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Special Use Properties Often Overassessed

We have noticed that when assessments are placed on special use properties in the Chicago area they are often higher than one would expect. In many cases it is not because the Cook County Assessor's values are wrong per se, but because they are assessing the wrong bundle of rights. The assessor's heavy reliance on the cost approach often results in values that would not be attainable in the marketplace if the properties were vacant and available for sale. In other cases the business value overlaps with real estate values resulting in too high a real estate assessment. The job of a Chicago commercial tax appraiser is to insure that only the real estate is being taxed and not the business.

As a point of clarification when appraising for a tax assessment purpose, the assignment requires the appraiser to value the property as if it is sold and available to be leased at market levels (a fee simple market value appraisal). The Cook County Assessor's office assessments are also supposed to estimate the fee simple value of the property. On an appeal in Chicago the commercial tax appraiser is likewise to appraise the property in fee simple estate.

Chicago area properties such as fast food restaurants, bank branches, hotels, freestanding pharmacies and fitness clubs are often built by owners to their specifications or built-to-suit for them and reflect a value in use or leased fee value. The building is designed for a particular business-model prototype. These custom built properties are occupied by the owner or tenant for whom the improvements were built, with the lease structured to recoup the original cost of the custom construction. If these properties were sold, they would sell as leased fees with rents well above the market rent. This would be expected as the improvements have been customized to the wants and needs of the occupant and those specifications are unlikely to meet the needs of another user. A Burger King restaurant, for example, may be a perfect design for a Burger King Business plan but is largely undesirable for the market in general, even for another fast-food outlet.

To properly appraise these properties in Chicago and Cook County the commercial tax appraiser must assume the properties are vacant and available to be leased or sold at market levels even if this is not in fact the case. If you purchase a custom built home the builder will put in whatever you want and charge you cost plus profit for it. When you sell the home, however, the market will only pay for features it wants, not the special features you wanted built-in. A fast food restaurant that is closed, for example, may be purchased by another fast food chain that will strip the building to a shell and rebuild their own prototype. We have seen the same thing happen to bank branches.

Custom-built commercial properties often sell, but they are sold subject to the lease of the original occupant so the lease payment is structured to cover the cost to build the custom design. These sales would be classified as leased fee, not fee simple sales. A second generation reuse of the property would be required to find the fee simple value. Commercial tax appraisers should be looking for this second generation space when finding sales comparables.

The cost approach can be particularly problematic for custom built and special use properties. The cost approach for custom-built buildings usually results in an understatement of depreciation, as these properties almost by definition have features that the general market is not willing to pay for. Even very new properties can suffer from functional and external obsolescence – sometimes substantial amounts. Estimating this depreciation can be very difficult and often requires second generation rental data to help get a handle on it. For example, Von Moody, CRE, MAI, FRICS, CCIM (a former Senior Vice President at Wachovia Corp involved in bank branch acquisition and disposition strategies) indicated in a Onesource Property Tax newsletter concerning bank branches that "It is not unusual for alternate users to purchase relatively new branches for around 20% to 40% (or even less) of what it might cost to build a new building (plus land value)."

So why would a sophisticated national company pay well above the market value or market rent for these custom-built properties? It is because while the cost of the real estate might not make sense on a stand-alone basis, it could make sense as a part of the overall business operation of the owner or tenant. When a nationally known fast-food establishment was asked why it had paid what was seemingly a high premium for land for one of its restaurants, the response was, "We're not in the real estate business, we're in the hamburger business. The land price is completely acceptable as a part of the overall business plan, and that is all we care about." Other buyers, however, would not be willing to pay an above market premium for sale or rent for a custom built property designed around someone else's business model. A new buyer would pay less, sometimes substantially less, than the cost-based amounts. This is why the cost approach frequently overstates property values.

Our commercial tax appraisal assignment for the Cook County assessor is to estimate the fee simple market value of the property. The value in use or leased fee value could be dramatically higher than the fee  simple market value in many cases. The fee simple market value is simply measuring a different bundle of rights.

In many cases the assessor is actually measuring the value-in-use or leased fee value and not the fee simple market value. Hotels, for example, might have a very substantial business value that must be reconciled from the overall value as it is not real estate. A commercial tax appraiser in the Chicago market must segregate out and allocate values attributable to real estate business.

When having your Chicago area commercial or industrial property appraised for assessment purposes it is important that your commercial tax appraiser understand the distinctions between the fee simple real estate value and leased fee or business values. Real estate taxes are a fact of life but you only want to be paying your fair share and they should be based on the real estate values not your business value.