Appraisal Matters

Continuing from Part 1, we have five more secrets to regional mall tax appeals.

Rule # 6 - Welcome to the World of Investment Grade Real Estate

Sure, the first tier regional and super-regional malls are the prize of REITs.  However, when you look at the ownership of second and third tier regional malls, something stands outs.  They are rarely owned by the major real estate players, REITs included.  Doesn’t it make sense that if the owners are not the investment grade players that the real estate is not investment grade?  Not much of a stretch there.

But don’t tell the Assessors.  They always quote the Korpacz Real Estate Investment Survey for their cap rates.  There are three problems with this:

1. The investment grade real estate is of a higher caliber or market tier than a second or third tier mall.  It’s like comparing a Mercedes to the Ford.  The anchor tenants have the top credit ratings, they have far more national retailers and both the condition and design are visually superior.
2. It is a national-level survey, so how does the investor in, say, Dallas or Chicago who wants a 7 percent cap rate have any bearing on a Maryland second or third tier regional mall?
3. This survey is based on investment grade investor expectations.  If expectations mostly matched reality, we wouldn’t be in a recession, would we?  The results of this survey have to take a back seat to real, market derive cap rates that are both local in nature and based on the same tier of investment.

Rule # 7 - Sales Are Like Toys To Be Played With

So regional malls are bought and sold based on their income and market value is predicated on the income approach.  What have sales got to do with it?  Technically, they help us form a mental picture of comparability as well as providing a basis for comparison on a price per square foot basis.  That’s where the comparison should end, but it doesn’t.

Price per square foot can easily be manipulated up and down by unsupported adjustments.  Mall A is physically inferior to our mall, so we adjust it upward match what we’re appraising, and Mall B is physically superior, so we adjust it downward.   What’s wrong with that?  Simply that if buyers and sellers are deriving a transactional price based on net income, should there not be be some way to adjust sales for net income?  That’s a big no-no because you’re now mixing valuation techniques and you compromise the integrity of the approach.  So instead, adjustments are made based on physical characteristics, condition, land size, traffic volume, etc., when in reality these characteristics take a distant second place to net income.  The more time you talk about sales, the less time you have to make arguments about the income approach.

Rule # 8 - The Joke Behind the Cost Approach

We all know that assessments break out the value of the land from the improvements.  Many of these assessments are based on the cost approach.  This is a joke because the cost approach assumes that you can build an improvement profitably.  The investment must be profitable because entrepreneurial profit is included.  The theory goes that the developer would not bother to invest his/her time and effort building an improvement without making some profit.  How many regional and super-regional malls are under construction right now?  How many are still going through the approval process?  Seems to me that developers don’t see it as profitable, otherwise they wouldn’t build it.  Seems to me that the publicly traded REITs that develop real estate are more concerned with their stock price than sticking one more shovel into the ground.

There are lot of other reasons why the cost approach is not a reliable market value indicator, but the argument above is the most damaging in this current recession.

Rule # 9 - The Business Value Paradox

To say separating going-concern (business) value from real estate is difficult is an understatement.  Articles have been written on how to do it, but for the most part it’s nebulous not just for an appraiser but also for judges.  Theory has a way of colliding with cold, hard facts and it’s highly improbable that all the right variables will be in place to create a defensible separation that will stand up under the pressure of a talented opposing counsel.

I’m not saying it’s impossible (perhaps others have been so fortunate).  What I feel is the much better approach for the property owners, tax consultants or attorneys that hire us is that it muddies the water.  It detracts too much from the core issues that decide market value.  What is a better use of our client’s time - taking two days to prepare a business value separation that amounts to 2 to 5 percent of total market value in most cases or two days gathering data on the assessor’s sales or bulletproofing the appraisal arguments.  What is a better use - business value or taking the time to craft convincing arguments, creating relevant graphics and statistics or interviewing market participants for support?  The assessor won’t separate business and real estate; why be on an island?

Rule # 10 - Tell Them, Tell Them What You Told Them and Tell Them Again

You can probably guess from the prior rule that I have an opinion on presentation.  I won’t go off on any tangents.  What is relevant about the title above is you need to get your key points across.  You need to put them everywhere they need to be seen.  Use boldface, italics, both or whatever.

In one of my early blog posts on this site, I mentioned that the human mind is capable of processing only seven variables at a time, plus or minus one or two.  This theory was created way back in 1956 by George A. Miller.  That’s what a report must focus on - those 7 +/- points that make an appraiser’s market value conclusion stick (defensible) and that tell the story the mall has to tell.

It must be the truth.  A skewed argument is a losing argument.  Don’t waste the judge’s, assessor’s, attorney’s or clients time with anything that doesn’t tell the story in 7 +/- points or less.

Conclusion

Crafting a winning regional mall tax appeal is not hard as long as you follow these “rules” and the property has legitimate, supportable reasons for the market value being less than the assessment.

John Simpson, MAI