Dark Store Theory - Big Box Vs Assessors & Communities

[Gobears81]

It is circular reasoning to make NOI adjustments in the SCA. TAJ had an article on that (from the 90s?). It is then double dipping to then make physical/economic adjustments on top of the NOI adjustments which already reflect some/all of those physical/economic characteristics.

I haven't read those articles, but based on the assumption that any above/below-market lease is reflected in the property rights adjustment, I completely agree.

For going-concern properties, in cases where appraisals adjust on a per unit basis, rather than analyze multipliers in the sales comparison approach, I've seen (and have done) multiple appraisals where there are adjustments made for non-realty components that largely captures the additional variance in performance after adjustments for location and age are accounted for. I personally think that NOI/ SF (or NOI/ Unit, etc) adjustments for those types of properties could yield a more meaningful value indication if implemented correctly. But, I suspect that those property types were not the subject of those articles and are certainly off topic for this thread

 

[Thomas Holding]

I read an article that came out in the last day or so concerning an appeal by the mid-west retail chain Menards, where they lost their appeal based on this theory. In my career I have been fortunate enough to work with both retailers appealing their assessments and with several county governments as a tax appraiser, so it has been interesting to see the arguments that each side makes when presenting their case before local and state property tax boards. In North Carolina, a large home improvement retailer appealed the assessed value of just about every one of their stores in the state using this theory. Their argument basically was that their buildings have so much functional obsolescence built into them due to unique design elements (unique exteriors, layouts, etc., that it severely impacted their value. According to their appraisers, lawyers, and experts from the AI, no competing retailer would reuse these buildings due to the amount of renovation required to cure this functional obsolescence. When the case came before the NC Property Tax Commission, the county challenged the appeal and the appraisal that it was based on, by examining the deed restrictions that were in place on each of the comparable properties. Typically, a retailer will limit redevelopment potential by making the deed restrictions too restrictive in an effort to eliminate any future competitor from buying and or leasing the property. Thus, they have made a business decision to lower the value of their own real estate. After the fact, they try to claim that it is the functional obsolescence that has lowered the market value of their property. They also try to make the argument that their own leases are not "market leases", because they include a bunch of intangible elements that are used mostly for accounting purposes, therefore they can't be used to determine the value of the improvements even if the property is encumbered with it for the next 20 years. They reason that only abandoned or "dark" stores, (which by the way have the deed restrictions in place) are suitable to be used as sale or lease comps. It's a catch 22 situation of their own creation. The county challenged the appraisal used in the appeal due to the fact that the appraiser failed to analyze or even mention the deed restrictions in place on every one of his comparable sales. The PTC did not consider the report to be credible due to these omissions, and dismissed the case. I sat through the two days of the hearing before the PTC and listened intently to both sides argue their cases. I don't really want to offer any specific opinion regarding the merits of this "theory" due to the fact that said retailer has appealed the assessed values of their stores in the county where I now work. I will say that state and county governments across the country are alerted to what is happening with these types of appeals and are actively working on ways to counter them.

 

[EddieB]

Their argument basically was that their buildings have so much functional obsolescence built into them due to unique design elements (unique exteriors, layouts, etc., that it severely impacted their value. According to their appraisers, lawyers, and experts from the AI, no competing retailer would reuse these buildings due to the amount of renovation required to cure this functional obsolescence. When the case came before the NC Property Tax Commission, the county challenged the appeal and the appraisal that it was based on, by examining the deed restrictions that were in place on each of the comparable properties. Typically, a retailer will limit redevelopment potential by making the deed restrictions too restrictive in an effort to eliminate any future competitor from buying and or leasing the property. Thus, they have made a business decision to lower the value of their own real estate. After the fact, they try to claim that it is the functional obsolescence that has lowered the market value of their property. They also try to make the argument that their own leases are not "market leases", because they include a bunch of intangible elements that are used mostly for accounting purposes, therefore they can't be used to determine the value of the improvements even if the property is encumbered with it for the next 20 years. They reason that only abandoned or "dark" stores, (which by the way have the deed restrictions in place) are suitable to be used as sale or lease comps. It's a catch 22 situation of their own creation. The county challenged the appraisal used in the appeal due to the fact that the appraiser failed to analyze or even mention the deed restrictions in place on every one of his comparable sales. The PTC did not consider the report to be credible due to these omissions, and dismissed the case. I sat through the two days of the hearing before the PTC and listened intently to both sides argue their cases.

Would you mind going into detail about the assistance or advise the AI provided to the big box store?

 

[Thomas Holding]

Would you mind going into detail about the assistance or advise the AI provided to the big box store?

The AI expert the retailer provided was the actual creator of the "dark store" theory I believe (He also wrote the income section of the Appraisal of Real Estate 16th edition). His assistance was mostly to explain his theory and to agree with the claim that the county had overvalued the real estate. Mostly his testimony explained the whole issue surrounding the functional obsolescence of the property and the reasons why contract rents should not be used when performing an income approach. He was there mostly as an advocate of his theory. He did not perform an appraisal on the property in question, and was mostly there to discredit the methodology used by Forsythe County. Since this was a public hearing before the NC Property Tax Commission, transcripts or at least summaries should be available from the PTC. There are 2 easily recognizable home improvement type stores. Search for Forsythe County, NC Property Tax Commission and one of the two retailers and you should be able to find a bunch of info.

 

[Terrel L. Shields]

www.waao.org/Committees/Legislation/Lowes_v_Wake_Cty_NC.pdf

Honestly to me the county is valuing BEV not merely real estate. Here I can't think of a single industrial sale that sold for as much as the assessment...just saying.

 

[KHS445]

Working in Michigan I have followed the Michigan cases regarding the proper way to assess Big Box stores with a good deal of interest. Just a couple of off the wall thoughts:

- What constitutes a big box? 50,000+ SF? What about the a building that is 49,900 SF? Well if we can allow an exception for 100 SF, what about 1,000 or 10,000? Where does the firm line get drawn? Maybe at a point just a bit larger than the mom and pop shops located along the main street.

- Following some of the dark theories put forward the problem is functional use. What about a specialty office like a Doctor or Dentist, a little tough to turn into retail or even a general business type office. They built the darn thing, so are they admitting they are idiots for building something that is functionally obsolete? Kind of reminds me of the kid who kills his parents and then asks the Court for leniency because he is an orphan.

- If I had any influence over the governmental unit where this theory was pushed I would inform the building owner that all municipal services would be terminated as the building is dark/vacant. Therefore there would be no water/sewer, police or fire protection, all traffic signals would be removed, etc. Two can play the game, if you want to be taxed as if the building is dark than the governmental units should provide no services. I wonder what would happen to their insurance costs if the municipal water pressure needed to operate the fire suppression system is terminated. In many cases Big Box stores receive some sort of zoning exception or special consideration and generally most zoning ordinances say that any exceptions or exemptions will expire after 12 months of non-use. Does dark store equal non-use? That might be an argument I would make. If you can ignore thousand's of people a day going into a "dark store" for tax purposes why can't you do the same for other purposes?

Not sure there is an ideal property tax/state tax collection system and Michigan's isn't perfect, but with the changes that brought the Homestead credit, the capping of taxable values and the ability to transfer certain property inter-family at least one time without the taxable value uncapping it is not too bad a system. Ultimately those with the highest value property pay the most property tax. It is a cost of doing business.

 

[djd09]

All real estate should be taxed on land only.

All tax assessments should be done by third parties, not employees.

 

[Thomas Holding]

Honestly to me the county is valuing BEV not merely real estate. Here I can't think of a single industrial sale that sold for as much as the assessment...just saying.[/QUOTE]

You are probably right. In this case the property very well could have been valued incorrectly by the county. Instead, Lowes never used that (in my opinion better) argument for the basis of their appeal. Their representatives pushed the whole dark store angle in an effort to establish a sort of legal precedent that could then be used to bluff all the other counties where they had appeals pending. They were trying to use this one appeal to make all the other counties fold without a fight. The law firm and the AI consultant representing Lowes would have made a bunch of money (typically a double digit percentage of the estimated tax savings) by litigating this single case. Unfortunately for them, they used a very flawed appraisal to try to determine the market value of the property. Once the attorney representing Forsythe picked apart the appraiser and his appraisal, the opposing legal team had nowhere to go. The Property Tax Commission had no choice but to dismiss the case out of hand. If Lowe's legal team had better served their client, they could have easily won their case using other arguments. They tried to pull off what they did in Michigan, but it didn't quite work out the way they hoped it would. They still have lots of appeals pending in the state, so maybe they will use different arguments in those cases. If I were a betting man however, I think that this particular legal team has too much invested in this strategy to acknowledge its flaws, and will not deviate from it.

 

[Terrel L. Shields]

They built the darn thing, so are they admitting they are idiots for building something that is functionally obsolete? Kind of reminds me of the kid who kills his parents and then asks the Court for leniency because he is an orphan...Ultimately those with the highest value property pay the most property tax.

The building is built to service a business. The builder is creating a business, not a building. Most states say they are not including the business enterprise value in the valuation, but, in fact, they are doing exactly that.

So you do so, and what happens? Well, you - the consumer - is paying for it...so those taxes are not paid by Lowes or Home Depot. They are paid by you every time you walk into the store and purchase something. So go to the state line. One state has a low tax rate. One has a high rate. Who gets the store...Hmmm, now what. Great we'll offer them tax incentives to build on our side of the "fence". So they do, with a 20 year "bye" on property taxes. Year 19, they announce they are packing it in and moving back across the line where taxes were cheaper. This is exactly what happened to the GM plant in Oklahoma City. It lasted as long as the tax incentives and not much longer.

they used a very flawed appraisal to try to determine the market value of the property

Good comments, but I don't agree.
No, they were defeated on the basis that they presented no evidence that the assessor had not valued it correctly by the method that they- the assessors- were required to use. At least that is what I read into the actual court ruling. It is not the appraiser's job to determine whether or not the assessor used correct procedure. In fact, he likely wasn't even aware of that as a requirement of law.

 

[Thomas Holding]

Working in Michigan I have followed the Michigan cases regarding the proper way to assess Big Box stores with a good deal of interest. ...... Ultimately those with the highest value property pay the most property tax. It is a cost of doing business.

The problem with this particular strategy is the practical effect it will have on municipalities, especially small ones. If these big box retailers successfully appeal their valuations using this theory, and significantly reduce their property taxes, then the tax burden will shift disproportionately to the residential homeowners. The municipalities will still have to provide services to these establishments (police, fire, sewer, etc.) but the funds to do so will have to come from somewhere. Municipalities rely on the assessed values derived by the county tax office. In effect, they have no real say in the matter. Their only choice will be to raise everyone's local property taxes to cover these costs. The effect on the county is much smaller since most of these types of properties reside within city and town limits. The county really doesn't have to provide the bulk of the services to these establishments.