Case Name: Dawson Properties Ltd. v. Municipal Property Assessment Corp., Region No. 32

Transcription

1 Page 1 1 of 1 DOCUMENT Update Week Residential Properties Case Name: Dawson Properties Ltd. v. Municipal Property Assessment Corp., Region No. 32 Appearances: IN THE MATTER OF Section 40 of the Assessment Act, R.S.O. 1990, c. A.31, as amended, and IN THE MATTER OF a complaint with respect to taxation year 2002 on premises known municipally as per Schedule "A" Attached Between Dawson Properties Limited, Assessed Persons/Complainants, and The Municipal Property Assessment Corporation, Region No. 32 and the City of Thunder Bay, Respondents [2003] O.A.R.B.D. No. 131 File No Hearing No Complaint No. See Schedule "A" Attached Ontario Assessment Review Board J.D. Brownlie, Member June 27, 2003 (44 paras.)

2 Page 2 J.B. Nixon, for the Assessed Persons/Complainants. J. Jamieson, for the Municipal Property Assessment Corporation. No one appeared for the Municipality. DECISION 1 These complaints came before the Assessment Review Board on nine hearing days from April 9, 2002 to June 25, 2002 at the Cities of Thunder Bay and Toronto. ISSUES 2 What is the correct method to assess the multi-residential apartment buildings in Thunder Bay owned by Dawson Properties Limited and what should be the assessments given to those buildings for the taxation years 1998, 1999, 2000, 2001 and DECISION 3 The buildings should be assessed using the direct capitalization rate method and should be assessed for the years in question as follows: (1) For 1998, 1999 and 2000: Building Address CVA Egan 415 Egan Street $ 440,000 Victorian 2635 Victoria Avenue East 716,000 Clarkson Towers 19 Clarkson Street South 755,000 Creekside 140 Jean Street 1,006,000 El Rancho 115 Churchill Drive West 1,104,000

3 Page 3 Walkover Terrance 33 Walkover Street 1,211,000 Hacienda 401 Edward Street North 1,549,000 Dawson 320 Dawson Street 1,229,000 Suncrest 540 Oliver Road 2,597,000 Clarkson Court 33 Clarkson Street South 2,214,000 Clarkson Heights 20 Walkover Street 2,664,000 Northwood Edward Street North 3,664,000 Hudson Hudson Avenue 3,319,000 (2) For 2001 and 2002: Egan 415 Egan Street $ 399,000 Victorian 2635 Victoria Avenue East 773,000 Clarkson

4 Page 4 Towers 19 Clarkson Street South 705,000 Creekside 140 Jean Street 872,000 El Rancho 115 Churchill Drive West 994,000 Walkover Terrance 33 Walkover Street 1,082,000 Hacienda 401 Edward Street North 1,486,000 Dawson 320 Dawson Street 1,096,000 Suncrest 540 Oliver Road 2,522,000 Clarkson Court 33 Clarkson Street South 2,169,000 Clarkson Heights 20 Walkover Street 2,799,000 Northwood Edward Street North 3,474,000 Hudson Hudson Avenue 3,895,000 REASONS FOR DECISION 4 This appeal extended over 11 days of scheduled hearings from April 9, 2002 to June 25, There were actually nine days of evidence and submissions, including a large number of exhibits.

5 Page 5 The transcripts of the hearings and a written reply submission from Mr. Nixon were received some time later. Five of the hearing days were in Thunder Bay and four in Toronto. 5 Dawson Properties Limited owns 13 multi-residential apartment buildings in the City of Thunder Bay. Approximately 70% of Dawson's apartment portfolio consists of buildings of 50 units or larger. This is atypical of the Thunder Bay market where almost 80% of the multi-residential units available for rental are located in buildings having under 40 suites or apartments. In fact, the evidence of Mr. Le Blanc indicated that some 54% of these smaller buildings were under 20 units in size. These smaller buildings were somewhat perjoratively referred to as "mom and pop" buildings. 6 All multi-residential apartment buildings in Thunder Bay were assessed by the Municipal Property Assessment Corporation (MPAC) using the gross income multiplier approach to value (the "GIM"). This method relies upon the multiplication of the individual property's gross income by a factor obtained by dividing the sale price of a comparable property by the gross income of that property. The GIM method is one fairly well known example of the use of the income approach to the valuation of real property. Another example is use of the direct capitalization rate; here the capitalization rate (the "cap" rate) is obtained by dividing the net operating income (the "NOI") by the sale price of a comparable building. The current value of the subject building is then obtained by dividing the subject building's NOI by the derived cap rate. 7 As mentioned, all multi-residential apartment buildings in Thunder Bay were valued using the GIM method, although other commercial, income-producing properties were valued using the direct capitalization rate. Briefly put, the complainant says that the GIM used in Thunder Bay was derived from the sales of small "mom and pop" apartment buildings and that this overvalues the Dawson properties because the GIM uses the gross potential income of a comparable property in deriving the GIM and thus fails to account for the expenses incurred by a professionally managed apartment building. The essence of the complainant's argument is that Mom and Pop operations fail to account for many expenses, such as unpaid labour, and thus indicate a higher net income and hence a higher (apparent) current value. In addition, the complainant says that since about 70% of its apartment buildings are 50 units or more in size, the potential purchasers of its larger buildings are different from those interested in purchasing smaller buildings. Large institutional investors would have no interest in purchasing smaller buildings whereas small investors would be unable to purchase larger buildings. The complainant says that there are very few institutional investors interested in purchasing apartment buildings in Thunder Bay but there is a fairly active market for small (less than 20 units) apartment buildings. It says that the institutional investor looks at the net income of the property and calculates a purchase price by using the capitalized net income approach; only MPAC and perhaps an unsophisticated investor would look to the gross income to value a building because that fails to account for the operating expenses which alone determine the net income which can be derived from the investment. 8 The taxation years 1998 through 2001 inclusive were appealed and it was agreed that 2002 was a deemed appeal. The assessments for 1998, 1999 and 2000, are based upon current values as of June 30, 1996, and the years 2001 and 2002 upon current values as of June 30, At the opening of the hearing it was suggested that the Board was being asked to select between use of the GIM or the direct capitalization rate to find current value and once one method was selected, what rate should be applied? It turned out to be somewhat more complicated than that, because each side produced evidence suggesting different current values both for each building and for the 1996 and 1999 base years.

6 Page 6 10 The complainant's first witness was Mr. Dennis Le Blanc, the Vice-President and General Manager of Dawson Properties Limited ("Dawson"). Mr. Le Blanc is a chartered accountant with a Bachelor of Commerce (Honours) degree from the University of Windsor. He has been employed by Dawson since 1989; prior to that he was employed from 1974 to 1989 with a firm of chartered accountants and two chartered banks. Clearly he is knowledgeable about the multi-residential real estate market in Thunder Bay and also has fairly extensive knowledge about bank lending to real estate development. Mr. Le Blanc testified that both the banking world and the multi-residential investor used the net income derived from a property in order to calculate its value. He referred to the GIM method as: A rule of thumb that may be relevant in small-you know, assessing smaller properties, but you have got to be very careful. The attributes of those smaller properties must be almost identical or similar and, in the real world, that does not exist. 11 He considered that the operating expense ratios of buildings having under 20 units (the Mom and Pop group) are lower than in larger buildings owned by investors such as Dawson, because all items of expense were not accounted for. In particular, he mentioned the labour costs, which are frequently carried out by the small unit owner personally and not put on the books. Dawson, he pointed out, has professional property managers, skilled tradesmen, (electrical, plumbing and carpentry) and the expenses of all these people obviously reduced the net income. Mr. Le Blanc also spoke of the declining economic conditions occurring in Thunder Bay, including a reduction in the rental population. The vacancy rate from 1989 to 1992 was from one to two percent. Beginning in 1994, the vacancy rate hit four percent and increased until it peaked at 9.3% in He said that this was probably the third highest vacancy rate of any Canadian city (See Exhibit 11). One of the consequences of this was that landlords began to pay for the tenant's utilities (heat, water and hydro). Prior to 1996 about half the rents in the city were quoted on a utilities - included basis (a socalled "hot rent") as opposed to a "cold rent" where the tenant was responsible for the utility costs. Mr. Leblanc said that the transition, in 1996, from a generally cold rent to a hot rent system was brought to MPAC's attention, in that it obviously reduced the net revenue. However, MPAC refused to lower its calculated income figures. (Presumably because MPAC was doing its calculations on a gross income basis.) Although the vacancy situation has improved to about 5.8% in 2001, the years 1997, 1998 and 1999 were the worst for the Thunder Bay market. 12 Mr. Leblanc said that about 80% of the sales of multi-residential properties in Thunder Bay were buildings having between six and 20 units. The largest building sold between 1989 and 2001 was 45 to 50 units in size. And beginning in 1996 there was a "significant decline in the price per unit". The result, he said, was that considering the high vacancy rates and the general economic prospects of Thunder Bay, investors were not interested in purchasing any apartment buildings larger than 20 to 25 units. Mr. Leblanc said that the reason Dawson appealed its assessments was that while they totalled about $25 million in 1992, they increased to $28.5 million based on 1996 values and to $33.5 million based on 1999 values. In other words, there was a 13.8% increase from 1992 to 1996, and a 17% increase from 1996 to a total increase of 33% (See Exhibit 12) - and that was in an economic situation where, claimed Mr. LeBlanc, the building values had declined from He said this value decline came about because of economic conditions in the Thunder Bay rental market, the average 30-year age of the buildings and the need for upgrades to the buildings. 13 Exhibit 1 has attached to it a "Corporate Report" prepared by the City of Thunder Bay in January This Report reveals that the re-assessment of all property in the city from 1996 to

7 Page values resulted in a total decrease in assessment of nearly $300,000,000. All classes of property lost value except multi-residential, which increased by more than $25,000,000, although only constituting about 5% of the total assessment base. 14 The next witness called by the complainant was Paul Morassatti, who has extensive experience in the appraisal of multi-residential properties across Canada, although located in Toronto. He was admitted by Mr. Jamieson to be qualified as an expert witness. He produced as Exhibit 2 his analysis of the merits of gross income multiplier methodology versus net income capitalization methodology. This exhibit also provides his estimate of cap rates applicable to each of the Dawson apartment buildings as of June 30, 1996 and June 30, His conclusion with respect to the appropriate valuation methodology is as follows: Our research confirms net income capitalization is the most accurate and widely relied upon approach to value both by appraisal practitioners and the market in general. GIM methodology, which fails to adequately reflect significant differences from one property to another, most notably operating expense ratios, is considered to have only limited applicability in the market. 16 He defined the two different approaches as follows: Direct Capitalization is a method used to convert an estimate of a single year's income expectancy into an indication of value in one step - usually by dividing the income estimate by an appropriate capitalization rate. The capitalization rate represents the relationship between the net operating income which a property is capable of producing at the date of valuation and the most probable selling price as of the same moment in time. Utilizing comparable capitalization rates derived from the market, market value is calculated as follows: Market Value = Net Operating Income Overall Capitalization Rate GIM Methodology: Just as a capitalization rate is used to express a relationship between net operating income (NOI) and value, a gross income multiplier is used to express a relationship between gross income and value. Gross Income Multipliers are ratios between the gross income of a property and the sale price, calculated by dividing the sale price by the gross income. 17 He concluded that "within the context of apartment building methodology, the Direct Capitalization method has greater applicability than the GIM method" and that "the GIM method estimates value based on gross income and net NOI, while investment property is purchased based primarily

8 Page 8 on its net earning power. Even in smaller buildings purchased by unsophisticated buyers, pricing is much more closely related to net income (the amount remaining after all operating expenses are deducted from the effective gross income). Since apartments transactions are virtually always financed, a buyer will consider whether the NOI is sufficient to service his debt and provide, hopefully, a return." (Exhibit 2). 18 Mr. Morassutti concluded that an inverse size to cap rate relationship is to be expected in virtually any market, but in the Thunder Bay market the difference will be more dramatic given the fact that there are so few buyers for large buildings. Hence the smaller buildings sales (the "mom and pop" type) reveal cap rates from 8.36% to 10.44% while the larger ones (there was only one sale of a building as large as 49 units) would be 12.7%. 19 Mr. Morasutti pointed out that a potential purchaser examines not only the actual financial records of a property (to see revenue and expenses and vacancy rates) but also looks at such external factors as the CMHC apartment vacancy rates for the municipality and the sales of other apartment buildings, in order to "normalize" the net operating income stream to be expected from the investment. It is this type of analysis that permits the potential investor to derive a capitalization rate with which to calculate a reliable purchase price. 20 Mr. Morassutti gave a reductio ad absurdum example to reveal what he called a major flaw in the GIM method, (which uses the gross potential income to calculate market value) by reference to the property at 2623 East Arthur Street (Exhibit 2, Tab. C) The gross potential income is $126,192; assume the building is vacant and the GIM is The method shows that the market value is $925,000 notwithstanding the fact that it has no income at all. 22 Finally, Mr. Morassutti said that, on reflection he had decided that the two smallest Dawson apartments, Egan (11 units) and Victorian (18 units) would be purchased by a smaller buyer who would assume a lower repair, maintenance and wages expense than has been experienced by Dawson and would therefore pay a higher price. Thus, he said, the value of these two units would be higher. 23 Mr. Morassutti was engaged only to prepare his opinion of the appropriate capitalization rates, not to prepare the building values. 24 The next witness called by the complainant was Mr. Terry Bishop, who is both a member of the Institute of Municipal Assessors (MIMA) and a Professional Land Economist. He had been retained by Dawson's counsel to review Mr. Morassutti's calculations of the appropriate cap rates to be used to value each of Dawson's buildings and also to review the normalized levels of operating expenses and normalized net operating incomes for those buildings prepared by Mr. LeBlanc. He accepted all of those figures and using them, calculated what in his opinion were the current value assessments for the 1996 and 1999 base years for each of the Dawson buildings. 25 He said that the Gross Income Multiplier method of assessing apartment buildings could be a useful tool if the operating expense ratios of the comparable sales were known and if they were similar to the property being assessed. Then his evidence was: This approach is often used as a "rule of thumb" in valuing smaller apartment buildings in which the owner typically occupies one unit or lives nearby and per-

9 Page 9 sonally manages and maintains the building. This self-management accounts for an uneven pattern of operating expenses and thus net income. 26 Mr. Bishop analysed the sales used by MPAC to develop the GIM's used to assess apartment buildings in Thunder Bay. His summary (See Exhibit 3 from pages 6 to 11) indicates that the sales of 26 apartment buildings were divided into four groups based on building age and number of units. As applied to the Dawson Buildings the summary is as follows with respect to the 1996 GIM's: 1. For buildings built in 1983 or thereafter and having 25 or more units there were no sales of comparable buildings. 2. For buildings built between 1976 and 1982 and having 25 or more units, there were no sales of comparable buildings. 3. For buildings built between 1940 and 1975 and having 25 or more units there were no sales of comparable buildings. 4. For buildings, built between 1940 and 1975 and having 17 to 24 units, there were two sales. (This applies to Dawson buildings, known as the Victorian and Clarkson Tower.) 5. For buildings built between 1940 and 1975 and having from 7 to 16 units, there were 10 sales used. (This applies to the Dawson building known as Egan Heights.) 27 Of the 13 Dawson buildings under appeal, all but three of them have 25 units or more. Mr. Bishop also criticized the time adjustments, which MPAC did on its comparable sales (to bring them to the 1996 and 1999 base years). The sales used by MPAC occurred from 1990 to 1997 and MPAC assumed sales prices rose steadily from the date of sale to the date of value; Bishop disputed that saying that "Sale prices began to fall through 1995 and 1996." 28 In developing the 1999 based assessments, MPAC applied GIM's based on different criteria than building age and number of units. This time, MPAC looked at the quality of the building's location and maintenance. (In this connection, see the Report to City Council in Exhibit 1, Page 2 of 6 - dealing with the re-assessments based on 1999 base year) Multi-residential properties increased in value primarily because of changes in the method used to value the properties. The primary change that took place was removal of an adjustment for age and number of units. This was replaced by a location and maintenance adjustment factor. 29 This by itself may mean little, since it could be that in earlier years the Dawson buildings were under-assessed. But it is of interest in that the average age of the Dawson buildings is 30 years; they were built between 1962 and All the witnesses called for the complainant stressed that older buildings such as these have high maintenance and renovation expenses. 30 The result of this change in method was that the assessor had no sales of comparable buildings with which to compare Dawson walk-up and high-rise buildings of average location and both average and well maintained. There were six sales to compare to Dawson buildings with average location and maintenance. In fact there were no sales of high-rise buildings at all. The six sales were used by the assessor to develop a GIM of 5.40; but none of the sales had more than 12 units, while all but one of the Dawson buildings have more than 12 units and most have more than 40 units.

10 Page Mr. Bishop's evidence was that of the six sales, three occurred outside the shoulder years and base year and no attempt was made to time adjust the sales; given a declining market for multiresidential property he said that a time adjustment would indicate a lower GIM. Mr. Bishop further criticized the change in method by saying that "grouping the GIM's exclusively by quality of location and maintenance places too much weight on these factors which, due to the forces of the rental market, will already be accounted for in the rents the property is able to achieve and ignores the impact of operating expense on value." 32 Mr. David Fedoruk is a graduate of the University of Manitoba with a B.A. in Economics and an associate member designation from the Institute of Municipal Assessors (AIMA). He is a senior assessor in the Thunder Bay, Kenora, Dryden and Fort Frances region responsible for the assessment of all multi-residential properties. Mr. Fedoruk was called as a witness for MPAC to explain how the Gross Income Multipliers (GIM) used for the 1996 and 1999 base years were developed and how the Dawson buildings were assessed for the taxation years 1998 through He developed the 1996 GIM's by investigating all 1990 to 1997 sales of multi-residential property, analysing their Gross Annual Income (GAI) based on the Typical Actual Rents (the median rents) (TAR). After those calculations, the indicated GIM was prepared by dividing the sale price for each building by the GAI. Where there were multiple sales of a property a time adjustment factor was established to provide adjusted sale prices to June 30, 1996 and the adjusted sale prices were divided by the 1996 TAR to establish a current market GIM. As a result of a review of all the GIM's, MPAC concluded that groupings of the GIM's should be made according to the age and number of units in the building. 33 Next, all multi-residential properties were valued by applying the appropriate GIM to the Potential Annual Gross Income of each building based on its TAR according to the formula: CVA = GIM x PGAI +other income (where applicable). 34 The GIM and TAR for the 1999 base year were developed by an investigation of all 1996 to 1999 sales of multi-residential properties in Thunder Bay. Again, GAI's were calculated based on TAR's for each type of suite (bachelor, one bedroom, etc.) for each sold property (and other income such as laundry revenue was added) Again, the sale price of each property was divided by the GAI at the time of sale to arrive at the GIM. This time, however MPAC concluded that groupings of the GIM's were required according to the location and condition of the buildings. 35 The CVA's of all multi-residential properties were obtained using the same formula as for the 1996 base year. The complex calculations involved in all this are set out in Exhibits 7n, 7o, 7p, 7q - Addendum 1 (1996 base year) (2 volumes) Addendum 2 (1999 base year) plus Addenda 3 and In the case of the Dawson properties, Mr. Fedoruk prepared a separate assessment report for each of the 13 properties (Exhibits 7a to 7m). These reports show a photograph of the building, its geographic location and the methodology involved in preparation of the CVA's (Current Value Assessment) for each base year. At the hearing MPAC recommended reductions in the assessments of five buildings for the 1996 base year and of 10 buildings for the 1999 base year (see Exhibit 6a). Exhibits 6 and 6a show the MPAC CVA's and the assessments recommended by Mr. Bishop and the difference in dollars between those different recommendations. Except in the case of one property in the 1996 base year, Mr. Bishop in each case recommends major reductions, ranging from nearly $50,000 to over 2 million dollars.

11 Page It is obvious from the evidence that Mr. Fedoruk and his colleagues have done a lot of work to arrive at their assessments. All the sold properties were investigated, as were all Dawson properties. Questionnaires were sent to apartment building owners and then analyzed. The question is whether that work produced appropriate assessments or whether work done by the complainant's experts produced the better result. The Board is satisfied that all of the witnesses were highly qualified to give the evidence each of them did give. Thus, as suggested by Mr. Jamieson at the opening, the Board is required to decide which methodology is the better, the GIM or the direct capitalization rate applied to the NOI. 38 The Board is satisfied that larger multi-residential buildings are purchased for the net income stream they can be expected to produce. Thus, except in the case of purchasers of "mom and pop" buildings having fewer units (say, less than 25 units), the market of willing vendors and willing purchasers relies almost solely on the direct capitalization rate to value the property. The Board recognizes that MPAC was faced in 1997 with the task of re-assessing an enormous number of properties and concluded that in the case of multi-residential properties, it should use the GIM method. But in the case of other income-producing commercial properties, the direct capitalization method is used by MPAC. Except as to its applicability in the case of smaller unit buildings, all of the complainant's witnesses referred to the GIM method as a "rule of thumb". Interestingly, that expression was used in a report prepared for MPAC by Lincoln North and Company Limited (Exhibit 22). The letter of transmittal of that Report said: With respect to apartment buildings, our instructions were to establish benchmarks for gross income multipliers, being the earnings ratio to be used by the Ministry in valuing residential properties. From our experience in valuing this type of property we have found that the market tends to use capitalization rates to establish value, whereas gross income multipliers are more than anything, just a derivative of these rates, and except in the case of smaller buildings, tend to be used only as a rule of thumb. 39 Exhibit 22 also cautions about the difficulties in using GIM's in the assessment of apartment buildings, mainly because of the differences in the income characteristics of the properties being considered. It gave as an example two adjacent buildings identical in every respect except the way in which utilities are paid. In the example given, the tenants in each building paid the same costs and the landlord achieved the same net income, yet while the overall cap. rates were identical, the GIM's were respectively 6.67 and The Board recognizes that MPAC tried to overcome this inherent weakness, by taking into account whether, for example, the building was a "hot" rent or "cold" rent building. Yet the problem remained that most of the Dawson buildings were older ones, (with higher maintenance costs) and larger ones generally than the "comparable" sold properties used to derive the GIM. 40 If it is conceded that use of the GIM method of valuation is, roughly, useful to value smaller buildings, what of the argument that it should be used to value all of Dawson's buildings, three of which have less than 25 units. In addition, Mr. Jamieson submitted that it would be unfair to the "Moms and Pops" smaller buildings, which did not record all their expenses, to have a higher assessment than larger professionally managed buildings that record all their expenses. He pointed to subsection 44(2) of the Assessment Act, which provides:

12 Page 12 44(2) Reference to similar lands in vicinity. - In determining the value at which any land shall be assessed, reference shall be had to the value at which similar lands in the vicinity are assessed. 41 In the Board's view, there are two answers to this submission. First, on the evidence it is clear that in Thunder Bay, there are two quite different markets for apartment building sales; smaller buildings sell fairly readily to the kind of investors available in Thunder Bay, whereas larger buildings are very difficult to sell. It follows that large multi-residential buildings are not "similar lands in the vicinity" to the small buildings. Second, subsection 19(1) of the Act must be applied: 19(1) Assessment based on current value. - The assessment of land shall be based on its current value or average current value, as determined under section In this Act "current value" means: "current value" means, in relation to land, the amount of money the fee simple, if unencumbered, would realize if sold at arm's length by a willing seller to a willing buyer. 43 The Board is of the view that the inherent tension between subsection 19(1) and subsection 44(2) should be resolved in this way: All taxpayers are entitled to have their property assessed at its current value. This is the fundamental right contained in the Act. If, after the mandatory "shall" obligation in subsection 44(2) has been carried out, it appears that "similar lands in the vicinity" have a lower level of assessment, the taxpayer is entitled to have its assessment reduced to that lower level. The reason for this entitlement is that the Assessment Act first gives the right to be assessed at current or market value and in addition subsection 44(2), now with its mandatory language, entitles the taxpayer to be assessed equitably with other taxpayers. But the converse is not true; the primary right is contained in section 19. While it is true that it may also be inequitable if the other "similar lands in the vicinity" are assessed higher than their current values the answer is that the Board cannot resolve an inequity unless an appeal is brought before it. 44 In view of Mr. Morasutti's comment that the two smallest buildings would be purchased by a "smaller buyer" who would assume lower expenses, the Egan and Victorian buildings should be assessed as recommended by MPAC. As to the remaining 11 Dawson properties, the Board orders that their assessments should be changed to the amounts found in the Derbyshire column in Exhibit 6a; for the years 1998, 1999 and 2000 based on 1996 base year, and for 2001 and 2002 based on 1999 base year. [Quicklaw note: Schedule A, Assessment Rolls, could not be reproduced online. Please contact Quicklaw Customer Service at or service@quicklaw.com to request the following document: 03oarb131 Schedule A.pdf] qp/e/nc/qlcct