Folsom v. Spokane County
| Decision Date | 02 October 1986 |
| Docket Number | No. 50579-9,50579-9 |
| Citation | 725 P.2d 987,106 Wn.2d 760 |
| Parties | Robert J. FOLSOM, as his sole and separate property; D.E. Belknap and Patricia Belknap, husband and wife; C.F. and Patricia MacNeill, husband and wife; R.W. and Sally Schmitz, husband and wife, W.A. Johnson, a single man, Respondents, v. COUNTY OF SPOKANE, Appellant, Spokane County Board of Equalization; Skip Chilbert, Spokane County Treasurer; and George Britton, Spokane County Assessor, Defendants. |
| Court | Washington Supreme Court |
Donald C. Brockett, Spokane County Prosecutor, Garald Gesinger, Deputy County Prosecutor, Spokane, for appellant.
Delay, Curran, Thompson & Pontarolo, Joseph
Delay, Spokane, for respondents.
This case raises the principal issue of whether, in capitalizing income for ad valorem property tax valuation, the taxing authority should capitalize actual rental income reserved in a long-term commercial lease if the existing fair market rate exceeds rent reserved. We hold that it should, but remand the case for additional proceedings consistent with this opinion.
Respondents (Owners) own land and buildings at North 6600 Division Street in Spokane, Washington. The Owners lease property to an anchor tenant, K-Mart, and several others. The parties only dispute the assessed valuation of the K-Mart property in this appeal.
The K-Mart lease commenced in 1966 and runs for 20 years, with three additional 5-year options on the same terms and conditions. The minimum annual rent reserved in the lease is $146,773, with an additional percentage rental of 1 percent over gross sales of $7,712,866. The Owners pay all taxes, insurance, maintenance and repairs, but are not responsible for the building interior.
For the assessment year 1982, the Spokane County property tax assessor valued the Owners' property at $3,148,500. The Owners' appraiser valued the property at $2,150,000. The assessor arrived at his valuation by capitalizing current fair market rent ("market rent") for similar property in the area. The Owners' appraiser arrived at his valuation by capitalizing rent reserved in the lease ("contract rent"). The discrepancy between their respective valuations is attributable to the difference between the contract rent reserved in the lease and the higher market rent for similar commercial property.
As a result of the assessor's appraisal, the assessor levied a real estate tax of $35,543.42, payable for the year 1983. The Owners paid the tax under protest and appealed to the Spokane County Board of Equalization for a tax reduction. After losing that appeal, the Owners appealed to the Washington State Board of Tax Appeals. The Board of Tax Appeals affirmed the decision of the Board of Equalization by final order.
Having perfected their right to de novo review in Superior Court, the Owners moved for summary judgment in Spokane County Superior Court. The Superior Court granted Owners' motion for summary judgment, holding that the assessor should value the Owners' property based upon contract income, and not upon market rent.
Accordingly, the trial court reversed the decisions of the Board of Equalization and the Board of Tax Appeals, ordered the assessor to assess the Owners' property at $2,150,000 for the year 1982, and granted judgment against Spokane County in the sum of $11,272, plus interest at 6 percent from the date of payment. Spokane County appealed the trial court's order, contending that the assessor properly valued Owners' property based upon fair market rent. The Washington State Board of Tax Appeals subsequently was dismissed as a party to the appeal.
Initially, we note that the Owners do not contest the County's contention that a leasehold interest in real property constitutes real property that should be valued; that has long been the law of this state. See Trimble v. Seattle, 64 Wash. 102, 116 P. 647 (1911), aff'd, 231 U.S. 683, 34 S.Ct. 218, 58 L.Ed. 435 (1914). Instead, the Owners contest the County's position as to how the leasehold should be valued. 1
RCW 84.40.030 provides that "[a]ll property shall be valued at one hundred percent of its true and fair value in money ..." WAC 458-12-300 defines "true and fair value" as " 'market value' or [the] amount of money a buyer willing but not obligated to buy would pay for it to a seller willing but not obligated to sell." Accord, Duwamish Warehouse Co. v. Hoppe, 102 Wash.2d 249, 254, 684 P.2d 703 (1984) (citing Carkonen v. Williams, 76 Wash.2d 617, 458 P.2d 280 (1969)). In determining market value, the assessor must "consider only those factors which ... affect the price in negotiations between a willing purchaser and a willing seller ..." WAC 458-12-300.
In determining the market value of real property, the assessor may consider (1) comparable sales made within the past 5 years ("market approach"), (2) cost, cost less depreciation, or reconstruction costs less depreciation ("cost approach"), and (3) capitalization of income that would be derived from "prudent use" 2 of the property ("income approach"). WAC 458-12-301. The assessor is instructed to rely most heavily on the cost and income approaches in valuing properties of a "complex nature", or property not having a recorded sale within 5 years, and not having a significant number of sales of comparable property in the general area. WAC 458-12-301.
The property in this case constitutes retail space in a shopping center for which there are few comparable sales. Accordingly, the Owners and Spokane County correctly relied upon the capitalization of income method to value the property. See Merrick Holding Corp. v. Board of Assessors of Cy. of Nassau, 45 N.Y.2d 538, 410 N.Y.S.2d 565, 382 N.E.2d 1341 (1978); Caroldee Realty Corp. v. Board of Assessors of Cy. of Nassau, 73 Misc.2d 41, 340 N.Y.S.2d 774 (1972); Roosevelt Nassau Operating Corp. v. Board of Assessors of Cy. of Nassau, 68 Misc.2d 183, 326 N.Y.S.2d 628 (1970), aff'd, 41 App.Div.2d 647, 340 N.Y.S.2d 871 (1973). See ialso Ancel, Determining Fair Market Value of a Shopping Center for Purposes of Property Tax Assessment, 1965 U.Ill.L.F. 253, 254; Annot., Income or Rental Value as a Factor in Evaluation of Real Property for Purposes of Taxation, 96 A.L.R.2d 666 (1964). The issue is whether the assessor should have capitalized the Owners' contract rent or existing market rent for similar property. To put the issue in context, an understanding of the interests involved and the accepted method of valuing those interests is necessary.
An estimation of the value of property subject to a lease focuses upon two major interests: (1) the interest of the lessor who owns the fee, and (2) the interest of the lessee occupying the leasehold. Further analyzed, the lessor's fee interest consists of (a) the right to receive contract rent, (b) the right of reversion, and (c) any right he might have to improvements at the end of the lease. The lessee's leasehold interest consists of (a) the right to occupy the leasehold, (b) the right to the difference between contract rent and higher market rent, 3 and (c) any interest he might have in any improvements to the leasehold. Solis-Cohen, Jr., Appraisal of Leaseholds in Encyclopedia of Real Estate Appraising 465, 473, 476-77 (1959).
An interest in real estate is a capital good, and the owner frequently receives benefits from owning it over an extended period of time. Under the capitalization of income approach, the value of an interest in income-producing real estate is determined by calculating the "present value" of the anticipated income to the owner over a specified period. Present value is the sum that a prudent purchaser-investor would pay for the right to receive the forecast net income stream over the specified period. W. Kinnard, Jr., at 62. Although application varies, present value analysis applies equally to the lessor's reversion and right to improvements and the lessee's rental advantage and right to improvements.
The market value of property can be estimated by capitalizing net operating income based upon market rental for similar property with market-derived rates of discount. The present worth of the leased fee can be estimated by capitalizing net operating income based on contract rent with rates of discount derived from the lessor, a specific investor, or both. Valuing the leasehold is more difficult because there rarely is an active market in leasehold interests from which to abstract rate data. Accordingly, appraisers generally value a leasehold as the residual difference between the capitalized market value of the property and present worth of the leased fee. W. Kinnard, Jr., at 429-30.
Although there might be exceptions, the sum of the present value of the lessor's interest and the present value of the lessee's interest generally should approximate the present value of the fee simple, unencumbered by a lease. W. Kinnard, Jr., at 417. Accordingly, neither approach suggested by the parties to this appeal satisfactorily accounts for the value of K-Mart's interest in the leased property.
Existing case law from other jurisdictions clearly supports Spokane County's position that capitalization of fair market rent constitutes the proper method of valuation. People ex rel. Gale v. Tax Comm'n, 17 A.D.2d 225, 233 N.Y.S.2d 501 (1962); In re Pine Raleigh Corp., 258 N.C. 398, 128 S.E.2d 855 (1963); Crossroads Center, Inc. v. Commissioner of Taxation, 286 Minn. 440, 176 N.W.2d 530 (1970); Demoulas v. Salem, 116 N.H. 775, 367 A.2d 588 (1976). Many courts have held that "the existence of an outstanding lease at an unrealistically low rental ... of the property, is not to be used as a basis for calculating actual value." People ex rel. Gale v. Tax Comm'n, supra, 17 A.D.2d at 230, 233 N.Y.S.2d 501. See also Barker's Stores v. Board of Review, 74 A.D.2d 994, 427 N.Y.S.2d 103 (1980).
Other courts have held, however, that contract rent is relevant as evidence of fair market rent, Board of...
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