Association of County Commissions of Alabama HOLDING ON TO AD VALOREM REVENUE 12/3/15 Kendrick E. Webb Webb & Eley, P.C. Post Office Box 240909 Montgomery,

Association of County Commissions of Alabama

HOLDING ON TO AD VALOREM REVENUE

12/3/15Kendrick E. Webb

Webb & Eley, P.C.

Post Office Box 240909

Montgomery, Alabama 36124

Telephone: (334) 262-1850

[email protected]

mailto:[email protected]

Ad Valorem Revenue Under Attack: Dark Store Theory

Nationally, retailers such as Lowe’s, CVS, Target, and others are attempting to lower the amount of property taxes they pay by challenging the valuations of their stores based on what is known as the Dark Store Theory. The Dark Store Theory gets its name because it

essentially promotes valuing a store as if it were completely empty.

Taxpayer’s expert: David Lennhoff – the nation’s leading proponent of the Dark Store Theory.

Mr. Lennhoff has been employed by Lowe’s as an expert witness in its Dark Store appraisal challenges in Alabama, and is very influential in pushing this theory in the appraisal community.

Lowe’s Tax Cases Lowe’s Home Improvement has filed

close to forty Notices of Appeal in roughly twenty counties regarding their property tax valuations. The earliest cases are set for trial at the

beginning of next year. The valuations are appealed from decisions

of the County Boards of Equalization and are set to be considered in each county’s respective circuit courts.

Dark Store Theory The Dark Store Theory asserts that big-box retail

stores are specially built for the merchants who occupy them.

A Lowe’s store is built and designed specifically to be a Lowe’s; a Best Buy is built and designed specifically to be a Best Buy; a Circuit City is built and designed specifically to be a Circuit City, etc.

This specificity means that the stores contain features that limit or reduce their value on the resale market because the next owner will have to spend money on major redesigns to make the store fit their needs and brand.

Dark Store Theory These supposed valueless features are

categorized as functional obsolescence because they are characteristics of the property that, allegedly, no one but the current owner will pay for.

Dark Store Theory proponents contend that a store’s value should only be measured by what it is worth on the secondary market to the merchant who buys the store after the first user moves out. However, big box stores often insert deed

restrictions that prohibit the property’s sale to competing big box merchants.

A Serious Threat to County Budgets

The real danger of the Dark Store Theory is that when one store is successful at having their property taxes reduced, other stores will follow in the same action. The domino effect will greatly reduce

funding for county services and schools. If it is used successfully by businesses

currently operating, it will mean millions of dollars in losses to a county budget.

A Serious Threat to County Budgets

Michigan communities have lost $74 million in the last two years because of Dark Store litigation according to the Michigan Association of County Treasurers.

Indiana ad valorem revenue losses were estimated recently to be $120 million if Dark Store appraisal became the norm.

A Tale of Two Counties The Dark Store Theory has already

had success in other states and is becoming more accepted at The Appraisal Institute and in appraisal circles. Florida, Indiana, Michigan, Ohio, and

Oregon are among the states that have litigated these suits.

Their cases show that counties prepared with their own experts and explanations of appraisal theory are much more likely to see their valuations upheld.

A Tale of Two Counties(Ohio)

Target v. Green County Board of Revision Target challenged the valuation of one

of its stores using Dark Store Theory arguments of sales comparison approach and functional obsolescence.

The county failed to provide the Board of Tax Appeals with any evidence or rationale to support its valuation, instead relying on its initial assessment as a prima facia case.


Target v. Greene County Bd. of Revision The Ohio Supreme Court noted that,

without any controverting evidence from the county, it was left to solely decide the case with Target’s data regarding values of second generation stores and functional obsolescence.

Therefore, the court ruled against the county.


Meijer Stores v. Franklin County Board of Revision Approximately one month later, another

retailer challenged its tax appraisal in another Ohio county using the same expert appraiser and the same methodology as Target did in Greene County.

The Ohio Supreme Court heard this case as well.


Meijer Stores v. Franklin County Board of Revision This time, however, the county was

prepared with its own expert appraiser and methodology.

The Board of Tax Appeals found that there was substantial evidence against heavily reducing the valuation for obsolescence.

The store had nearly-new improvements and was in a flourishing area.


Meijer Stores v. Franklin County Board of Revision The Ohio Supreme Court on appeal held

that the fact-finding court below weighed two opposing appraisals and chose the one it found more convincing.

The court also noted that a retail store could fall under the “Special Purpose Property Doctrine” which recognizes the best use of a property specially built is that unique, present use.

Dark Store Theory in Indiana

Meijer Stores v. Smith Meijer Stores challenged the valuation of

one of its stores in Indiana in 2010. Meijer’s used an expert with MAI

designation who compared the profitable Meijer store with stores that were vacant and abandoned.


Meijer Stores . Smith The county, in turn, presented no

evidence to refute the expert’s testimony and solicited no testimony on cross examination as to other sales.

The county simply argued that a 65% adjustment for obsolescence was improper on its face.


Meijer Stores v. Smith The Tax Court on appeal held for the

retailer reasoning that the county “needed to present some other market-based evidence that impeached Meijer’s appraisal and supported its own assessment.”

The court rejected the facial argument of the county, finding that there was no per se relationship between a store’s age and its obsolescence.

Dark Store Theory in Oregon

Lowe’s v. Linn County Assessor Lowe’s appealed the valuation of a

distribution warehouse. Lowe’s expert relied on the sales

comparison approach but relied only on comparable sales east of the Rocky Mountains.

Lennhoff has encouraged the use of a national market for comparable sales.


Lowe’s v. Linn County Assessor The County used its own appraiser but

also brought in an expert appraiser to testify.

The second appraiser used both the cost approach and sales comparison approach, finding their resulting values very similar.

The county used similar buildings sold in California on a leased fee basis as its comparable.


Lowe’s v. Linn County Assessor The court found many problems with the

Lowe’s appraiser, some of which were brought out by the county’s expert

The court took issue with Lowe’s appraiser looking outside the region and failing to make adjustments for location and age.

The court found the cost approach appropriate since the property was in the first tenth of its expected life.

Michigan – Fertile Ground for Dark Store Theory

Lowe’s Home Center v. Township of Marquette Both Lowe’s and Home Depot

challenged the valuations of two of their stores in the Upper Peninsula of Michigan.

The court held for the stores, relying on Michigan statutory language and case law that is very unfavorable for counties.


Lowe’s Home Center v. Township of Marquette The court found that the Michigan

Supreme Court had previously held that the state constitution and the General Property Tax Act require property be based on market value, and could not consider value to the current owner.


Lowe’s Home Center v. Township of Marquette The court also relied on previous case

law in finding that whether the owner actually intends to sell is irrelevant in determining the value of the store.

The usual selling price that would be accepted by “a willing seller” does not assume that the operating business would remain in business.

Highest and Best Use: a pivotal question

Courts will first determine the highest and best use of a property before determining its market value. Highest and Best Use (HBU) is the

reasonably probable use of property that results in the highest value.

To be reasonably probable a use must be physically possible, legally permissible, financially feasible, and finally, economically productive.

Highest and Best Use: a pivotal question

Determining the HBU of the subject property determines what types of other properties you can compare it to in order to determine market value. Dark Store theorists want to define HBU

broadly (general commercial property) because it broadens the pool of depreciated stores they can use as comparables.

HBU also determines what in a store can be considered functionally obsolete.

Dark Store’s Defeat in Florida

CVS v. Hillsborough County, FL CVS employed David Lennhoff as an

expert witness in its challenge to the valuation of approximately 40 stores in Florida.

CVS sought to have the drug stores “highest and best use” classified as general commercial property arguing that the stores were designed as drug stores and, thus, suffered from functional obsolescence.


CVS v. Hillsborough County, FL The county’s expert argued that the

highest and best use of drug stores, was their present use - drug stores.

The county’s expert also noted that the stores contained restrictive covenants placed on them by CVS preventing their future use as drug stores.


CVS v. Hillsborough County, FL The court sided with the county finding

that general commercial property was too broad of a category and led to comparisons with other properties that were dissimilar in use and market demand.

The court also noted that CVS only advocated the general commercial property classification when it was financially advantageous.

Dark Store’s Defeat in Florida CVS v. Hillsborough County, FL

The court noted that Florida statutory law required that the present use of the property be considered in its determination of highest and best use.

Florida case law discussed the importance of considering present use because “it keeps the highest and best use determination grounded in reality, as opposed to conjecture of potential future uses.” (emphasis added)

Solutions:Legislative

Indiana passed legislation addressing, in part, the Dark Store Theory. Legislation passed in May 2015 mandating

the cost approach for buildings less than ten years old.

This legislation also requires comparable sales include properties that have been on the market for less than a year, that are used for similar purposes, and must be absent substantial deed restrictions.

Solutions:Legislative

Florida already has a favorable statute addressing Dark Store Theory. As mentioned, Florida law requires

appraisers consider “present use” of the property when determining highest and best use.

This language was pivotal in a decision that prevented counties from having to refund tax revenue on approximately 40 stores.

Solutions:Rulemaking Authority

The Department of Revenue may be able to issue regulations/rules to require the cost approach for certain types of properties or in certain situations and to require commercial property to be valued at its present use.

DOR is presently considering amending the Appraisal Manual to provide stricter guidance regarding how property is assessed.

Solutions:Rulemaking Authority

Iowa courts have rejected Dark Store challenges after finding that Iowa regulations require property to be valued based on its present use.

Wisconsin courts have also rejected Dark Store challenges based on language in their appraisal manual that defines HBU as that which produces the greatest net return to the property owner.

Alabama Efforts Underway:Coordination of Litigation

1. DOR and ACCA are organizing a state-wide coordination of defenses of tax appeals.

2. Coordinating includes efforts to develop legal issues to raise. Issues include uniformity of assessments,

timeliness or prerequisites for appeal, related and relevant Alabama case law, and appropriate standard of review.


3. Coordination of Discovery. Preparing standardized discovery

requests. Sharing information obtained in the

discovery process: depositions, interrogatories, documents.


4. Retaining Expert Witnesses. To counter Lennhoff, the Department of

Revenue has contracted with Mark Kenney on behalf of the Counties.

Kenney is President of American Valuation Group, has MAI and SRPA designations and has given expert testimony, published articles, and given lectures on property tax valuation.

Counties will also need an Alabama appraiser with MAI designation to assess the subject properties and provide testimony.

Conclusion The domino effect that results from losing

an ad valorem tax appeal case has brought major losses in other states. Counties that present thorough defenses

utilizing expert testimony are much more likely to have their valuations upheld.

Therefore, coordination is continuing to present comprehensive defenses to valuation challenges brought under the Dark Store Theory.

Documents

Association of County Commissions of Alabama HOLDING ON TO AD VALOREM REVENUE 12/3/15 Kendrick E. Webb Webb & Eley, P.C. Post Office Box 240909 Montgomery,