessed values incorporate non-realty assets that should not be taxed in ad valorem situations. Recently in Indiana for example, the Indiana Board of Tax Review rendered a decision that supported the owner’s view that the Bloomington CVS was over-assessed since 2009. How big was the difference using the dark store theory? The assessment was reduced from $19.7 million to $7.2 million. The assessors had unsuccessfully argued that the use of the sales of vacant buildings or comparable leases for second generation users of space vastly under-valued this property.

The assessor’s argument rests on the proposition that as long as the initial user remains in the space and uses it for its business, then the value should reflect that circumstance. Conversely, the owners make the case that if CVS was not the tenant, then the property would sell at a much lower value because it would not be ideally suited for a subsequent user. Because this is proven by sales of vacant stores and by second generation leases, the higher values, they argue, reflect some measure of non-realty related items whether they are goodwill, or a given company’s corporate balance sheet. The crux of their argument I believe can be summarized as ‘we pay higher taxes simply because of who we are.”

According to the Indiana Business Journal, fearing the loss of over $120 million in tax revenues that could result from the state board ruling, Indiana passed a new law that prohibits closed or sold stores from being used as comparisons in the valuation of big-box stores. The law applies to the appraisal of all non-income (owner occupied) buildings that are ten years old or newer and are occupied by the original owner. This of course raises a number of thorny valuation issues that owners and assessors tend to disagree on for obvious reasons.

First there is the old concept that “cost does not necessarily equal market value.” We all know from experience that owner/users can spend vast sums of money for specific types of improvements such as design requirements, décor and branding concepts that only have value to them and would not recognized by the vast majority of market participants. I suppose an example would be one where a large big-box home center company builds a brand new store and at the last moment, for some reason internal to the firm and not driven by market factors, decides not to occupy it. What is a brand new, shiny, specifically branded and built big box store worth in the marketplace to someone for whom it was not designed? Is it worth the actual cost of development?

Secondly, many times the issue of a reasonable assessed value turns on a subtle but real debate as to whether that value is truly based upon the value in use, and not the value in exchange. The argument is frequently made that owner occupied properties have always been occupied, continues to be used by the owners, continues to serve the needs of the occupants and issues related to age or obsolescence don’t matter. As we all know, the reality of the marketplace sometimes deals hard news to owner/users when they put their properties up for sale.

These issues are not going to be easily resolved and some proposed legislative fixes may even raise constitutional issues. In spite of these controversies, try to be nice to your local assessors. After all, they have difficult and often thankless jobs. Happy Holidays!

Donald Bouchard, CRE, senior vice president at Lincoln Property Company, Boston and is the 2015-2016 chair of the New England Chapter of the Counselors of Real Estate (CRE).