Appraisal Matters

We’ve all gone to many regional malls in our lifetimes.  They don’t appear to be mysterious or difficult to comprehend.  There are lots of articles about them and malls are always in the news somewhere.  The income and expense statements are made available to Assessors and market value is all based on the income approach.  So when it comes to figuring out market value, there’s nothing mysterious about it, right?  You’d be amazed.

Rule # 1 - One Person’s Gold is Another Person’s Pyrite

Like most people, Assessors view regional malls as prized real estate investments.  For first-tier super-regional malls, that holds true.  Just look at who owns them - REITs (real estate investment trusts).  They only buy the best tenanted investment grade real estate.  But for second and third tier regional malls (the majority in this country), the shine of gold is just an overly bright reflection.

Second and third tier regional malls are subject to the same swings in the economy as other forms or real estate.  This is a fact that is frequently overlooked by Assessors.  For these properties, today’s tenant is tomorrow’s vacant tenant or else tomorrow’s renegotiated rent tenant.  Sudden changes in income for a large number of tenants and increased vacancies are not considered in assessments to the degree they should.

Rule # 2 - Each Mall Has a Story to Tell

When it comes time for a tax appeal, a regional mall takes on a character all its own.  Each mall has a story to tell and you’ll never hear the same story twice.  As discussed in detail in my Older Regional Mall “Catch 22″ Situation blog, viewing a mall as fully competitive when it is not financially feasible to renovate it creates a perception problem.  Physical problems can result in above-market operating expenses and permanent problems such as traffic congestion can limit a mall’s drawing power.  What you will find, however, is that management has tried everything possible to keep expenses down and attract new tenants, but through no fault of their own, the economy simply prevents retailers from spending precious cash flow on new stores.  This is the story that begs to be told and seldom is it factored into an assessment.

Rule # 3 - The Devil is in the Details

Let’s have some fun and break a whole bunch of rules at once!  Rents don’t always increase by the consumer price index during a recession even when the lease says it will.  Sometimes tenants go bankrupt or leave, spurring costly and time consuming litigation.  Utility costs seem to increase at a pace that is hard to accurately predict in a computer assisted mass appraisal assessment model.  That new “temporary” tenant isn’t really leasing space… they’re on a license agreement and can leave anytime.  Suddenly a “Rent Relief” line item shows up on the current financial statement (rent relief is when a landlord collects partial or no rent from a tenant and still lets them occupy the space, hoping things will turn around for them).  I could probably do this all day; the point is financial statements can change substantially from one year to the next - just like the economy.  Therein lies the crux of the plaintiff’s tax appeal case.

Rule # 4 - Let’s Get This Size Thing Straight

Building size for a regional mall is everywhere.  It’s reported on building plans, marketing brochures, surveys, site plans, broker listing sites, the mall’s website and databases such as that put together by the International Council of Shopping Centers.  Given this list, what are the odds that all of these sources will report the same gross building area?  How about net rentable area?  It would be great if they all went to the most accurate source - the “as built” plans, but, alas, that seems never to be the case.

It should come as no surprise that the size that is shown on the assessment can vary from what the owner or manager has in his/her files.  To complicate things further, if you add up the net rentable area for each tenant according to the lease and the net rentable area of any vacancies, you can often find a large discrepancy with that reported by the assessor!

Most jurisdictions have rules on the books to handle “clerical” errors like this one.  This is easy pickings for a tax appeal.  It’s an easy tax appeal refund.  What is not so clear is how many years back the plaintiff can go to get a refund.  I’ve seen three years and I’ve seen ten.  It varies by jurisdiction.  No matter how long, it’s a ton of money for the type of due diligence we do every day.

Rule # 5 - The Market Versus The Court

There are two types of income approach techniques - direct capitalization and discounted cash flow (DCF).  Courts want to see one year’s income modeled via direct capitalization.  The market usually wants 5 to 10 years worth of future income modeled via DCF.  Never the two shall meet.

This creates the quandary where the actions, thinking, motivation and behaviour of the market is contrary to the way presented in court.  This is not a problem for most property types, but it is for a regional mall.  As discussed in Rule # 3, lots of things on an annual financial statement can change.  Over a 5 to 10 year DCF projection period, they can be “leveled out”, but not so in a single year’s projection.  Advantage goes to the  property owner.

Another aspect of this is the capitalization rate (cap rate).  This is a number that converts income into value.  Last year’s cap rate can be just a useful as last year’s newspaper.  This is what an Assessor will rely on, yet it may not reflect the simple realities of the current market.  Let’s take now versus a year or two ago.  With the credit crunch, how much financing is available for real estate?  Not a whole lot from a bank partially or wholly taken over by the Federal Government or another major bank for pennies on the dollar, that’s for sure.  What’s happened to the stocks of most of the retailers in the malls?  And so it goes.  Advantage goes to the property owner… again.

Rules 6 through 10 are just a hyperlink away.

John Simpson, MAI