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Valuing Retail Buildings for Real Estate Assessment Purposes

Go With the Cost Approach for Best Results

James Siebers    |    Property Valuation

Recently, several national chain retailers have attempted to get their property assessments and taxes reduced based on the assumption that the buildings out of which they operate should be valued by comparing them to vacant or “dark” buildings, or buildings that are used for a different, less valuable purpose than what they were intended for. The retailers argue they should receive a break on their buildings’ assessed value because their buildings are only worth what the vacant or abandoned buildings in the community are worth. The retailers also contend that their buildings are customized specifically for their use and thereby are not able to be used by another occupant. Because there has been some legal success using this method of argument in Indiana, Michigan and Wisconsin, both the Income Approach (valuing cash flows) and Sales Comparison Approach (using comparable sales) are becoming less reliable approaches to valuing retail properties.

The same national retailers argue that the rent they pay to their landlords—owners of the real estate development that was built specifically for their use—is not “market rent” and cannot be used in setting a value using the Income Approach1. The landlords are mandated by corporate standards to purchase the premium high-traffic lots and build stores to certain specifications. The rents paid to landlords generally cover the costs to assemble the land and build the structure. Instead of basing the value on actual rents, they hope to have their building valued by using the rents of vacant and distressed buildings. The landlords of these vacant buildings are often willing to accept lower than market-value rents.

This argument is also in play when using the Sales Comparison Approach. Vacant, and many times abandoned, retail establishments generally sell for significantly discounted prices. Using these sales as comparable sales in an appraisal would severely affect the valuation of the property.

Of the three approaches to value, the Cost Approach, or the cost to replace the building less depreciation, is the most reliable method for valuing these national chain retailers at full value. Additionally, the Cost Approach is most useful when there is relatively new construction, and reduced market transactions limit the effectiveness of the Sales Comparison Approach. The Cost Approach is also the best method to use when land value is well supported with market activity and when improvements represent the highest and best use of the land. Based on the reasoning that a retail building should be valued for tax assessment purposes for what it costs to construct, the Cost Approach is the preferred method to determine a full value replacement or reproduction cost.

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