Opinion
No. 106,323.
2012-05-11
In the Matter of the Equalization Appeal of the SANDSTONE CREEK APARTMENTS, LLC, for the Year 2008 in Johnson County, Kansas.
Appeal from Court of Tax Appeals. Darcy Demetre Hill and Linda Terrill, of Property Tax Law Group, LLC of Leawood, for appellant Sandstone Creek Apartments, LLC. Kathryn D. Myers, assistant county counselor, for appellee Board of Johnson County Commissioners.
Appeal from Court of Tax Appeals.
Darcy Demetre Hill and Linda Terrill, of Property Tax Law Group, LLC of Leawood, for appellant Sandstone Creek Apartments, LLC. Kathryn D. Myers, assistant county counselor, for appellee Board of Johnson County Commissioners.
Before HILL, P.J., GREEN, J., and LARSON, S.J.
MEMORANDUM OPINION
PER CURIAM.
Sandstone Creek Apartments, LLC (Sandstone or Taxpayer) appeals a Court of Tax Appeals (COTA) order valuing an apartment complex (property) in Johnson County (County) for ad valorem tax purposes of $37,371,600 for the 2008 tax year.
Sandstone argues COTA erroneously applied the wrong legal standard to the facts in this case and that COTA's decision was not supported by substantial and competent evidence.
Factual and Procedural Background
The property is a luxury apartment complex consisting of 300 units located near similar complexes at 139th and Metcalf Avenue in Overland Park. The County initially valued the property at $39,239,000, with an effective date of January 1, 2008.
Sandstone filed an equalization/protest form, challenging the valuation. The taxpayer requested a valuation of $28,000,000.
The valuation of the Sandstone property was determined through usage of the “income approach” because apartment properties in Johnson County are normally owned and operated as income producing investment properties. Sandstone did not challenge the County's use of the income approach in valuing its property for ad valorem tax purposes.
The income approach to determine value is obtained by usage of the following equation: V=NOI/R where “V” represents valuation, “NOI” stands for net operating income from the property, and “R” is the direct capitalization rate. The capitalization rate to be utilized was not challenged by Sandstone. Thus, the ultimate issue before COTA and on appeal is the proper determination of the net operating income (NOI) of the property.
Net operating income is calculated by determining the property's projected gross income through market rents less stabilized vacancy and collection losses and further less marketing expenses relating to the property's characteristics.
The County utilized a mass appraisal process to determine the inputs necessary to compute NOI. Market information was gathered and a computer program approved by the Property Valuation Division (PVD) of the Kansas Department of Revenue was utilized. The results are based on inputs not only of the property in issue but on comparable apartment complexes in Johnson County. The hearing before the Court of Tax Appeals
Sandstone's appeal was heard by COTA in May 2010. The County's position was established by its registered and certified appraiser, Stan Moulder, who was its sole witness.
Moulder was not the appraiser who originally valued the property, but he revalued the property for the purpose of the tax appeal and arrived at an opinion of value as of January 1, 2008, of $37,371,600.
Moulder testified that what he did amounted to modifications of the mass appraisal valuation and not a new single property appraisal which complies with Standard 6 of the Uniform Standards of Professional Appraisal Practice (USPAP) (1992) and not Standards 1 and 2.
Moulder testified that in reaching his opinion of valuation, he inspected the property, corrected the net leasable area from 429,320 to 413,116 square feet based on the rent roll provided to the County by Sandstone, reduced the property's miscellaneous income from 7% of potential gross income (meaning the income derived from rents) to 5% based on the history of the subject property, and adjusted the property's expenses upward from $3.10 per square foot to $3.40 per square foot after “looking at a history of the subject property and how it fit the mass appraisal parameters.” Each of these adjustments was based on the information which was significant to the Sandstone property but did not result in the substantial differences in valuation that the parties contend.
The crux of the parties' dispute is how the “history of the subject property” could or should fit into the “mass appraisal parameters.” Sandstone had submitted the actual income and expenses for the years 2005, 2006, and 2007 and contended the NOI should be based on the property's actual performance in past years, not on mass parameters. The actual dispute focused on the inputs from the vacancy rate and the concession rate.
Vacancy rate is normally the percentage of the net leasable area which is vacant, but Moulder and Sandstone's witness disagreed on the calculation. Moulder based his calculation on “square footage rather than dollars” and used an average derived from county-wide data. Sandstone's testimony showed actual vacancy and collection rates far in excess to the amounts Moulder utilized.
Moulder testified that he believed there was a statutory obligation, see K.S.A.2011 Supp. 79–503a, to consider the earning capacity of the property which is “diminished somewhat if its ... above market vacancy.” Based on the Sandstone protest and his actual inspection, Moulder did take into account the property's actual vacancy rate on January 1, 2008, which he testified was 11%. But, Moulder did not change the vacancy rate used in the County's initial valuation which showed an 8% vacancy and collection rate.
Instead of changing the vacancy rate, Moulder subtracted $77,382 from the penultimate (or below the line) value of the property as “rent loss.” Moulder testified he arrived at this number by considering “actual square footage of vacant space exceeding what market vacancy would calculate,” but the actual calculation is not clear. Moulder justified this figure by noting actual vacancy was a figure “site-specific and ... not reflective of the market in general.” He did acknowledge that increasing the vacancy rate earlier in his calculation (or above the line) would have significantly reduced the property's value. He also admitted on cross-examination that taking the rent loss in this manner “minimizes the amount of deduction by taking it at the end of the calculation.”
Merrill Lancaster, chief investment officer of Sandstone's parent company, although not an appraiser, testified as to actual figures based on the prior 3 years. He distinguished between “physical vacancy” meaning an unoccupied apartment and “financial vacancy” meaning an occupied apartment which generates less than full rent due to a concession. A concession is “anything that you're giving [ sic ] a prospective tenant to rent that apartment,” typically such as 1 month free with a 12–month lease.
Lancaster testified that for calendar year 2005 the losses attributable to vacancies and income loss for collection were vacancy loss $600,117.73, concession loss $663,387.95, and collection loss of $64,197.02 for a total of $1,327,703, or 27% of potential gross income, with the NOI for tax year 2006 being $1,933,958.
For the calendar year 2006, Lancaster testified the losses attributable to vacancy and income loss for collection were vacancy loss $402,181.44, concession loss $735,079.14, and collection loss $72,788.08 for a total of $1,210,048, or 30% of potential gross income, with the NOI for tax year 2007 being $2,283,032.
Finally, for the calendar year 2007, Lancaster testified the losses attributable to vacancy and income loss for collection were vacancy loss $570,053.56, concession loss $647,162.92, and collection loss $85,126.79 for atotal of $1,302,343, or 25% of potential gross income, with the NOI for tax year 2008 being $2,015,355.
Lancaster's testimony as to the concession rate, based on monetary amounts and the amount of gross potential income, was “anywhere from 15 to 16 percent.” As to the County's initial valuation, it is not clear what concession rate was utilized, but the 2008 apartment parameters stated “concessions range from approximately 4–6% and will be allowed in the rent estimates applied .” Moulder testified this was the range for all classes of apartments. But, the County apparently conducted research after its initial valuation and found concession offered ranged from 0% to the admitted Sandstone rate of 14%. Moulder only allowed 1% which was the median for all properties. He testified he would have used Sandstone's rate if “typical” but did not do so because it was not typical.
Ultimately, Moulder used an 8% vacancy rate and a concession and collection rate of 1% for a total adjustment of 9%. He testified that after his adjustments, “the value being recommended still falls within the parameters for a class A apartment complex.”
Sandstone summarized the respective arguments of the parties by stating that the County is requesting COTA deduct a vacancy/concession/collection loss amount of $392,401 when the actual amount in calendar year 2007 was $1,302,343. Sandstone argued that the amount of deductions was less than one-third of the amount of actual loss and to account for the excess vacancy, Moulder employed a below the line rent loss methodology that had been expressly disapproved in the recently decided case of In re Tax Appeal of Brocato, 46 Kan.App.2d 722, 234 P.3d 866 (2010).
Sandstone further argued Moulder had not followed the USPAP as required by K.S.A. 79–505 and K.S.A. 79–506. Sandstone contended Moulder had not provided a mass appraisal and report under Standard 6 of the USPAP, as Moulder testified, but an individual appraisal and report subject to Standards 1 and 2 of the USPAP. “His appraisal was the result of his review of the actual income & expenses of the taxpayer, not as a result of a mass appraisal of a universe of properties. His appraisal was the result of his independent investigation, inspection and analysis.” Considering Moulder's acknowledgment that he did not prepare an individual appraisal, Sandstone concluded his report did not comply with Standards 1 and 2. With respect to the valuation itself, Sandstone argued Moulder failed to “look at property specific information and, instead, went with market parameters.” Sandstone asked COTA “to look at the actual income and expenses,” not those derived from the mass appraisal process.
Two of the COTA judges rejected both arguments, stating:
“It is clear from the evidence that the scope of the [C]ounty's work was a mass appraisal assignment and that the [C]ounty's appraisal was based on data developed using standard methods applied through computer-assisted mass appraisal modeling, ...
“The Court rejects the notion that the [C]ounty's inclusion of supplemental materials in its standard mass appraisal report changes, ipso facto, the scope and character of the [C]ounty's valuation evidence.”
With respect to the valuation, the COTA majority noted “This case involves a narrow dispute over what inputs should be used to arrive at a reliable estimate of net operating income (NOI) for the subject property under the income approach as of January 1, 2008.” COTA held the County properly used both inputs derived from the mass appraisal process and the property's actual operating history and stated:
“In this case, the record reveals that the [C]ounty reviewed and considered the subject [P]roperty's actual operating history and made appropriate corrections and adjustments to its valuation based on the data. The [C]ounty nevertheless declined to make changes where the actual data could not be reconciled with the [C]ounty's market analysis of comparable apartment properties. The Court finds nothing improper about the [C]ounty's exercise of appraisal discretion in this manner.
....
“Overall, the [C]ounty's value is supported by sound market analysis, and the inputs it used in its income approach reflect typical income and expenses for competing apartment properties. Conversely, [Sandstone's] actual income and expenses are discrepant with the relevant market data and are thus not indicative of what a typical owner could expect from the subject [P]roperty during the course of a normal holding period.”
The COTA majority adopted the valuation that Moulder opined and set the appraised value of the subject property for the tax year 2008 at $37,371,600.
COTA Judge J. Fred Kubik dissented and disagreed with the COTA majority on numerous points, including the ultimate value of the property.
Judge Kubik's dissenting opinion stated:
“The [C]ounty argues that the fair market value of the subject property's fee simple estate must be calculated using the [C]ounty's conclusions concerning rents, occupancy, and operating expenses derived from the market. This presumes that Taxpayer, an experienced apartment property owner and operator, is under-pricing its apartments, a presumption I find objectionable.”
The principle value difference under Judge Kubik's analysis was the rental concessions difference, which was explained as follows:
“The Taxpayer's published rental rates are, therefore, in the nature of target rents. They represent the amount the landlord hopes to receive in rentals, similar to the asking price for residential property. If the County is not adjusting for this pricing procedure in its survey of rental rates, then its rate study is flawed. However, no evidence was presented on this issue. What was presented was the County's study of concession rates for Class A apartment complexes for the year 2007. Eighteen complexes were surveyed in its study. Seven of these complexes had no concessions at all. Three had concessions of 1%, and the remaining seven had concessions of 2%, 3%, 4%, 6%, 7%, 9%, 10%, and 14%. From this the County determined the appropriate ‘market’ concession rate was 1%, the median rate in the study. The [C]ounty apparently did not consider that the differences in concession rates might be the result of different philosophies in setting published rental rates.”
The dissent opinion reached the following conclusions:
“At root, this controversy is about the evidentiary burden. The [C]ounty has the duty ‘to initiate the production of evidence to demonstrate, by a preponderance of the evidence, the validity and correctness of [its] determination.’ K.S.A. 79–1609. On one side we have the [C]ounty's high-level, statistical analysis drawn from the market in general; on the other side we have Taxpayer's historical income and expense data specific to the subject property. From all accounts, the subject property is a well-managed apartment complex. This Court should be reticent to presume that tenants of a commercially operated apartment complex are being charged inadequate rents. Without convincing evidence to the contrary—which I find lacking here—the ongoing operating data of a large, commercially operated apartment complex should provide prima facie proof of air market value.
“The subject property's chronic problems with rent concessions over the three years immediately preceding the tax year in issue are well documented. The long-term costs associated with these problems should be accounted for in the [C]ounty's appraisal. Based on the weight of the evidence, I would conclude that Taxpayer's asserted valuation based on actual historical data is a more reasonable estimate of fair market value.”
Judge Kubik presented a comparison of the information utilized by the County and the Taxpayer in reaching the respective valuations, and he opined that the appropriate valuation was $29,250,000 as set forth in the following attachment to his dissenting opinion:
“ATTACHMENT
+-----------------------------------------------------------------------------+ ¦ ¦COUNTY ¦TAXPAYER 3 YEAR AVERAGE ¦ +------------------------------------+--------------+-------------------------¦ ¦“Potential gross income ¦$4,360,009 ¦$4,455,357 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Vacancy/collection loss County 8%, ¦$ (348,801) ¦$ (562,479) ¦ ¦Taxpayer actual 12.6% ¦ ¦ ¦ +------------------------------------+--------------+-------------------------¦ ¦“Concessions–County 1%, Taxpayer ¦$ (43,600) ¦$ (681,877) ¦ ¦actual 15.3% ¦ ¦ ¦ +------------------------------------+--------------+-------------------------¦ ¦“Net rental income ¦$ 3,967,608 ¦$3,211,001 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Miscellaneous income ¦$ 198,380 ¦$ 195,002 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Total revenue ¦$4,165,988 ¦$3,406,003 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Total expense ¦$(1,404,594) ¦$(1,404,594) ¦ +------------------------------------+--------------+-------------------------¦ ¦“Net operating income ¦$2,761,394 ¦$2,156,475 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Overall Capitalization Rate (6% ¦$38,409,244 ¦$29,995,201 ¦ ¦plus 1.1894% tax) ¦ ¦ ¦ +------------------------------------+--------------+-------------------------¦ ¦“2.5% personal property ¦$ (960,231) ¦$ (749,880) ¦ +------------------------------------+--------------+-------------------------¦ ¦“Indicated Value ¦$37,449,013 ¦$29,245,321 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Less—rent loss ¦$ (77,382) ¦- ¦ +------------------------------------+--------------+-------------------------¦ ¦“Calculated value ¦$37,371,631 ¦$29,245,321 ¦ +------------------------------------+--------------+-------------------------¦ ¦“Rounded to ¦$37,371,600 ¦$29,250,000 ” ¦ +-----------------------------------------------------------------------------+
In concluding his dissent, Judge Kubik also noted that the County's value did include an adjustment for rent loss in the amount of $77,382, which was deducted from the final computed value. He concluded “aside from the fact that the deduction seems completely inadequate, it also appears to be a short-term adjustment for a long-term problem.”
Sandstone petitioned for reconsideration based on a recently decided case from this court, In re Tax Appeal of Brocato, No. 102,565, then an unpublished opinion filed July 23, 2010, later ordered published. Although Brocato was an appeal by the County, and the taxpayer had not cross-appealed, the panel in Brocato ruled on “other critical errors in COTA's valuation that have not been challenged by the County.” 46 Kan.App.2d at 729. The panel held the mass appraisal process must give “due consideration of property-specific evidence in ascertaining the proper vacancy rate.” 46 Kan.App.2d at 730. The panel did not believe the County had done so with respect to the “property's historic and chronic vacancies.” 46 Kan.App.2d at 730. The panel stated the evidence was “unequivocal” on this point: “this property has historically suffered extensive vacancy and there appears no prospect for any change in the foreseeable future.” 46 Kan.App.2d at 731. The panel concluded the County's vacancy rate of 4% was too low and that the County's allowance for rent loss ‘ “below the line’ “ served only to compensate for a “short term loss of rent.” 46 Kan.App.2d at 730. “Where the evidence establishes a chronic and long-term vacancy problem with the property under appraisal, this must be accounted for in the vacancy rate—not as rent loss.” 46 Kan.App.2d at 730. The panel directed COTA “to redetermine the value of the subject property in accordance with prescribed procedure, USPAP standards, and not contrary to this opinion, including consideration and application of an accurate vacancy rate for this property.” 46 Kan.App.2d at 731.
Sandstone then argued “the Court of Appeals [in Brocato ] informed the [COTA] that the methodology employed by [the County] with respect to excess vacancy is a USPAP violation. Sandstone asked “COTA [to] correct its decision to comport with the direction given it by the Court of Appeals [in Brocato ], thus alleviating [Sandstone] from having to appeal to the Court of Appeals for the relief it is entitled to.” COTA refused, distinguishing Brocato by finding “nothing inherent in the subject property that would justify a vacancy rate in excess of the prevailing rate for Class A apartments in the market area.”
Sandstone timely appealed, contending that COTA erroneously applied Kansas law to the appraisal process and the COTA decision was not supported by substantial and competent evidence.
Standards of Review
Judicial review of rulings of COTA is governed by K.S.A.2011 Supp. 77–621. For purposes of this appeal, this statute requires us to grant relief if (1) the agency has erroneously interpreted or applied the law, K.S.A.2011 Supp. 77–621(c)(4); (2) the agency has engaged in unlawful procedure or has failed to follow prescribed procedure, K.S.A.2011 Supp. 77–621(c)(5); (3) the agency action is based on a determination of fact, made or implied by the agency, that is not supported to the appropriate standard of proof by evidence that is substantial when viewed in light of the record as a whole, K.S.A.2011 Supp. 77–721(c)(7); and (4) the agency action is otherwise unreasonable, arbitrary, or capricious, K.S.A.2011 Supp. 77–721(c)(8).
In this case, the Taxpayer furnished the County a complete income and expense statement for the 3 years next preceding the year of appeal so the County bears the burden of proof before COTA pursuant to K.S.A.2011 Supp. 79–1609, which states:
“With regard to any matter properly submitted to the court relating to the determination of valuation of residential property or real property used for commercial and industrial purposes for taxation purposes, it shall be the duty of the county appraiser to initiate the production of evidence to demonstrate, by a preponderance of the evidence, the validity and correctness of such determination except that no duty shall accrue with regard to leased commercial and industrial property unless the property owner has furnished to the county or district appraiser a complete income and expense statement for the property for the three years next preceding the year of appeal. No presumption shall exist in favor of the county appraiser with respect to the validity and correctness of such determination.” (This same language is found in K.S.A.2011 Supp. 79–2005(i) for tax protests to COTA).
However, on appeal of a COTA decision, the burden of proving the invalidity of agency action is on the party asserting the invalidity. K.S.A.2011 Supp. 77–621(a)(l).
When construing tax statutes, imposition provisions are considered penal in nature and must be construed strictly in favor of the taxpayer. In re Tax Appeal of Harbour Brothers Constr. Co., 256 Kan. 216, 223, 883 P.2d 1194 (1994). Interpretation of a statute is a question of law over which appellate courts have unlimited review. Unruh v. Purina Mills, 289 Kan. 1185, 1193, 221 P.3d 1130 (2009). In making our unlimited review of a Kansas statute, deference is no longer being given to the agency's interpretation. See Fort Hays St. Univ. v. University Ch., Am. Ass'n of Univ. Profs, 290 Kan. 446, Syl. ¶ 2, 228 P.3d 403 (2010). This ruling has been specifically applied to decisions of COTA in In re Tax Exemption Application of Kouri Place, 44 Kan.App.2d 467, 472, 239 P.3d 96 (2010).
To the extent that issues are raised herein concerning the existence of substantial competent evidence to support an agency's findings our court in Herrera–Gallegos v. H & H Delivery Service, Inc., 42 Kan.App.2d 360, Syl. ¶¶ 1, 2, 3, 212 P.3d 239 (2009), stated:
“Under the Kansas Judicial Review Act, K.S.A. 77–601 et seq. , an appellate court reviews an agency's factual findings to see whether substantial evidence supports them in light of the whole record, considering evidence both supporting and detracting from the agency's findings. This substantial-evidence standard evaluates the reasonableness of an agency's conclusion in terms of the evidence. Substantial evidence is such evidence as a reasonable person would accept as sufficient to support a conclusion.”
“If a hearing officer has made credibility determinations regarding a witness who appeared in person before that hearing officer, the appellate court must consider any credibility determinations made by the hearing officer. If an agency head disagrees with those credibility determinations, that agency head should give reasons for disagreeing, and the appellate court would need to consider those reasons on appeal as well.”
“The appellate courts do not reweigh the evidence or engage in de novo review of an agency's factual findings. But the appellate court must consider all of the evidence—including evidence that detracts from an agency's factual findings—when assessing whether the evidence is substantial enough to support those findings. So the appellate court must determine whether the evidence supporting the agency's decision has been so undermined by cross-examination or other evidence that it is insufficient to support the agency's conclusion.”
Governing Law and Decisions
All real and personal property in Kansas is subject to taxation on a uniform and equal basis unless specifically exempted. Kan. Const., Art. 11, § 1(a) (2011 Supp.). It is the duty of the legislature to provide for a uniform and equal rate of assessment and taxation. K.S.A. 79–101. Property is to be appraised at fair market value as of January 1 of each taxable year.
Each parcel of nonagricultural “real property shall be appraised at its fair market value in money.” K.S.A. 79–501. The term “fair market value” means “the amount in terms of money that a well informed buyer is justified in paying and a well informed seller is justified in accepting for property in an open and competitive market, assuming the parties are acting without undue compulsion.” K.S.A.2011 Supp. 79–503a. This statute also describes the following factors that are to be considered in determining fair market value.
“Sales in and of themselves shall not be the sole criteria of fair market value but shall be used in connection with cost, income and other factors including but not by way of exclusion:
(a) The proper classification of lands and improvements;
(b) the size thereof;
(c) the effect of location on value;
(d) depreciation, including physical deterioration or functional, economic or social obsolescence;
(e) cost of reproduction of improvements;
(f) productivity taking into account all restrictions imposed by the state or federal government and local governing bodies, including, but not limited to ...;
(g) earning capacity as indicated by lease price, by capitalization of net income or by absorption or sell-out period;
(h) rental or reasonable rental values or rental values restricted by the state or federal government or local governing bodies, including, but not limited to, restrictions on property rented or leased to low income individuals and families, as authorized by section 42 of the federal internal revenue code of 1986, as amended;
(i) sale value on open market with due allowance to abnormal inflationary factors influencing such values;
(j) restrictions or requirements imposed upon the use of real estate by the state or federal government or local governing bodies, including zoning and planning boards or commissions, and including, but not limited to ...;
(k) comparison with values of other property of known or recognized value. The assessment-sales ratio study shall not be used as an appraisal for appraisal purposes.
“The appraisal process utilized in the valuation of all real and tangible personal property for ad valorem tax purposes shall conform to generally accepted appraisal procedures which are adaptable to mass appraisal and consistent with the definition of fair market value unless otherwise specified by law.” K.S.A.2011 Supp. 79–503a.
Our court in In re Tax Appeal of Yellow Freight System, Inc., 36 Kan.App.2d 210, Syl ¶¶ 5, 6, 7, 137 P.3d 1051,rev. denied 282 Kan. 790 (2006), set forth the following additional considerations to be utilized in the appraisal and appeal process:
“Appraisals produced by the computer assisted mass appraisal system that are prescribed or approved by the Kansas Director of Property Valuation shall be deemed to be written appraisals that fulfill the statutory requirements.”
“Appraisal directive No. 92–006 issued by the Kansas Director of Property Valuation requires the county appraiser to perform all appraisal functions in conformity with Standard 6 of the 1992 Uniform Standards of Professional Appraisal Practice.”
“The Uniform Standards of Professional Appraisal Practice include a departure rule that permits exceptions from sections of the Uniform Standards. One important departure exception is the jurisdictional exception rule, which allows an appraiser to void any requirement of the Uniform Standards which would be contrary to the law or public policy of any jurisdiction.”
Recently, our court in In re Tax Appeal of Brocato, 46 Kan.App.2d 722, Syl. ¶ 3, 6, 8, ––– P.3d –––– (2010), set forth the following additional considerations to be utilized where issues similar to those we face are in issue:
“K.S.A. 79–505 and K.S.A. 79–506 require that appraisal practice be governed by Appraisal Foundation, Uniform Standards of Professional Appraisal Practice (USPAP) (1992). These standards are embodied in the statutory scheme of valuation, and a failure by COTA to adhere to them may constitute a deviation from a prescribed procedure or an error of law.”
“Vacancy rate is intended to be an allowance for reductions in potential income attributable to vacancies and varies depending on the type and characteristics of the physical property, the quality of current tenants, the current and projected supply and demand relationships, and general and local economic conditions. According to USPAP, an appraiser of real property must analyze the relevant economic conditions at the time of the valuation, including market acceptability, and supply, demand, scarcity, or rarity. When necessary for credible assignment results, the appraiser must assess value by potential earnings including rentals, expenses, interest rates, capitalization rates, and vacancy data. Finally, an appraiser must base the estimates of vacancy rates on reasonable and appropriate evidence. These standards clearly contemplate due consideration of property-specific evidence in ascertaining the property vacancy rate.”
“The County's rent loss adjustment ‘below the line’ in an income approach to value is not the proper vehicle to adjust for such an egregious vacancy rate experienced on the subject property. Rent loss adjustments ‘below the line’ are intended to compensate for a known short term loss of rent due to a period prior to occupancy, between tenants, or necessary to tenant improvements prior to a new lease. Where the evidence establishes a chronic and long-term vacancy problem with the property under appraisal, this must be accounted for in the vacancy rate—not as rent loss.”
Analysis
Did COTA erroneously apply Kansas law?
Sandstone first contends on appeal, as it did before COTA, that the USPAP was erroneously applied to the evidence introduced and in COTA's findings of fact and conclusions of law.
Specifically, Sandstone argues COTA utilized the erroneously legal standard when it did not treat Moulder's report and testimony as an individual appraisal under USPAP Standards 1 and 2 but rather as a mass appraisal under USPAP Standard 6.
USPAP Standard 1 controls the development of individual appraisals, Standard 2 controls the reporting of individual appraisals, and Standard 6 controls both the development and reporting of mass appraisals. See USPAP, pp. 9, 15, 29 (1992); In re Tax Appeal of Yellow Freight System, Inc., 36 Kan.App.2d at 214.
K.S.A. 79–505(a) requires the “director of property valuation” (DPV) to establish “appropriate standards for the performance of appraisals in connection with ad valorem taxation.” At “a minimum” these standards must require “(1) That all appraisals be performed in accordance with generally accepted appraisal standards as evidenced by the appraisal standards promulgated by the appraisal standards board [ASB] of the appraisal foundation which are in effect on March 1, 1992, and (2) that such appraisals shall be written appraisals.” K.S.A. 79–505(a). The parties agree the DPV has issued appraisal directive No. 92–006, which requires county appraisers to “perform all appraisal functions in conformity with the [USPAP] Standards 2 and 6,” and which incorporates the USPAP generally by reference.
Sandstone does not deny the County's initial valuation was based on the mass appraisal process. Its argument is that once Moulder examined the property and made numerous adjustments from the initial valuation, the process was no longer one of mass appraisals. Sandstone relies on an advisory opinion promulgated in the 2008–2009 edition of the USPAP, Advisory Opinion 32 (AO–32). See USPAP, p. U-vi (2008–2009 ed.).
The County argues AO–32 is a nonlegal citation to publications not admitted by COTA. But, it appears to “illustrate the applicability of appraisal standards in specific situations and to offer advice from the ASB for the resolution of appraisal issues and problems.” USPAP, p. 111.AO–32 should be considered as providing guidance to a court considering a professional appraisal. See Cottonwood v. Yavapai County, 205 Ariz. 427, 429, 72 P.3d 357 (2003) (“This Court in determining how property should be appraised, would give strong deference to the ... USPAP ... and the Advisory Opinions that govern the conduct of certified appraisers throughout the United States.”).
Sandstone relies on the following illustration: “An assessment appeal is in process, and an appraisal of an individual property is being conducted as part of that appeal. Which development standards apply? STANDARD 1 ... would apply because an individual property is being appraised rather than a universe of properties.” USPAP, p. A–114.
The County says the Sandstone contentions misrepresent a PVD directive, the testimony of Moulder, the statutory scheme for ad valorem valuation, and previous Kansas decisions, principally In re Yellow Freight System, Inc., where the County argues that testimony by Moulder in that case was held to “fit [s] within the definition of a written appraisal as specified in K.S.A. 79–504(b).” 36 Kan.App.2d at 217.
The County further argues that the Sandstone complex is not a special purpose property, that Sandstone has not shown that the parameters used in the mass appraisal are flawed, or that there is something inherently different in its property that makes it different from otherwise like properties.
Sandstone makes a convincing argument that Moulder's report was prepared specifically for the hearing and falls squarely under AO–32 and PVD directive No. 92–006. Sandstone contends that Moulder changed the valuation from $39,139,000 to $37,371,600; made corrections to the net leasable area; changed the miscellaneous income from 7% to 5% after review of the site-specific subject property's income and expenses; adjusted the expenses to $3.40 per square foot after looking at the property's historic financials; and did not utilize the county market parameters for concessions, which were 4% to 6%, and instead used 1%. All of these actions are indicative of an appraiser doing a single property appraisal.
In attempting to address excess vacancy, Moulder utilized a totally different analysis from those he applied to specific income, expenses, concessions, and leasable area as discussed above. He testified that because K.S.A.2011 Supp. 79–503a(g) includes “earning capacity” in the definition of “fair market,” value the property's actual vacancy rate had to be considered.
Although the actual established vacancy rate over the previous 3 years was well in excess of 10%. Moulder chose to factor in this well-proven fact by taking a 1–year rent loss “below the line” deduction of $77,382. This is the amount which Judge Kubik referred to in his dissenting opinion as “completely inadequate” and a “short term adjustment for a long term problem.” Moulder admitted on cross-examination that this method had the effect of minimizing the deduction. His justification for this action was that excess vacancies were site-specific and could not be used if they exceeded market vacancy rates.
It is clear to us that the manner in which Moulder attempted to adjust the valuation for a clearly shown 3–year excess vacancy rate is in violation of the teachings of our court's holding in Brocato, 46 Kan.App.2d 722, Syl. ¶ 8, which we have previously set forth and will later discuss in this opinion.
But, as to the question of whether Moulder's opinion was one based on Standards 1 and 2 or Standard 6 of the USPAP, it appears to be a combination of all three, with several actual site-specific inputs used and, in other instances, mass appraisal factors selected in order to ultimately support the valuation figure which the witness opined. As such, the appraisal presented to COTA in this case might more correctly be deemed a hybrid appraisal that satisfies none (or all three combined?) of the USPAP Standards.
COTA judges appear to allow appraisers to utilize all three standards, and we find in the record during a discussion of the cost and sales approach the following question by one of the COTA judges:
“Q. (BY JUDGE CROTTY) But— but this Court has taken a pretty relaxed view of some of the technical requirements of USPAP when we have somebody that's been qualified as an expert to give us valid testimony. But you've been pretty obscure in really justifying some—some of the deviation. So that's why I want to give you the opportunity to do that.” (Emphasis added.)
It is apparent to us that COTA's “pretty relaxed view” of the “technical requirements of USPAP” has not in the past, and did not in this case, limit testimony of an appraiser to a single USPAP standard.
Moulder was allowed by COTA to utilize site-specific information at numerous times, but when excess vacancy was clearly shown by Sandstone's testimony, Moulder moved to the mass appraisal rate and attempted to justify his actions by taking a questionable 1–year rent loss “below the line.”
Although the difference between an “above the line” adjustment to which the capitalization rate is applied and a “below the line” adjustment which is simply subtracted from the valuation is understood by those familiar with the appraisal process, the difference in the amount of the ultimate valuation is significant. For example, in this case, if the $77,382 supposed rent loss had been taken above the line and the agreed capitalization rate of 7.1894% was applied under the valuation formula we have previously set forth, the reduction in the value of the property would have been $1,076,335.
Not only is the derivation of the $77,382 amount unclear from the record, but Judge Kubik's characterization of the appraisal tactic as being “completely inadequate” and a “short term adjustment for a long term problem” is correct, both factually and legally. While the appraisal handling of the chronic rent loss by the County may require further action by COTA, it does not aid Sandstone in its argument that COTA erred in allowing the County to present a Standard 6 mass appraisal.
An examination of the appellate cases over the last 20 years since the PVD issued directive No. 92–006, which requires county appraisers to perform all appraisals in compliance with USPAP Standards 2 and 6, has resulted in county appraisers utilizing Standard 6 whenever possible and the taxpayers who are protesting a valuation or the amount of a tax normally presenting site-specific appraisals and valuations under USPAP Standards 1 and 2.
With the parties to appeal following different Standards, there are often sharp differences in valuations which COTA has the difficult task of resolving. The two opinions of COTA in this case are an example of the inherent difficulty in the appeal process.
But, we do not see how, based on the statutory provisions, the PDV directive, the USPAP, and reported appellate decisions, that we can adopt Sandstone's AO–32 based argument that once a valuation appeal or a tax protest based on valuation is filed the resulting appraisal to be presented for purposes of a COTA hearing would be solely based on USPAP Standards 1 and 2. If such is to become the rule, it should come from the PDV or by express legislative action.
However, in not requiring such a ruling and allowing the present system to continue, we recognize that a strong argument does exist that K.S.A.2011 Supp. 79–503a is not being followed for a “well informed buyer” would rarely purchase a property from a “well informed seller” based only on a value established by a mass appraisal system.
Purchases of property in the real world are more often based on the actual income and expenses of the specific property with due consideration for the location of the property, comparable sales, and other economic conditions.
Until the Kansas Property Valuation Division or the Kansas Legislature so requires, we decline to apply the suggestions of USPAP Advisory Opinion 32 as Sandstone suggests. Was the COTA decision supported by substantial and competent evidence when it relied on an opinion of value that was not developed or reported in compliance with USPAP?
Sandstone does not abandon its argument that the County appraisal failed to comply with USPAP Standard 2, but it argues that even if we were to find that Standard 6 applies, the appraisal report is deficient under that Standard. It is Sandstone's contention that when a report fails to meet the minimum standards of USPAP, it is so sufficiently unreliable that it cannot be considered to be substantial and competent evidence upon which COTA can rely.
We need not restate all the standards of review, governing law, and decisions which were previously set forth. We will, however, examine in detail the factual situation and ruling of In re Tax Appeal of Brocato, 46 Kan.App.2d 722, 234 P.3d 866 (2010), which was decided shortly after the hearing before COTA in our case, argued to COTA by Sandstone in its petition for reconsideration, and relied upon extensively before us on appeal.
Sandstone's basic contention is that the County's appraiser appreciably overstated the valuation because he did not consider the chronic vacancy/concession/collection loss facts for the specific property and only applied an inadequate deduction. Sandstone further argues the appraiser compounded the error by taking only an improper “below the line” rent loss deduction premised on the assumption that property which had averaged 27% vacancy for the prior 3 years would only be 8% vacant for 2008. Sandstone argued its evidence showed competent management but a property with significant concessions (financial vacancy) together with physical vacancy which both affect the ability of the property to generate income.
Sandstone argues the County's approach was specifically rejected in Brocato, which addressed this issue in the following manner:
“Vacancy rate is intended to be an allowance for reductions in potential income attributable to vacancies and varies depending n the type and characteristics of the physical property, the quality of current tenants, the current and projected supply and demand relationships, and general and local economic conditions. Appraisal Institute, The Appraisal of Real “Estate 489 (11th ed.1996). According to USPAP, an appraiser of real property must analyze the relevant economic conditions at the time of the valuation, including market acceptability and supply, demand, scarcity, or rarity. USPAP Standards Rule 6–2(h) (1992). When necessary for credible assignment results, the appraiser must assess value by potential earnings, including rentals, expenses, interest rates, capitalization rates, and vacancy data. USPAP Standards Rule 6–5(a)(v) (1992). Finally, an appraiser must base the estimates of vacancy rates on reasonable and appropriate evidence. USPAP Standards Rule 6–5(b) (1992). These standards clearly contemplate due consideration of property-specific evidence in ascertaining the proper vacancy rate.
....
“The County's rent loss adjustment ‘below the line’ is not the proper vehicle to adjust for such an egregious vacancy rate experienced on the subject property, and it has been improperly calculated by the County in any event. Rent loss adjustments ‘below the line’ are intended to compensate for a known short term loss of rent due to a period prior to occupancy, between tenants, or necessary to tenant improvements prior to a new lease. See Appraisal Institute, The Appraisal of Real Estate 591–92. The court is unaware of any reliable and authoritative source on appraisal standards that recognizes an approach like that applied here. Where the evidence establishes a chronic and long-term vacancy problem with the property under appraisal, this must be accounted for in the vacancy rate—not as rent loss.” Brocato, 46 Kan.App.2d at 729–30.
Sandstone quotes Judge Kubik's dissenting opinion, which states:
“This Court should be reticent to presume that tenants of a commercially operated apartment complex are being charged inadequate rents. Without convincing evidence to the contrary which I find lacking here—the ongoing operating data of a large commercially operated apartment complex should provide prima facie proof of fair market value.”
Sandstone concludes by arguing that we should follow Brocato and require COTA to make its valuation using an “accurate” vacancy rate.
The County argues Brocato does not apply to this case because here there were no property specific factors that limit the performance of the Sandstone property like the testified to limited access which Mr. Brocato showed. The County says there has been no showing that the Sandstone property is unique, the last above statement from Judge Kubik's dissent does not comport with Kansas law and suggests that Sandstone's actions in lowering rent in subsequent years rather than offering concessions showed it was utilizing a failed business strategy and not reflecting a property specific problem.
While the ultimate issue in this case is over vacancy rate, if the County is correct in its “failed business strategy contention, the lowering of rent in later years by Sandstone would more likely show that the potential gross income for the 2008 appraisal should have been a significantly lower amount which would have offset the concessions and vacancy deductions.
We have earlier referred to Brocato, but we now set forth its facts in detail, its primary holding, and the extended holding which may or may not control our decision in this case.
The subject property in Brocato was a strip shopping center consisting of 17,948 square feet in Johnson County which had an access problem and had experienced a 50% vacancy since at least 2004. The County urged a $2,871,100 value and taxpayer contended the value should not exceed $1,794,800.
As in our case, the County's appraiser did not initially appraise the property, but she examined the work of others in her office and supplemented that work with her own property observation and market study. She relied exclusively on the income approach and, with the exception of a rent loss calculation, used market data rather than actual data to determine the various inputs for her model.
For rental rate, the County's appraiser said the market rent ranged from $12 to $20 per square foot and utilized $16 in her appraisal as the County had in its valuation model. For expenses, the appraiser explained market expenses for comparable properties ranged from $.70 to $2.65 per square foot, discounted information furnished by the taxpayer, and selected $1.25 per square foot for her expense input.
For vacancy rate, the County's appraiser utilized 4% from her market study for retail strip centers and did not adjust for the vacancy rate experienced by the subject property. She did, however, allow a rent loss adjustment to the final valuation indicator “below the line” reflecting a 45% additional vacancy which was based on the present value of 1–year of rent attributable to the additional vacancy, or a value reduction of $163,723.
Brocato testified in his own behalf. As to rent rate, he said $16 per square foot was not appropriate and $14 was more accurate based on actual facts. As to the $1.25 per square foot for expenses, he stated $3.77 per square foot before taxes and tenant reimbursements were his costs. He stressed his problems with access and provided a lengthy narrative to support the long-time vacancy rate.
COTA valued the property at $2,225,000 using the County's income model, found Brocato's testimony “unsupported” but utilized his $14 per square foot rental rate and his expense rate of $3.77 per square foot. With this result, it was the County that appealed.
Our Brocato opinion found the $14 per square foot rental rate was not supported by the evidence and that COTA's selection of $3.77 as expenses failed to consider the existence of net-net basis leases which required tenants to pay prorata share of certain expenses. For these reasons, our opinion stated reversal was required but further noted the County expense rate was unsubstantiated because “it assumed full occupancy and full reimbursement of typical reimbursable expense without any recognition of the property's historic and chronic vacancy rate ‘above the line.’ “ 46 Kan.App.2d at 729.
Although a cross-appeal had not been, filed, the following additional errors were noted in the interest of judicial economy in order to not require another judicial review of COTA's order on remand.
The Brocato opinion then set forth the paragraph we have previously quoted in full as Sandstone's contention relating to vacancy rate and USPAP Standards which concluded by opining: “These standards clearly contemplate due consideration to property specific evidence in ascertaining proper vacancy rate.” 46 Kan.App.2d at 730.
Next, the Brocato opinion held that in applying its market vacancy rate of only 4%, the County had not analyzed the necessary property specific factors which affected the failure income and expense streams. Applying the 4% market vacancy rate without regard to the property's historic vacancy failed to account for actual reduction in income to the property which was a failure to follow prescribed procedure required by USPAP and K.S.A. 79–505. The opinion opined “The County had the burden to support its valuation and when the method by which it accounted for the vacancy rate is flawed, it has not met the burden.” 46 Kan.App.2d at 730.
The Brocato opinion then sets forth the paragraph we have also previously quoted in full as a Sandstone contention that the County's rent loss adjustment “below the line” is not a proper way to adjust an egregious vacancy and was improperly calculated in any event. 46 Kan.App.2d at 730.
We need not here repeat the large difference we earlier set forth which results in valuation between taking a rental loss above the line and applying the agreed capitalization rate and taking it below the line which under our facts was admitted to have the effect of minimizing the deduction. As we earlier stated, this improper manner of handling a long-term vacancy rate substantially greater than an appraisal model does by itself require reversal and remand of the COTA valuation in our Sandstone case.
The Brocato opinion held rent loss adjustments below the line are intended only to compensate for a known short-term loss which did not exist there, nor did it exist with the Sandstone property.
The Brocato opinion reiterated it was unaware of any reliable and authoritative appraisal standard which recognized the approach there applied and concluded that “where the evidence established a chronic and long-term vacancy problem with the property under appraisal, this must be accounted for in the vacancy rate not as rate loss.” 46 Kan. Ap.2d at 730. We agree.
We further agree with Sandstone's final argument that the Brocato ruling is directly applicable to and governs the result we must reach in our case.
The evidence in our case did show at least a 3 year history of vacancy rates and concessions by Sandstone that were far in excess of the County's model. There was no evidence that this was because of a “flawed business model” as the County suggested, and it is necessary to apply the vacancy rate as an above the line deduction in order to reach a statutorily and USPAP approved fair market value of the property.
We hold, as was held in Brocato, that the County had the burden to support its valuation, and when the method by which it accounted for the vacancy rate is flawed, it has not met this burden. The COTA decision was not supported by substantial competent evidence.
Reversed and remanded to COTA with instructions to redetermine the value of the subject property in accordance with prescribed statutory procedure and direction, USPAP standards, and not contrary to this opinion.