Valuing Retail Properties
Assessments can differ, so understand what considerations go into calculating the value of retail properties.
A store owned and operated by Lowe’s in Georgia was valued
by the local tax assessor at $10.4 million. Not satisfied, Lowe’s counsel hired
its own appraiser, who valued the property at $3.9 million. How can these
valuations differ by that much on the same property?
Market value is, in the most basic sense, what someone will
pay for something. But who exactly is someone? When a property owner or
her adviser is considering the disposition of an asset, the first question is, “What
is the profile of the likely buyer?”
Big-box stores, regional malls, and department stores are
often occupied by large, well-capitalized retailers who are either tenants or
owner-occupants. Such properties could be valued based on the premise that they
benefit from having well-capitalized occupants. In reality, though, it depends
on the situation; different ownership interests may require that different data
be used to develop a credible valuation.
What types of ownership interests are marketable to
different types of buyers? What explains the disparity between what different
types of buyers will pay? Let’s explore how to match the profile of a likely
buyer with the property being valued in the retail segment.
Most states tax property on the market value of the
fee-simple interest, including tangible real property. Fee-simple interest is
unencumbered by any other interest, such as a lease. Tangible refers to
property that you can touch, such as land, buildings, pavement, and fencing.
Specifically excluded from tax valuations is intangible real property, such as
non-physical assets like franchises, trademarks, goodwill, and contracts.
Since a fee-simple valuation requires that the value not
reflect any actual leases that may be in place, it assumes that the property is
available for lease or owner-occupancy. As most real estate professionals can
attest, properties leased to a credit tenant often sell for a premium because
the security associated with a stable income stream is widely sought after.
However, if the property being valued is viewed as if available for lease or
owner-occupancy and not as if leased to a credit tenant (regardless of its
actual leasing status), no premium to reflect a credit tenant is appropriate.
This concept is critical to identifying the profiles of likely buyers.
- Are the
buyers of properties leased to credit tenants also the buyers of properties
available for lease or owner-occupancy? Typically no, at least not at a similar
- Do the
prices paid by buyers of properties leased to credit tenants indicate what
price could be reached for properties available for lease or owner-occupancy?
Again, typically, no.
- If the
prices paid for properties leased to credit tenants command a premium
associated with credit tenants, are the prices for these properties likely
overstated as an indication of value for ad valorem tax purposes? While this
point is highly debated, an argument can be made that the answer is an
irrefutable and resounding yes.
Many contend that, for example, if the fee-simple interest
of a Lowe’s is being valued, an appropriate comparable might be a physically
similar home improvement store — even if it was leased to Lowe’s at the time of
sale. While most well-intentioned appraisers would agree that a premium to
reflect a credit tenant is inappropriate when valuing a fee-simple interest,
many would then unintentionally capture such a benefit in their valuation by
using comparables of leased properties with these premiums embedded within
their sale prices.
What further makes this practice improper is that a sale of
a property is comparable only if it’s a competitive alternative for the
property being valued. If the property being valued is available for occupancy,
most prospective purchasers would not consider a property encumbered by a
long-term lease as an alternative. A better indication of value for the
fee-simple interest in a Lowe’s store would be a freestanding retail property —
one not encumbered by a lease with a credit tenant, even if it didn’t share the
Lowe’s design, and even if it were vacant.
One of the best ways to examine the market is to review
investor surveys, which consistently show that investors have a lower rate-of-return
requirement for institutional properties than for non-institutional properties,
with the disparity apparently attributable to the security of the income stream
associated with credit tenants.
Another way to evaluate the market is to analyze transaction
activity, including sales of owner-occupant (or fee simple) sales and investor
(or leased fee) sales. Benton Advisory Group compiled information regarding 106
sales of big-box retail properties where a fee-simple interest was conveyed,
along with 39 sales of big-box retail properties that reflected a leased-fee
interest. The sales that conveyed a fee-simple interest had a median sales
price of $28.30 psf, while leased properties had a median sales price of $77.66
psf — an astounding difference of 174 percent.
Additionally, investor sales consistently sell at higher
prices than large retail properties purchased by owner-users. The research also
supports that pricing is different for these asset types — and by an even wider
margin than expected.
Let’s look at actual tax assessment practices. An early step
in any valuation is to research comparable sales, the basis being evaluating
highest and best use. This concept involves developing a profile of the most
likely buyer. Sales of leased fee properties are plentiful, and professional
valuers often err by using them as the basis of fee-simple valuations. In the
Lowe’s example, the tax assessor’s valuation of more than $10.4 million was so
much higher because it was based on comparable sales that were meaningful in every
regard — except the properties were leased to financially strong tenants and
purchased by investors seeking those secure income streams.
The appraiser’s $3.9 million valuation appropriately used
sales of properties that reflected fee-simple transfers (i.e., owner-occupied
or vacant). They argued that their much lower appraisal was a pure real
property valuation, not influenced by an income stream that would not be
generated by an owner-occupied property and would not be part of an
owner-occupant’s purchase decision. They eventually settled on $5.5 million —
47 percent less than the original valuation.
This methodology, that the value of a fee-simple interest is
best estimated by analyzing sales that conveyed a fee-simple interest, is
accepted by numerous courts. Two prime examples are Target Corporation v.
Sedgwick County, Kansas and Lowe’s Home Ctrs., Inc. v. Twp. of
Once the buyer profile is established, a thorough
demographic analysis is critical, including trade area population, median household
income, per capita income, percentage of shoppers age 15 to 35, and number of
households. Average daily traffic count, competition within the trade area, and
the balance of retail supply/demand are also important.
In summary, establish an appropriate buyer profile, and, if
the purpose of the valuation is for ad valorem tax purposes, and the value
sought is that of the property unencumbered by leases, then the data relied
upon should reflect that. Two Costco stores, for example, that look identical
to shoppers can look very different to buyers if one is encumbered by a highly
desirable lease with Costco, and the other property offers nothing but real
estate. The comparables appropriate for valuing a fee-simple interest are sales
that conveyed a fee-simple interest — which would typically involve properties
that were vacant or occupied by their owner.