What's in a name? Discussing valuation principles with concise language avoids misunderstanding.
By Cecilia Hyun, Esq., as published by Heartland Real Estate Business, September 2017
Dark store theory is being used incorrectly to name what is standard, accepted, and proper appraisal practice. It is most often employed by news media to mistakenly suggest that big-box storeowners are taking advantage of a property tax loophole and arguing that a property should be valued as if it were vacant even when the store is open and operating.
While the words "dark store" evoke images of villainous or nefarious activity, assessors and taxpayers should see through this provocative language.
The phrase often confuses the fee simple (absolute ownership of the real estate subject only to governmental powers) market value of the real estate with other types of quantifiable value, such as investment or insurable value.
Investment value reflects value to a specific investor based on his own investment requirements, while insurable value reflects improvements or the portion of the property that may be destroyed.
Typically, property taxes should only be assessed on the real estate value. That's why it's important to differentiate property value for real estate tax assessment from other types of value.
What local law deems real estate value often is different from the property's value to a lender or investor. For example, an owner may include large manufacturing equipment as part of collateral for a mortgage.
This equipment may be valued along with the real estate in determining a loan amount, and may even be included in a financing appraisal; yet the value of that equipment should not be taxed as real estate.
Although this careless and unsystematic misapplication of dark store theory concerns commercial real estate, we will use examples of singlefamily homes to illustrate its concepts.
Comparable sales valuation
In many jurisdictions, assessors value the land, building and improvements for real estate tax purposes. If using sales of comparable properties to determine value, the assessor should examine exactly how much was paid, by whom, for what.
If the sale price of the comparable property includes value for an above-market lease, for unusually favorable financing terms, or for an above-average credit rated tenant, the assessor must adjust the sale price to reflect market conditions. The flip side is also true: a sales price based on below-market rent should also be adjusted.
Users of the "dark store theory" label often argue that a busy store deserves a higher real estate tax assessment because a large and sophisticated company is running a successful business there. But excluding business value from the real estate assessment doesn't mean that the property owner made ill-advised business decisions.
The adjustments recognize that the sale included additional sources of value or achieved valuable business objectives in addition to the exchange of real estate. The value of these items is separate, and must be excluded from the real estate value for tax purposes.
Consider this residential example: a buyer pays 20 percent more than the high end of the market range to buy the house next door to the buyer's brother. The two families have children of similar ages and expect to save money by carpooling and sharing child care and other expenses.
The buyer is acting in his own selfinterest and values the proximity to the brother's household, and the objectives the buyer will meet by living next door. That does not mean that the additional money the buyer paid for those considerations increases the value of the house itself to the typical buyer.
lf an appraiser uses this purchase price as a comparable sale to value a similar house across the street, the purchase price should be adjusted to reflect a more typical market participant.
Similarly, any sales of comparable properties used to value big-box retail stores must be adjusted to exclude any value paid for items that are not real estate, whether they are an abovemarket-quality tenant, atypically long lease duration or other intangible property.
Income approach valuation
Two distinct and important issues get muddied by dark store adherents in valuations based on potential income generation.
The first is whether the properties are valued as if vacant, or as if occupied at market terms. Valuation as if occupied at market terms by a typical market tenant does not include a landlord's lease-up time and costs, which are factors in the value of a vacant property.
Secondly, there will generally be a correlation between better retail properties in better locations and the financial strength of the tenants in those properties and areas. However, the business success or failure of a specific tenant cannot be the basis of a real estate tax assessment if that tenant is not representative of the market.
Returning to the single-family world, houses in desirable areas with good schools, municipal services and low crime rates are generally occupied by people with higher incomes than homes in less-desirable areas.
However, that does not mean that the income of a specific resident determines the value of the house that he or she occupies. If a brain surgeon and a retail cashier are next-door neighbors in similar houses, the values of the homes do not change.
If two similar retail stores are located in a similar area, but one is generating extremely high store sales while the other is vacant because of a business decision to exit the local market, the value of the properties for real estate tax purposes should be the same.
Valuing property is always fact intensive, and the array of specifics differs from situation to situation. There are no shortcuts to an accurate and fair tax assessment value. If the data used is bad and valuation process sloppy, the value conclusion will also be wrong. Consistent and rigorous analysis is vital.
Don't be fooled by labels
Proper appraisal methodology does not become nefarious just because it is erroneously called a "dark store loophole." A rose by another name would smell as sweet. Taxpayers need to pay attention when the term "dark store" is bandied about - it is often used to confuse important appraisal concepts and practices.
To be fair and uniform, property taxes must be assessed only against the real estate, and be based on accurate data reflecting typical market participants. Value related to the success of the retailer's business is captured by other taxes levied on income, sales or commercial activity.
To include those items as part of the property tax assessment is not closing a tax loophole; it amounts to double taxation.
Ignore incendiary language and apply appraisal methodology consistently and diligently to arrive at a fair value for real estate taxes.
Cris K. O'Neall, Esq., as published by Western Real Estate Business - September 2017
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By J. Kieran Jennings, Esq. as published on the Commercial Property Executive website, September 2017
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