Missouri Baptist Children's Home v. State Tax Com'n, 76003

• Decision Date: 21 December 1993
• Docket Number: No. 76003,76003
• Citation: 867 S.W.2d 510
• Parties: MISSOURI BAPTIST CHILDREN'S HOME, Appellant, v. STATE TAX COMMISSION OF MISSOURI, et al., Respondents.
• Court: Missouri Supreme Court

Page 510

867 S.W.2d 510

MISSOURI BAPTIST CHILDREN'S HOME, Appellant, v. STATE TAX COMMISSION OF MISSOURI, et al., Respondents.

No. 76003.

Supreme Court of Missouri,

En Banc.

Dec. 21, 1993.

Douglas A. Copeland, Stephen C. Hiotis, Clayton, for appellant.

John A. Ross, County Counselor, Dennis C. Affolter, Associate County Counselor, St. Louis County, Clayton, for respondents.

HOLSTEIN, Judge.

Plaintiff Missouri Baptist Children's Home (MBCH) owns commercial property in St. Louis County that has been leased as a K-Mart store since 1967. In 1989 the county assessor informed MBCH that the property's assessed valuation for that year would be $990,430.00, an increase of more than 100% over the previous assessed value. An initial appeal to the St. Louis County Board of Equalization was denied. § 138.180, RSMo Supp.1992. Review was sought before the State Tax Commission of Missouri (Commission), which ordered the assessment increased to $1,000,000.00. § 138.430.1, RSMo. Supp.1992. ¹ Review was then sought in the circuit court. Following denial of relief in the circuit court and an appeal to the Court of Appeals, Eastern District, this Court granted transfer.

Commercial property must be assessed at 32% of its "true value in money." § 137.115.5(1,), (3). ² The preliminary issue is whether a below-market lease may be taken into consideration in determining the "true value in money" of the subject property. A second issue in this case is whether the Commission's analysis of the effect of the lease on the property's value is "supported by competent and substantial evidence on the whole record." Mo. Const. art. V, § 18.

FACTS

The MBCH property was leased to S.S. Kresge Company in 1967 and has been occupied as a K-Mart store since that time. The lease contains three five-year options following the initial twenty years. The lease was typical of those entered into in the late 1960's. At the time the tax was assessed in 1989, K-Mart was in the middle of the first option period.

MBCH receives rentals of $166,500.00 annually, plus 1% of the gross sales exceeding $6,720,000.00. As landlord, MBCH is responsible for upkeep of the building, parking lot, maintenance and insurance, and payment of utilities and taxes, including real estate taxes.

The only evidence as to value was the testimony of MBCH's expert, appraiser Tom McReynolds. Relying on three standard methods of valuing real property, ³ he estimated that the property's fee value, unencumbered by the lease, was $3,125,000.00. His income capitalization analysis ascribed rental value to the property of approximately $3.50 per square foot, based on current market rentals. However, the actual rent under the lease nets only about $1.00 per square foot. Using that rental to calculate the capitalized rental income, McReynolds concluded that the value of the property to MBCH was $1,092,000.00. He calculated this value by adding capitalized actual rental income to MBCH's reversionary interest in the property at the end of the lease period. His valuation assumed that the options would be renewed even though K-Mart was considering moving elsewhere. He testified that under present market conditions, the lease is highly favorable to K-Mart.

Gary Collins, the manager for MBCH, testified that while MBCH was not actively marketing the property, it had received two offers to purchase the property. One was made on the assumption that the buyer would assume the lease and was for $2,050,000.00. The other offer, for $2,200,000.00, was made on the assumption that the lease would be terminated. There was no evidence that MBCH made a counteroffer or entered into further negotiations with either potential purchaser. Collins also testified that there had been rumors that K-Mart might leave, but K-Mart had indicated no interest in terminating the lease. Subject to certain exceptions, the lease permits K-Mart to assign its lease or sublet the property to others without MBCH's permission.

I.

The position of the Commission on appeal is different from that reflected in the order of the hearing officer, which the Commission adopted as its own. ⁴ It is the Commission's contention now that the actual rental may not be considered a factor in determining value when relying on the income capitalization method of valuation. The hearing officer whose findings were adopted by the Commission relied in part on the income capitalization method to determine value. She concluded the K-Mart lease was a relevant factor to consider. The Commission now argues that such conclusion was mistaken.

True value in money is the price which the property would bring from a willing buyer when offered for sale by a willing seller. Thus, the true value is the fair market value of the property on the valuation date. St. Joe Mineral Corp. v. State Tax Comm'n, 854 S.W.2d 526, 529 (Mo.App.1993).

Although no Missouri case has specifically held what effect a below-market lease should have on an assessment, the subject property in Stephen & Stephen Properties, Inc. v. State Tax Comm'n, 499 S.W.2d 798 (Mo.1973), was "encumbered by the existence of a ten year lease ... by which the income of the prospective buyer would be limited to the yearly rental payments." Id. at 803. This fact was held to be relevant to a determination of value. Id. at 804.

Although courts in other jurisdictions generally equate fair market value on the date of assessment with the true value, the cases are not in accord as to whether a long-term sub-market lease may be factored into a determination of value under the income capitalization method. Those courts rejecting the actual rental as a factor in the income capitalization method of valuation base their decisions on two propositions. The first is that the potential income, not actual income, determines the highest and best use of the property. Swan Lake Moulding Co. v. Dept. of Revenue, 257 Or. 622, 480 P.2d 713, 714 (1971). The other proposition is that the tax must be assessed against all interests in the land to avoid an assessment below fair market value. Schultz v. TM Florida-Ohio Realty Ltd. Partnership, 577 So.2d 573, 575 (Fla.1991).

Other courts, while paying lip service to those propositions, have stopped short of saying that a below-market long-term lease may not be considered. For example, the Ohio Supreme Court held that the tax assessment board, faced with widely varying appraisals, could give more weight to the "economic rent" over "contract rent" in determining the true value in money of rental property subject to a below-market long-term lease. Wynwood Apts., Inc. v. Board of Revision of Cuyahoga County, 59 Ohio St.2d 34, 391 N.E.2d 346, 347-48 (1979). The court in that case noted that no "hard-and-fast rule" ignoring contract rent in favor of economic rent was adopted. Id., 391 N.E.2d at 349.

The more recent and better-reasoned approach is to authorize the assessing authority to utilize actual as well as potential income in determining true value. Denver v. Board of Assessment Appeals, 848 P.2d 355, 361 (Colo.1993); Folsom v. County of Spokane, 106 Wash.2d 760, 725 P.2d 987 (1986); C.A.F. Investment Co. v. Michigan State Tax Comm'n, 392 Mich. 442, 221 N.W.2d 588, 594-95 (1974). These cases take a realistic approach to the economic conditions which cause property subject to long-term leases to have lower actual rentals than might be obtained if the property was unencumbered by the lease in the current market place. They note that it is often the long-term lease that gives value to property. The fact that a long-term lease is necessary to obtain long-term...