Dark Store Theory - Big Box Vs Assessors & Communities

[Funky Obsolescence]

I searched but didn't see any topics on this in the forum. So I would like to start a thread on the Dark Store Theory. Here is a nice little summary dated June 12, 2017 from by John Tomasic on Route Fifty.

The Dark Store Theory refers to a movement that has pushed down property tax rates for "big box" retailers across several Midwestern states in recent years. The theory holds that the value of bigbox retail property should be assessed as if it were empty. Companies like Menards, Home Depot, Target and Walmart say the dark stores theory more accurately tracks with the market because demand for big-box retail space is fairly limited. They say the value of an operating big-box business is much greater than the value of a cavernous vacant storefront property. Opponents of the theory argue that all kinds of property similarly treated would see their tax assessments plunge. The value of an occupied home, they point out, is not equal to the same home fallen into foreclosure and left unoccupied for weeks or months or longer. State tax revenue has plummeted as a result- by $100 million since 2013, according to some estimates. State tax revenue has plummeted as a result- by $100 million since 2013, according to some estimates.

I can see both sides of the argument. I have spoken with MAIs who disagree on the issue. I have also read some things by the Appraisal Institute that seem to support the corporate owner's position. Here are some issues that are snagging me at the moment. Love to get your thoughts!

1. VALUE AN OCCUPIED BUILDING AS IF VACANT??? Courts are ordering assessors to value occupied buildings using vacant comps. I still can't see how this doesn't violate USPAP. Shouldn't the court specifically say that they want these appraised as "bricks and mortar". If that is the case, I would think that they would have to order that the appraiser to use a "hypothetical condition" when valuing these properties for assessment purposes. Then the value would be based on Cost Approach (not accurate for old buildings) and the Sales Comparison Approach using empty comps.

2. SALES COMPARISON CAN'T CONSIDER IMPACT FROM INCOME??? Sales Comparison approach does not automatically consider an occupied property vacant. Appraisers used to be able to use NOI adjustments to show the value of the income in the Sales Comparison. But that is now considered "double dipping". I still see appraiser's make occupancy adjustments and I know of banks that ask for these. So the idea that, on a Fee Simple basis, the Sales Comparison Approach excludes any impact from income or occupancy, have never made sense to me.

3. LOOPHOLE OR GOOD APPRAISAL PRACTICE??? Tax reps and lawyers call assessors "activist". I would argue that this whole "dark store" thing is a loop hole and big companies are trying to save big $ on tax expenses. This loss of revenue will hurt residential home owners the most, as they will have to fill in the gaps to provide the income lost from these big box stores. Some will want to argue that governments show just lower taxes and lay off staff etc. I think conversations about poor tax income stewardship by local and national government needs to happen. However, I think this needs to be discussed separately. I'm interested in real estate appraisal standards and theories here. I get it. It is hard to sell an empty big box store. Second generation sales and rents are much lower. And using vacant big box comps might work if you had a big box tenant who was a year or two away from ending their lease and moving out. But to use vacant comps for a Walmart or Lowes that has 15 to 20 years left on their lease just seems crazy.

4. BIG BOX LEASES ARE NOT MARKET??? Courts are also saying that contract lease income information is irrelevant because big box stores have non-market leases. The rental rates include cost to build-to-suit that are amortized over the life of the lease. Ok. I get that. But if nearly all big box tenants have leases like that, doesn't that mean that these leases are "market"? It seems obvious to me that, if a income approach is considered, corporations want 2nd generation market leases to be used. These are much lower for obvious reasons. Some 2nd generation big box use include churches etc.

Some interesting articles...

Walmart v Michigan

Dark Store Theory and "Activist Assessors"

How Big-Box Retailers Weaponize Old Stores

 

[Gobears81]

There's been a few threads posted on related issues, and I've been of a minority view for a couple. I tend to agree with you...to some extent. One must evaluate the supply/ demand characteristics of that type of property, the age/ quality of the building, and where it is in the neighborhood life cycle (among other issues) for determination of how to analyze. Big box properties in expanding locations that meet sufficient site/ property specifications are rarely vacant for quite some time after they are constructed, so to compare them to the deteriorating 30-year-old vacant K-Marts in declining neighborhoods, simply because one is based on fee simple rights, is fundamentally off. Market value does not equate to what it would sell for if vacant unless the property indicates such. For example, the aforementioned 30-year-old former K-Mart store would most likely be valued based on a comparison with other vacant big box stores because that is how those properties sell.

But to use vacant comps for a Walmart or Lowes that has 15 to 20 years left on their lease just seems crazy.

Here's a statement that I think you need to be careful of. While properties like this do typically sell as leased properties in the newer stages of their life cycle, the objection to using vacant comps for a leased property in ad valorem purposes has nothing to do with how long the lease is, as it is based on fee simple and the actual lease length does not affect the fee simple property rights.

4. BIG BOX LEASES ARE NOT MARKET??? Courts are also saying that contract lease income information is irrelevant because big box stores have non-market leases. The rental rates include cost to build-to-suit that are amortized over the life of the lease. Ok. I get that. But if nearly all big box tenants have leases like that, doesn't that mean that these leases are "market"? It seems obvious to me that, if a income approach is considered, corporations want 2nd generation market leases to be used. These are much lower for obvious reasons. Some 2nd generation big box use include churches etc.

Another item that you may need to be careful of. Build-to-suit leases for these types of properties often have rents that are based on costs which include large developer fees, etc. I agree that second-generation rents are not comparable for the reasons cited above, but I would be careful of relying solely on build-to-suit rents for this type of analysis and intended use.

 

[NachoPerito]

1. I don't get why it seems reasonable to value an occupied building if vacant.
2. I can see both sides of this one
3. True, lower assessed values will lower taxes, which will make others have to pick up the slack, but how taxes are dispersed is not our concern.
4. I don't agree with the argument here. If the lease is for the Real estate and it is arm's length then it is a market lease.

I understand that it is reasonable to assess a store as dark when it is dark and assess it higher when occupied, but it doesn't make senese to always assess it as dark. Lets say it cost $8M to build and the land is worth $2M. The value is $10M as occupied. Then it goes dark and the value is $6M because nobody wants it. While the tenant is in there it should be assessed at $10M not $6M.

 

[Michigan CG]

This came in my e-mail yesterday.


Michigan Report for Tuesday, October 31, 2017
Friday, October 20, 2017
Locals Win Tax Victory As 'Dark Store' Appeal Rejected
A unanimous Supreme Court has refused to hear the appeal of Menard's challenge of a property tax valuation in Escanaba, which means, at least for now, the "dark store" concept of valuing large, vacant retail locations cannot be used.
The decision is a victory for local governments in the state that argued that large, big box retailers would use an improper deed restriction on their properties banning any potential competitor from moving into a location the retailer left. Local governments argued that left the property with a substantially lower assessment, affecting the community's overall revenues.
The Supreme Court's dispositive order issued Friday morning, in Menard v. Escanaba (SC docket No. 154062), caught many people by surprise, coming just eight days after the court took arguments on whether it should hear a full appeal on the case.
"We are not persuaded that the questions presented should be reviewed by this court," the order concluded.
The decision leaves in place a ruling by the Court of Appeals that unanimously rejected a decision by the Michigan Tax Tribunal to use a sales-comparison valuation of Menard's former store in Escanaba that allowed it to get a much lower tax bill. The Appeals Court said the correct valuation that should have been used was a cost-less-depreciation approach, which would have resulted in a higher tax bill.
Local governments praised the decision, saying the order helped assure that all local taxpayers are treated similarly.
But the ruling was criticized by retailers. Meegan Holland, spokesperson for the Michigan Retailers Association, said, "All Michigan retailers ask for is fairness."
"We hoped the courts would follow the Michigan property tax act. We felt the Court of Appeals didn't follow the act," Ms. Holland said.
Rep. Dave Maturen (R-Vicksburg) who has led an effort in the Legislature to block the use of "dark stores" assessments, said the decision is a "clear victory for small business and local communities. This decision sets a legal precedent that mirrors legislation I have introduced in the Michigan House to ensure that the tax assessment process is fair for local retailers and communities. It does away with a tactic some large retail corporations have used to unfairly and dramatically reduce the taxes on their properties."
And Rep. Scott Dianda (D-Calumet) said, "Small communities like mine in the western U.P. welcome these stores because they create jobs and sell products we all need. But when they can get tax breaks and prevent other similar stores from buying their property, local units of government suffer and have a hard time providing the services residents, and these stores, expect." Mr. Dianda's district does not include Escanaba.
In the arguments before the Supreme Court, the justices raised a number of questions about the deed restriction on the property that held a similar type of store could not purchase the property once Menards had moved to another location. This type of restriction has become common throughout the state.
During the arguments, for example, Justice Richard Bernstein asked if such a restriction would not hurt the value of the property.
The Michigan Association of Counties estimated that so many valuations have been reduced following the Tax Tribunal's ruling that local revenues have been cut "by at least $100 million since 2013." And it has forced homeowners to take on more of the burden to finance the public services that benefit residents and businesses, the MAC said.
Stephan Currie, the MAC's executive director, called the decision a "most promising development."
And Larry Merrill, executive director for the Michigan Townships Association, said the decision "validates local governments' long-standing concerns and sets a blueprint for how to successfully establish valuations."

 

[Terrel L. Shields]

I love low taxes, but the use of the dark store theory is a perversion of law. In fact, the store, if going "dark", could easily undo the restriction and sell to any comer. So I agree with the court in this case.

People are thinking of how to 'game the system' every day and this was a transparent idea how to do so. But OTOH, I think tax valuations are very often erroneous and I don't understand why it is the obligation of the owner of property to spend tons of money unraveling bad mass appraisal. The entire assessment system could be replaced with a sales tax on all deeds and mortgages filed (excepting family transactions on deeds).

 

[EddieB]

https://www.bna.com/property-tax-post-b73014471372/

Good article which mentions the IAAO paper and provides a link to the study.

It is too large for me to upload it here

 

[Michael P Jacobs MAI]

I know you are looking for a one-size-fits-all solution here, but it doesn't work that way. You have to go to highest and best use. If there is no demand for big box retail that's the way you value it. If there is demand that's the way you value. Every County will be different. Even locations within the county will be different.

 

[leasedfee]

Courts are ordering assessors to value occupied buildings using vacant comps. I still can't see how this doesn't violate USPAP.

Courts aren't bound by USPAP, and it becomes a JE for the mass appraisal for that assessor. Every state has its own peculiar rule sets that deviates from the market. Colorado Assessors can't use the income/cost approaches on apartments per state statute. It does simplify things.

The entire assessment system could be replaced with a sales tax on all deeds and mortgages filed (excepting family transactions on deeds).

You'd just get a different set of games and struggles. The new strategy would become: never sell real property, sell the corporate shares or LLC's interests (no deed), or mask transactions. You'd also have a pretty massive transfer tax to make up for the fact that 1% of properties trade hands per years when the ad valorem system taxes essentially all property stock. The French mansard roof originated from avoiding a rooftop/full floor assessment system. When King Phillip of Spain relocated the capital to Madrid bringing 10,000 bureaucrats, to overcome the housing shortage, the 2nd floor of any new building had to be for the occupancy of the government employees. Thus, nobody built two-story buildings.

Terrel, what's your thoughts on the simpler square footage tax without regard to quality/characteristics? (Of course the people with great buildings or dumpy buildings would scream, but it would be very simple.) Or Henry George's land-only tax? Real property tax assessment goes back to the Romans, likely earlier. Ad valorem with its warts seems to work acceptably.

 

[timd354]

The entire assessment system could be replaced with a sales tax on all deeds and mortgages filed (excepting family transactions on deeds).

There is no way that a sales tax on mortgages and deeds could raise anywhere near the amount of revenue that property taxes raise and deeds and mortgages are already pretty heavily taxed in some locations (Florida in particular).

My township collected $24.5 million in general property taxes last year and $92 million in property taxes for the school board (a total of $116.5 million). In the past 12 months, there have been approximately 650 sales of residential properties and probably less than 20 transfers of commercial properties as the township has very little commercial real estate. Lets assume that there were 1,000 mortgages in the last year (which is likely wildly high) that would result in 1,650 deed/mortgage transactions that would possibly be taxable....even rounding that number up to 2,000 transactions, you would have to tax those transactions at an average of $58,250 each to derive sufficient revenue to replace the township general property tax and the township school property tax.

Obviously, that simply cannot be done. The only way to replace the revenue provided by property taxes would be to institute a local income tax which in a township like mine where the median income for a family is in excess $100k might work, but it probably would not work in other lower income townships unless the income tax rates were set at a confiscatory level.

 

[Terrel L. Shields]

You'd just get a different set of games and struggles.

That's the fly in the ointment.

There is no way that a sales tax on mortgages and deeds could raise anywhere near the amount of revenue

Based on 0.052 millage, 20% ratio, my county raised $240,000,000 in property tax. (2011) about $2400/deed/mortgage filed.

The average owner refis or sells every five years. We had about 125,000 deeds morts filed. Average sale price is over 200,000. Say mtg averages $160,000

So 50/50 mortgage/deed over five years means annual average = $36,000. $2400/36000 = 6.7% tax. And much lower assessment costs.