The holy grail of property tax attorneys is to exclude business enterprise value from the valuation for real estate. Unfortunately, efforts by the property tax bar have had limited success. Consider these four scenarios that clearly involve entrepreneurial effort beyond simply developing a building.

Joe Enterprise developed a 500,000 square-foot outlet center in Nowheresville, N.Y., located near a thruway exit and in the midst of farmland near a relatively depressed, aging city. The land was inexpensively adquired. Cheap cinder-block store buildings were erected and given an attractive "Olde Towne" motif. Total costs are only $80 per square foot.

Joe Enterprise has developed outlet malls across the nation. Because of his reputation and relationships, he has enticed 60 companies into signing leases averaging $25 per square foot, net rent.

Bill Megamall determined that a community is slightly understored and served by a 37-year-old regional mall barely keeping up with the times. He decides to go head to head, building a new mall diagonally across the Thruway exit from the existing mall.

The new mall is state of the art, and maybe more. The tenant mix is superb. Bill Megamall managed to entice two of the biggest drawing anchors (Nordstrom/Bloomingdale quality) to his mall. Several of the newest, most exciting theme restaurants and a 12-plex cinema signed up. Advertising and promotion are excellent. The crowds come and shop 'til they drop.

Jane Hospitality acquired a landmarked, architecturally renowned downtown 80-year-old office building with architectural highlights. She gutted the building and created a charming, efficient hotel with the latest in staffing innovations and operating systems, bearing the flag of the nation's most profitable franchise. The restaurants and bistros of France and Hong Kong were scoured for key kitchen and dining staff.

Jane's hotel was soon written up in travel magazines, receiving five stars for lodging and food, and put on the list of "10 most in" places to go. Its average daily rate and occupancy factors exceed the city's norm by 15 percent - even when compared to newer hotels of its five-star class.

Dennis Dogood grew up in the family nursing home business. Licenses for new homes are hard to get, but he managed to obtain one and constructs a 150-bed facility in a slightly out of the way suburban area. Medicare is soon paying $325 a day for skilled nursing services.

Dennis' staff includes nurses, physical therapists, occupational therapists, recreational therapists, dieticians and social workers, requiringextensive management. The nursing home operation also includes a great deal of personal property - including beds, recreational equipment, and kitchen equipment. His costs are slightly more than the $100 per square foot to build a hotel or office building. But, Dennis earns a considerable profit on the entire nursing home.

There is little doubt that business enterprise value exists. The Appraisal of Real Estate, 11th ed, states:

Business enterprise value is a value enhancement that results from items of intangible personal property such as marketing and management skill, an assembled work force, working capital, trade names, franchises, patents, trademarks, non-realty related contracts or leases, and some operating agreements. Going-concern value is the value created by a proven property operation with income sufficient to pay a fair return to all the agents of production. It consists of the total value of the real property; personal property such as furniture, fixtures and equipment; and intangible personal property, or the business enterprise. Properties with a business value component include hotels and motels, restaurants, bowling alleys, nursing homes, and other labor-intensive operations. (Emphasis in original)

The authoritative treatise further states:

The reporting requirements of [Uniform Standards of Professional Appraisal Practice] as well as certain assignments, such as appraisals for tax appeals or eminent domain, require that value be allocated among its various components, i.e., real estate, FF&E, business enterprise, and other intangibles. There are divergent methods of estimating business enterprise value and no single technique is universally accepted.

The Internal Revenue Code allows the segregation of non-real estate items and provides a shorter amortization period than the 38-year period for real estate. Section 197 allows taxpayers to amortize certain intangibles over a 15-year recovery period, including:

• Goodwill and going concern value;
• Work force in place, information base, customer and supplied based intangibles;
• Licenses, permits and other rights;
• Franchises, trademarks and trade names.

Amortizable items also include hotel and mall management teams, customer lists, tenant mixes, operating agreements with anchor stores and distinctive trade names, such as Fockerfeller Center, Mall of America or Roosevelt Field.

Despite Extensive efforts property tax attorneys have so far only succeeded in separating business enterprise value for hotels and nursing homes.

The new York Court of Appeals long ago recognized the existence of business enterprise value for hotels. People ex rel Hotel Paramount Corp. v. Chambers, 298 N.Y> 372, 83 N.E.2d 839 (1949), involved the sale of the hotel and business of the old Hotel Paramount on Times Square in 1945 for $3 million. A year later, the stock sold for $3.6 million.

The Court held:

Concededly, the sales prices of the hotel enterprise, as well as the hotel income, reflected not only the value of the real estate, the only proper subject of the real property ta - but the worth of such additional elements as management, good will, hotel furniture and furnishings, inventory of food and beverages and the usual hotel services. ... In these circumstances, the valuation of a transient hotel property is in essence the valuation of a 'specialty,' a term including real estate, which, unlike an apartment house or office building, produces income only in combination with a business conducted upon it.

The then-limited appraisal methodology allowed the Court to exclude business value only by treating the Hotel Paramount as "in essence" a "specialty."

New York is the only state using reproduction cost as the ceiling of value. The importance of this concept in separating business value from real estate value was made clear by the Iowa Supreme Court in Merle Hay Mall v. City of Des Moines Board of Review, 564 N.W.2d 419 (1977), whihc rejected the concept that business value should be omitted from the valuation of a regional mall because Iowa statutes did not provide for use of the cost approach as the sole method of value or the ceiling of value.

The most significant development in the valuation of hotels for assessment purposes was the publication of "The Valuation of HOtels & MOtels for Assessment Purposes" by Stephen Rushmore and Karen E. Rubin in the Appraisal Journal, April 1984.

Among the points made in this seminal article were:

Appraisers soon learn that lodging facilities are more than land, bricks, and mortar; they are retail-oriented, labor-intensive businesses necessitating a high level of managerial expertise. In addition hostelries require a significant investment in personal property (furniture, fixtures, and equipment) that has a relatively short useful life and is subject to rapid depreciation and obsolescence. All these unusual characteristics must be handled in a proper manner during the hotel valuation process in order to derive a supportable estimate of market value.

The article set forth a method to accomplish this which is too complicated to explain in this article. Newer methodologies, particularly those proffered by David C. Lennhoff, have more recently been developed. See, e.g. Lennhoff, Business Enterprise Value, anthology, Appraisal Institute, 2000.

More recent cases have held business enterprise value to be excludable for hotels. See Hilton Inns, Inc. v. Board of Assessors, Village of Tarrytown, 39 Misc2d 792, 242 N.Y.S.2d 433, 436 (Sup. Ct. 1963), where the court held:

Thus, the petitioner's hotel income is relevant and material herein. The village can employ its own experts to segregate that portion of the business income which is attributable to the real estate.

The first case to actually use an income method to value a hotel ixcluding business value was Dann's Motel Corp./Lodge on the Green v. Board of Assessors, Town of Erwin Real Property Tax Administration Reporter, No.1, p.5 (Sup. Ct. 1992):

The court finds therefore that neither the market approach nor the reproduction cost - less depreciation methods - are appropriate. The method of income capitalization was utilized by both of the parties. ...

The petitioner's expert appraiser... capitalized the net income after making adjustments to the income stream for management of the business and personal property. ...

The court adopts the appraisal of the petitioner's expert.

See also Blue Hill Plaza Inn, Inc. v. Assessor, Town of Orangetown, 3 Real Property TAx Administration Report, No. 4, p. 4 (Sup Ct. 1995). This is probably the most relevant case on the methodology of the income approach since it is the only case in which both appraisers expertly used this method. The court largely adopted appraisals following the Rushmore methodology, disallowing a management fee, but allowing a 3 percent franchise fee.

A notable success in excluding business value was the nursing home case of Tarrytown Hall Care Center v. Assessor, Town of Greenburgh, Westchester County Sup. Ct. 2004, 12 Real Property Tax Administration Reporter, No. 2, p. 140, where the court described the appraisal method adopted as follows:

Sterling [the appraiser for the taxpayer] stated that the profit and loss statements for the subject could not be used as a starting point because it was impossible to estimate the revenues attributable to the real esate Medicaid patients on public assistance, and within those reimbursements are specific payments of use of the real estate.

The court further held that: The Court finds persuasive, however, Sterling's contention that the lion's share of net income should be attributed to the non real estate aspects of the subject. It is clear that the great majority of the subjects' patients are on Medicaid (publid assistance), and there is logic in Sterling's method of capitalizing Medicaid reimbursements [for the real property portion of the nursing home], with adjustments for Medicare reimbursements and private pay income.

Case law, especially in New York, has not yet advanced to the adoption of appraisal methodologies that separate business enterprise value for shopping center or mall properties. As noted earlier, the cost method may sometimes accomplish this, to some degree.

Even the leading proponents of separating the values in retail properties readily admit that, while appraisal literature defines going concern value and business enterprise value quite well, such literature "does not, however, provide adequate exposition on the variables that enter into the estimate of going concern value, thus affecting business enterprise value or intangible value." (rabianski, "Going Concern Value, Market Value and Intangible Value," The Appraisal Journal, April 1996.)

In other words, we know it's there, but we cannot calculate it. Maybe someday it can be accomplished.

William D. Siegel is a senior partner in the Oyster Bay law firm of Siegel Fenchel & Peddy, P.C. and the New York State member of the American Property Tax Counsel. He can be reached at wds@nytaxappeal.com