From a small northwestern observatory…

Finance and economics generally focused on real estate

Property taxes and the dark store theory

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This is a continuation of my piece from last week on Property taxes. I suspect that this will be an issue of no small concern to property investors, appraisers, and financial advisors in 2021 and beyond, not just as a result of COVID, but certainly exacerbated by COVID.

I was recently looking at a 10,000 square foot stand-alone commercial building — an “out-parcel” in a shopping center. For a variety of reasons (COVID being only one of them) this shopping center has fallen on hard times, and the tenant (a big national chain) has declared bankruptcy. This store, and nearly all of the properties near it, are vacant, and there is little forecast that this will change in the near future.

So, the total taxable value of the property back when everything was hunky-dory was about $2.2 million. Today, the total taxable value is… you guessed it, $2.2 million. The question which perplexes property owners, appraisers, and tax assessors is the valuation of these “dark stores”. Do they get valued at their highest-and-best use (even though they are vacant) or as some value-in-use, recognizing the current economic condition. More to the point, even when these properties are up-and-running, should the value be reflective of the current contract rent or some other theory of valuation?

As an aside, about 30 years ago, I published a paper on the impact of the failure of anchor tenants in strip shopping centers. The original tenants are typically very stable, boring grocery stores. The other tenants, who on a per-square-foot basis are usually much more profitable to the landlord, draw business as a result of proximity to the grocery anchor. After one fails or moves out, all too often, the landlords scramble around for a substitute, picking up an anchor tenant that may be very risky and/or fails to provide traffic to the other tenants. The result is often a financial failure of the whole shopping center.

Back in February, 2017, the Texas Comptroller published a piece on the Dark Story Theory and how it impacts property tax assessments. There is a lot more written on the subject, and a full literature review would be beyond the scope of what I hope to accomplish today. This theory first gained purchase with the big-box landlords, but it is now the theory du jour with many tax advisors in the commercial sector. In short, the Dark Story Theory holds that a big-box retailer really only has value due to the unique tenant. As such, these properties should always be valued as if they are vacant (or “dark”), because these locations would be difficult to sell to subsequent buyers without the big-box tenant. The Texas Comptroller article notes that the most vigorous proponent of this theory in that state, at least in 2017, was Lowes Home Improvements Stores, with 141 operating locations in that state. In Texas, Bexar County alone estimates it would cost the schools $850 million per year in property tax revenues if this theory was to succeed. As of 2017, Bexar County had spent $300,000 on Lowe’s tax appeals.

Note that the definition of market value for commercial properties, for tax purposes, may be somewhat different than the definition used for a simple home mortgage. Texas law, for example, taxes property at its current use, including any rents it generates. Note that many dark stores are still generating rent for the landlords due to the complex build-and-lease-back provisions in the original development.

This is not an issue limited to Texas. A study out of the U. North Carolina in 2018 showed that this theory has caught on with commercial property owners throughout the U.S., and that the reductions sought often amount to 50% or more of the otherwise assessed value. With millions of dollars in annual tax expense at stake per building, the landlords can afford to hire the best talent and litigate these appeals. Courts are increasingly finding merit with the landlords’ arguments. In 2008, the Wisconsin Supreme Court held in  Walgreen Co. v. City of Madison, 311 Wis. 2d 158 (2008), that the market value for tax purposes must be based on market rents rather than contract rents, because the latter, “artificially increased sales prices cause by unusual financing arrangements[.]” The Walgreens decision has resulted in over 140 property tax appeals in that state alone. A bill to effectively reverse this decision failed in the Wisconsin legislature in 2018.

In Indiana, the state tax court was persuaded by appraisers and attorneys for Kohl’s to rely on sales data from nine “dark box” retail stores. This was effectively upheld by the State’s Supreme Court. (See Howard Cty. Assessor v. Kohl’s Indiana LP, 57 N.E.3d 913, Ind. T.C. 2016, review denied, 86 N.E.3d 171). In North Carolina, the Lowes Store in Kernersville (Forsythe County) was valued at $16 million. Using the dark story theory, Lowes appealed with a $6 million valuation, which was upheld by the Property Tax commission. (Matter of Lowe’s Home Centers, LLC, COA17-220, 2018 WL 708657, N.C. Ct. App. Feb. 6, 2018)

With the implosion of certain sectors of commercial real estate becoming more of a reality in the COVID recession, we can surmise that these theories will be more vigorously litigated in the coming months. There is very real money at stake on both sides of this issue.

Written by johnkilpatrick

January 11, 2021 at 9:26 am

Posted in Uncategorized

One Response

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  1. Steven Laposa Yet, there are states such as Indiana that recognize that the dark store theory is truly dark and not that theoretical.

    The IAAO has several white papers on big box retail and the debate over leased fee and fee simple.


    Steven Laposa

    January 12, 2021 at 5:15 am

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