New Property Tax Valuations Under the “Dark Store” Theory

Real Estate

The rise of e-Commerce and the general consumers breakaway from physical on-site shopping is unsurprisingly having a negative impact on commercial retail real estate. Since 2008, and expected to peak in 2018, numerous physical stores are expected to close as companies contract their physical presence amongst the states. Due to a combination of over expansion, increasing rents, and bankruptcies, traditional national retailers such as Toys R’ Us, Sears, and Macy’s succumbed to the reality of a new economy populated by internet retailers.

Becoming more prevalent in many states are the instances of “dead malls,” in which the departure of anchor tenants (resulting in what can termed a “ghostbox”) results in lowered consumer traffic, further affecting the remaining businesses and ultimately resulting in completely unused retail property for the entirety of the property (“dead mall”). As real estate taxes are often the most significant tax expense for physical retailers, those with significant physical presence are being forced to close their less profitable stores.

Most states require taxes to be levied against real property uniformly, upon similarly situated properties. This is often achieved by valuing the property in the fee simple (“absolute ownership unencumbered by any other interest or estate”). For purposes of a fee simple valuation, the most accurate method for valuing real property under the sales comparison approach often is to compare it to similar properties that have sold (“comparables”). In most cases, properties sold in the fee simple are vacated by the prior occupant before the sale.

Property Tax World’s “Dark Store” Theory

However, a push is being made in many states by “big-box retailers” (i.e. large retailers occupying large amounts of physical space and often physically resembling a box in the shape of their retail store, such as Wal-Mart, Rite Aid, Lowe’s, Home Depot and Best Buy) for property tax purposes under what has become known in the property tax world as “Dark Store” theory. Taxpayers and certain assessors are shifting the property tax valuation methodology applied to these taxpayers from one based upon “value-in-use” and its relative worth to the current individual user, to one more arguably objective, based instead on value “as if vacant,” attempting to reflect economic reality representative as “value-in-exchange.” As big-box retail properties are often subject to long-term above-market rate leases, the argument is that the attempt to value these properties based on their value-in-use leads to a leased fee valuation, rather than a fee simple valuation, which frequently results in higher assessed values.

When property is deemed vacant or unoccupied beyond the normal period for property in the same real estate market segment, such property (sitting vacant and unlit, being without electricity) is considered to be a “dark store.” Occupied, operating big box stores in certain jurisdictions should be valued, when applicable, against comparable vacant and available-for-sale or available-for-rent properties. To do otherwise would be to unfairly over-assess their property relative to the prospective user rather than the current user of the property. In practice, the assessed value of a new store should be based on the value of vacant or abandoned buildings of similar size in the respective taxing jurisdiction.

Dark Store Loophole

The IAAO (International Association of Assessing Officers) has come forward with its own whitepaper taking the position that big boxes should not be valued in this manner. The theory is derogatively termed as the “dark store loophole,” the application of which disadvantages smaller businesses and inherently compares a valuable, operating property with an unused one, hurting tax revenue while benefitting the largest retailers. While appraisals used by big boxes in excessive assessment litigation often use vacant properties to challenge valuation, big box taxpayers and their representatives take the position that use of these properties is not a “loophole,” but rather just the application of evolving and more accurate appraisal techniques.

Of course, this isn’t without its challenge and counterargument. The APTC (American Property Tax Counsel), for example, questions the legal underpinnings and conclusions determined by the IAAO without proper litigation or legislation providing the necessary scrutiny over their valuation. Further, big box retailers are not without their own lobbyists and sympathetic assessors who view the “Dark Store” alternative as better representing the unique valuation.

“Dark Store” theory has been litigated and/or legislated in Alabama, Kansas, Iowa, Indiana, Michigan, Minnesota, New York, Ohio, Missouri, Texas, and Wisconsin. Dark store theory has moved into the national discussion in the past year, and experts believe the resolution for each state will ultimately come either by judicial or legislative means as the increase in unused commercial property juxtaposed against the local budgetary needs of jurisdictions meet. Review of recent judicial treatment amongst the states largely indicates pushback against the theory, followed by resultant legislative attempts to codify its nonuse, which at present, are meeting headway from retailers and their lobbyists.

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