Western Real Estate Business

SEP 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

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www.REBusinessOnline.com Western Real Estate Business • September 2018 • 73 BIG BOX STORES SUFFER EXCESSIVE TAXATION Careful preparation is the key to contesting these unfair property taxes. By H. Michael Miller, Esq. I t may be paradoxical that big box retail has lost property value in real estate markets where commercial property values are generally climb- ing, but that is the message many owners must convey to achieve a low- er property tax bill. For decades, big box properties generated significant tax revenue for schools and local governments, but that story is changing. Annual valu- ation gains of 2 percent to 10 percent increases may have become a simple rule of thumb at one time for assessed values, but are no longer expected or acceptable to most big box owners. Instead, there is now a major struggle between the big box owners and the local property tax assessor. Many companies have changed their real estate and marketing strat- egies to adapt to declining big box property values. Toys"R"Us, Kmart, Sears and other stores have either closed stores or no longer exist. Oth- ers, including Walmart and Target, have adapted to suit customers who are no longer happy shopping in a mega store, or having to walk to a dis- tant corner of a mega store to pick up a tooth brush, bottle of milk or a pair of shoes. Many retailers have achieved posi- tive results by reducing store sizes. Target moved away from the super- store format to stores of 25,000 square feet to 45,000 square feet, emphasizing the "grab and go" concept rather than the full grocery store. Some experiments have not worked so well. Walmart opened a number of smaller Neighborhood Markets, only to close many a few years later. Mega stores still exist, but while commercial real estate values in general may be soaring, the value of these mega stores is typically not. Yet, the local assessors do not see it that way. They're applying either a simple, across-the-board increase based on the general market, or using the standard cost, income capitaliza- tion and market/sales approaches to perpetuate valuation increases that ig- nore changing retail dynamics. Points of Contention The cost approach often results in an inflated and unrealistic value that no one would pay in an open-market transaction. The cost approach should only be used on a relatively new building with little depreciation or obsolescence to take into account. The original cost may also include single- purpose features that have little or no value to a second-generation user. Finally, if the building is to be repur- posed, there is enormous added cost to convert a mega store to multitenant occupancy or to a different use with a shallower usable depth; it may not be economically feasible. The income approach is often un- available since these stores are most often owner-occupied, and this ap- proach should only be applied for a rental property. An owner-occupied property should never be required to produce income and expenses in the context of a valuation of the property for property tax purposes. Such in- formation values the business that is being operated from the property, and not the bricks, mortar and land. This leaves the third option, the market or sales approach, as the pri- mary appraisal method. Here starts the war. First, many assessors see a Walmart, Kohl's, Target or Lowe's store differ- ently than they do a local mom-and- pop store operated from a similar property. Yet this is wrong, because it violates basic principles of property tax valuations. A taxing entity cannot collect prop- erty taxes on the value to the name as an ongoing business, but only on the bricks, mortar and land. Buildings with comparable size, location, age, quality and other real estate character- istics should have the same value, re- gardless of whether there is a national name on the building. Second, most big boxes are own- er-occupied. If sold, there would be no lease to transfer to the buyer; the building would be vacant and avail- able to the buyer for its own use or subsequent leasing to a user-tenant. The way to apply this sales approach in such cases is to compare the big box to comparable sales of non-leased property that are, or soon will be, va- cant and available. Such sales in the relevant period are often hard to find. Many of these properties linger on the market for years before they are sold or repur- posed. As a result of such few sales for comparison, the assessor will gravi- tate to using sales of leased properties. A leased property is a totally differ- ent animal from an owner-occupied, big box store. The sale is based on the lease itself — the remaining term on the lease, the net income generated, the tenant's credit and the like. Often, the lease predates the sale by years and does not reflect current market rent. Sometimes the property was a build-to-suit project with rent based on the cost resulting from the user's spe- cific requirements, which resulted in an initial inflated cost to build. Case in Point This played out in one of my recent cases. The assessor valued a big box at $105 per square foot, based on recent sales of leased properties, with the rent in most of these buildings having been established 10 to 20 years earlier. Some were build-to-suit leases. There was, however, a recent sale at $75 per square foot of a vacant big box store in a neighboring county. The Colorado Board rejected the as- sessor's valuation, finding that a va- cant store represented the true market value, and reduced the taxable value to $10 million from the assessor's $15 million. This $5 million reduction re- sulted from digging into the asses- sor's analysis, pointing out the flaw in the cost and income approaches, and eliminating sales of leased properties. The battle will soon start anew, and it is never too early to start accumulat- ing the necessary data that will deter- mine the victor. H. Michael Miller, Esq., Of Counsel, Spencer Fane LLP in Denver. The firm is the Colorado member of the American Property Tax Counsel, the national affiliation or property tax attorneys. Miller Our magazines, newsletters, websites and conferences cover all aspects of commercial real estate. We offer those in commercial real estate the ability to receive content specialized to their geographic area and sector. Please contact us for more information: Scott France 404-832-8262 scott@francemediainc.com www.francemediainc.com ANCILLARY RETAIL TM SENIORS H O U S I N G B U S I N E S S ®

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