PROTECTING FEE SIMPLE VALUE FROM A LEASED FEE ANALYSIS: WHY YOUR PROPERTY MAY BE NEXT Adam C. Strasser, Esq. Senior Tax Manager Walgreens Deerfield, IL adam.strasser@walgreens.com Anthony Barna, MAI Appraiser Kelly, Rielly, Nell, Barna Associates Pittsburgh, PA tony@krnbvaluation.com J. Kieran Jennings, Esq. Partner Siegel Jennings Co., L.P.A. Cleveland, OH kjennings@siegeltax.com
What s the problem? Assessor s are using triple net, leased-fee sales to justify real estate assessment increases of 100-200%. Why now? THE PROBLEM Property taxes are, on average, 74% of local tax collections, nationally. Dadayan, Lucy. "The Impact of the Great Recession on Local Property Taxes." ROCKEFELLER INSTITUTE BRIEF (2012): 1-13. Web. 4 Sept. 2014. The Great Recession caused a decline in property tax assessments and collections. Id. Assessments have lagged behind the decline in market values by 2-3 years. Id.
THE PROBLEM Source: Lucy Dadayan, The Impact of the Great Recession on Local Property Taxes (Albany, NY: The Nelson A. Rockefeller Institute of Government, July 2012)
Why now? (continued) THE PROBLEM As of Q1 2014, property taxes had seven consecutive quarters of growth. Dadayan, Lucy, and Donald J. Boyd. "After Four Years of Uninterrupted Growth, Tax Revenues Decline in the First Quarter: Preliminary Figures for the Second Quarter of 2014 Signal Further Declines in Personal Income Tax." STATE REVENUE REPORT (2014): 1-25. The Nelson A. Rockefeller Institute of Government. The Nelson A. Rockefeller Institute of Government. Web. 4 Sept. 2014. BUT in Q1 2014 states also reported the first decline in overall tax collections since 2009. Id. Enter the net lease retail investment boom Cap rates in the net lease retail sector hit a historic low of 6.5% in Q2 2014. Feeney, John. "THE NET LEASE MARKET REPORT, Q2 2014." Net Lease Market Report (2014): 1-3. The Boulder Group. The Boulder Group. Web. 4 Sept. 2014. Published sales of triple-net leased properties at double or quadruple the FMV as assessed have proved too much temptation for assessors to resist, especially where the law surrounding fee simple value is unclear.
THE PROBLEM What are assessors looking at? Leased Fee Sales Credit Tenant Lease Financing: While traditional real estate loans are written against the value of the real estate, CTL financing emphasizes the credit quality of the tenant and the structure of the lease in order to establish the cost of borrowing. "CBRE United States - Commercial Real Estate Services." CBRE United States - Commercial Real Estate Services. CBRE United States - Commercial Real Estate Services, n.d. Web. 04 Sept. 2014. What s a credit tenant? Investment Grade Entities: Moody s Baa3 or S&P BBB-, Commercial Mortgage Advisors. "Credit Tenant Lease (CTL) Financing." Credit Tenant Lease (CTL) Financing (n.d.): 2-8. Web. 4 Sept. 2014. Letter updates of existing appraisal and environmental reports are acceptable. A structural report is not required. Id. CTL has no maximum Loan-to-Cost. "CBRE United States - Commercial Real Estate Services." CBRE United States - Commercial Real Estate Services. CBRE United States - Commercial Real Estate Services, n.d. Web. 04 Sept. 2014. CTL Financing is non-recourse lessee has payment and performance obligations. Id. The vast majority of the triple net lease retail property sales price is attributable to the leased fee, not the real estate.
THE PROBLEM What are assessors looking at? Special Build-to-suit Leases Developer finds the property and acquires the property: Assemblage of Parcels Business Buyouts and Relocations Demolition Reciprocal Easements and Lease Restrictions Develop the Site Build the Store Lease payments: All Land Acquisition Costs (above) Site Development Costs Any and all financial expenses Legal and architectural expenses PLUS Entrepreneurial Profit Rents are higher than market.
PROTECTING FEE SIMPLE VALUE FROM LEASED FEE ANALYSIS THE LAW: Kieran Jennings Partner Siegel Jennings Co., L.P.A. Cleveland, Ohio kjennings@siegeltax.com
A VARIETY OF LAWS Wisconsin Walgreens v. City of Madison Ohio Isssue: whether a property tax assessment of retail property leased at above market rent values should be based on market rents (as Walgreens argues) or if such assessments should be based on the above market rent terms of Walgreens' actual leases (as the City argues). Hin, L.L.C. v. Cuyahoga County Board of Revision Issue: Whether a lease encumbrance or appraisal evidence invalidates a sale where the law provides that the auditor shall consider the sale price of such tract, lot, or parcel to be the true value for taxation purposes. Pennsylvania Tech One Associates v. Board of Property Assessment, Appeals and Review of Allegheny County Issue: Whether in conducting this valuation [of the market value of the real estate as a whole], the impact of the lease on the market value of the real estate owned as the leased fee and, also, on the market value of the real estate owned as a leasehold interest must be considered.
WALGREENS V. MADISON Facts: Walgreens leases the subject property. In addition to lease payments, Walgreens is also responsible for paying the property taxes for those properties. The properties were constructed by a developer to suit Walgreens' needs As the circuit court described it, the rent in the Walgreens leases is higher than normal in part because the developer is recovering his development costs on a building that contains the superadequacies demanded by Walgreens.
Holding: WALGREENS V. MADISON Wis. Stat. 70.32(1) requires an assessor valuing leased real property to estimate the value of a fee simple interest in the leased property. The Court quoted the appraisal of real estate stating "[a] lease never increases the market value of real property rights to the fee simple estate."
HIN, L.L.C. v. Cuyahoga County Board of Revision Facts: A single tenant office building was the subject of two sales within 5 months of each other. Sale one was negotiated prior to a lease being established. Sale two was purchased based on the lease in place with an above market tenant.
HIN, L.L.C. V. CUYAHOGA COUNTY BOARD OF REVISION Holding: Sale price is presumed to establish value Lease encumbrance or appraisal evidence does not invalidate sale price. Dissent: Fortunately, based on recent changes to the statutory scheme, entities involved in the valuation of real estate for taxation purposes, including this court, will be required to adopt a more nuanced approach. New Statute: R.C. 5713.03 requires county auditors to determine the true value of the fee simple estate, as if unencumbered and allows, but does not require, county auditors to consider a recent arm s-length transaction as the true value for taxation purposes.
Tech One Associates v. Board of Property Assessment, Appeals and Review of Allegheny County Facts: Century Square Shopping Center 50 acres of land 50 years Annual rent flat for entire term Subsequent to lease 415,000 square feet shopping center, constructed
TECH ONE ASSOCIATES V. BOARD OF PROPERTY ASSESSMENT, APPEALS AND REVIEW OF ALLEGHENY COUNTY Holding: Leased fee + Lease Hold to be valued the value of the real estate owned as the leased fee, alone, was not determinative of the value of the entire tax parcel in this matter, which consisted of all of the real estate owned as the leased fee and leasehold interests.
WHERE DO WE GO FROM HERE? Advance case law where courts are ameanable Advance statutory law where the legislative branch seeks fairness Taxpayers do not need to win to advance good law. Where there is uniformity and equal treatment taxpayers win.
PROTECTING FEE SIMPLE VALUE FROM LEASED FEE ANALYSIS THE SOLUTION Anthony C. Barna, MAI, SRA Kelly Rielly Nell Barna Associates 3535 Boulevard of the Allies Pittsburgh, Pennsylvania 15213 T 412-683-2212 tony@krnbvaluation.com
FEE SIMPLE VS. LEASED FEE Fee simple absolute ownership; entire bundle of rights. Leased fee possessory interest granted to another party.
MARKET VALUE VS. USE VALUE Market value exposed in a competitive market. Use value specific use.
THE DISTINCTION For tax assessment we seek - Market value of the fee simple interest in real property. But we re confronted with - Use value of the leased fee interest in a build to suit property.
CLARIFICATION Use value of the leased fee interest in a build to suit property is NOT market value NOT fee simple NOT only real property Tangible assets + Intangible assets A lease never increases the market value of real property rights to the fee simple estate. The Appraisal of Real Estate 13 th Edition, Page 447
THE SOLUTION Consistency and adherence to the fee simple property rights is the key. Cost Approach depreciation is critical Income Approach fee simple ingredients are necessary Sales Comparison Approach comparables must reflect fee simple condition
COST APPROACH Cost new of improvements - Depreciation = Depreciated cost of improvements + Site value = Fee Simple Market Value Depreciation is the critical component Physical Functional External
MARKET EXTRACTION Market extraction will best quantify depreciation: Sale price $5,000,000 Site value - 1,000,000 Improvements $4,000,000 Cost new - 10,000,000 Depreciation ($) $6,000,000 Depreciation (%) $6M/$10M = 60% All Forms Age 10 years Depreciation 6.0%/year straight line
DRILL DOWN 6.0% straight line depreciation Is this the reality? What does it represent? All forms of depreciation Physical Functional External
REAL DATA Big Box Depreciation Extractions 100% 95% 90% Depreciation 85% 80% 75% 70% 65% 83% 71% 84% 80% 68% 84% 86% 82% 86% 88% 60% 59% 55% 50% 5 10 15 20 25 30 35 40 45 Property Age (Years)
INCOME APPROACH Gross Income -Vacancy =Effective Gross Income -Expenses =Net Income /Capitalization Rate =Fee Simple Market Value Market rent Stabilized or lease-up Usually NNN Extracted from sales
SALES COMPARISON APPROACH Fee simple comparables NOT sale leaseback comparables Sale leaseback are leased fee sales (w/tangible & intangible components) and a property rights adjustment is necessary The comparables must reflect fee simple conditions
THE TAKEAWAY Cost Approach Accurate depreciation Income Approach Proper ingredients Sales Comparison Approach Comparable comparables
THANK YOU! Adam C. Strasser, Esq. Senior Tax Manager Walgreens Deerfield, IL adam.strasser@walgreens.com J. Kieran Jennings, Esq. Partner Siegel Jennings Co., L.P.A. Cleveland, OH kjennings@siegeltax.com Anthony Barna, MAI Appraiser Kelly, Rielly, Nell, Barna Associates Pittsburgh, PA tony@krnbvaluation.com