Property Tax Post: Dark Stores, Property Tax and the Changing Face of the Retail Industry, Part Two



Welcome to Part Two of our series covering what many refer to as the “dark store theory.” In Part One, we highlighted the controversy surrounding valuation of built-to-suit commercial properties.

This installment gets to the heart of the matter, offering an in-depth look at one side of this contentious debate, hopefully, shedding some light on an issue that has taken the property tax world by storm. To better present the position of big-box retailers on this issue, I enlisted the help of Michelle DeLappe, Esq., owner at Garvey Schubert Barer.

At the beginning of the interview, DeLappe wanted to make one thing very clear before she addressed my questions—she does not like the phrases “dark store litigation” or “dark store theory,” finding them problematic. She explained that these particular catchphrases have an overwhelmingly negative connotation that implies some wrongdoing on the part of retailers. Instead, she believes that “basic fairness and the uniformity laws of most states demand that all real property be valued the same.” Simply stated, DeLappe believes the properties as issue should not be valued differently from other properties in a jurisdiction. She points out that it is the real property and not the business that should be valued for property tax purposes.

On that note, below are DeLappe’s answers and opinions regarding the so-called “dark store” controversy.

Bloomberg BNA: What standards and methods do most jurisdictions use to determine the value of built-to-suit commercial properties? Are there geographical limitations on where local taxing jurisdictions can look for comparable built-to-suit properties? How might taxable value of these particular properties differ if comparable properties are operative and located in thriving areas, for example?

DeLappe: Most jurisdictions use standard appraisal methods, which are subject to the Uniform Standards of Professional Appraisal Practice. Generally accepted authorities on appraisal methods include the Appraisal Institute; its main authoritative text is The Appraisal of Real Estate.

The valuation of built-to-suit commercial properties is no different in this respect from valuing any other real property. The key questions in every valuation assignment are (1) “what value?” and (2) “the value of what?” (I’m stealing this from an eminent writer on appraisal theory, Bill Kinnard). Based on the laws in most jurisdictions, the answer to “what value?” should be market value; the answer to “the value of what?” should be the real property. Market value means the value to the market—not to the current user.

If a particular area is generally thriving, then the market should be strong—but that does not mean that buyers generally would want to pay for the special features that the current user included in the construction of the property as part of the current user’s trade dress. More likely, any buyer, except for the current user, would spend money to remove those features from the property. Nor does a thriving business mean that the value of the business is taxable—the aim is still to value only the real property.

If a particular property is vacant, we have to examine why. Is the area generally depressed? Then the market in that area is not strong, and the sale of a vacant property in that area would require an upward adjustment for location if the appraiser is using that sale to value a comparable property in a stronger market area. Alternatively, is it just one property that is vacant in an area that is generally thriving? Then that may be similar to when you buy a vacant house in an otherwise attractive neighborhood. The fact that it has no tenant means that you can move in; you don’t necessarily treat it as a drawback. Like that house buyer, the buyer of a retail property may be an owner-occupant, who may pay even more for a vacant property. If the buyer is an investor hoping to lease the property, then the buyer will usually make a deduction based on the costs for leasing the property up (federal law requires lenders to do this in appraising it for financing purposes: “the appraiser must make appropriate deductions and discounts to reflect that the property has not achieved stabilized occupancy”).

So, depending on the circumstances, the taxable value of a vacant property may or may not differ from that of an operating property.

Bloomberg BNA: What kind of comparable properties do built-to-suit commercial retailers and similarly situated companies think should be used to value operating built-to-suit properties, and why do these entities believe this is an appropriate measure of market value?

DeLappe: Just as in any valuation assignment, good comparables are properties that would compete with the subject property for the same buyer in the market. And since we are looking at the value of the real property, that requires a focus on physical aspects of the property, not the specific business operated at the property or the special custom features of the property. For example, an appraiser valuing a drug store may very well look at an automotive parts supply store or other retail spaces as good comparables. The appraiser may also use a vacant store as a suitable comparable. In all events, the appraiser must adjust the comparable properties’ sales prices for differences with the subject property.

One error that we sometimes see for appraising build-to-suit properties is that some assessors believe one particular retailer’s store is only comparable to other stores occupied by that retailer or its competitors. That overly restricts the field of comparable properties. Using only properties currently occupied by the same or similar tenant excludes evidence that the appraiser should analyze about the value of that particular tenant’s use of the property. As The Appraisal of Real Estate points out, “The sale of a property encumbered by a lease involves rights other than the complete fee simple estate, and valuation of those rights requires knowledge of the terms of all leases and an understanding of the tenant or tenants occupying the premises.” In property tax valuations, the appraiser must exclude the value of those rights because they are not taxable.

Bloomberg BNA: “Dark store” litigation is a contentious issue because property tax revenues are a major source of funding for local governments. Due to the relatively high value of commercial property compared to residential property, a “dark store” valuation can have a significant impact on a taxing jurisdiction and who carries the majority of the tax burden. Is there a way to reconcile competing interests of residential and commercial property owners? 

DeLappe: Every property owner, whether of residential or commercial property, has the right to have their property valued at market value of the real property only. Funding constraints should not factor into property tax valuations. Nor should assessors cater to residential property owners (aka voters) by trying to have them carry less of the tax burden than is dictated by the law and the market-value standard. The fact that a given community may base its public spending on overvaluations of certain types of property is not the problem of the owner of the overvalued properties. Communities suffering tax base reductions due to overvaluations should instead turn their attention to those who improperly overvalued the properties in the first place.

Bloomberg BNA: E-commerce giants like might be setting up brick-and-mortar retail locations in some states, while established national retailers are struggling to keep the lights on. Considering this theory’s success, do you think we can expect to see state legislatures stepping in to prevent built-to-suit retail properties from being valued according to the “dark store theory”? If so, what might this legislation look like?

DeLappe: Retail stores do not pose any valuation challenge that does not already exist in valuing numerous other types of real property. Current laws already address those valuation challenges. Creating legislation specific to national retailers is unnecessary. It is also unhelpful as it threatens to confuse the constitutional imperative of uniformity in property taxes that exists in most states. My hope is that those on all sides of the controversy bring their focus back to generally accepted appraisal standards and market valuation of the real property.

Despite efforts by some state legislators, the “dark store” dispute has presented itself in a number of states and is likely to be an ongoing issue for local governments, retailers and property owners alike.  For example, as reported by Bloomberg BNA’s Michael Bologna, Wisconsin may soon be considering a bill that will “[close] off the so-called ‘dark store theory’ of property valuation and roll back the Wisconsin Supreme Court's 2008 precedent in Walgreens Co. v. City of Madison, 311 Wis. 2d 158, which invalidated a retail assessment strategy focusing on above-market rental contract values.” Meanwhile, the Iowa Department of Revenue is attempting to address another point of contention with a proposal to amend its administrative code to include language explicitly preventing appraisers from utilizing “data relating to the financial performance of the owner or the owner’s business, including but not limited to its sales, revenue, expenses or profits … in determining [an owner-occupied commercial] property’s actual value.”

In our next installment, you will hear from experts presenting another perspective on the “dark store theory.”

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How do you think states and local jurisdictions should handle the competing interests at play? Can states address the controversy by codifying appraisal methods with explicit guidance on what data appraisers may use?

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