Property Tax: Dark Store Controversy and COVID-19

Property Tax: Dark Store Controversy and COVID-19

Bob Butterbaugh, Practice Leader, Property Tax Services

30-Second Summary

  • The Dark Store Theory is putting Big Box retailers back in the spotlight for challenging the values of real estate for property tax purposes as a result of COVID-19 and other market drivers
  • Retailers, suppliers, and communities are re-examining the valuation premises used to value real estate as they try to determine how the landscape and viability of “bricks and sticks” retail property will change
  • This article shares the foundational valuation premises that are at issue, perspectives from professionals in the appraisal and assessment communities, and practical insights and steps you may consider before legislation, litigation, or common sense proposals are enacted

The Dark store theory is a complex and often contentious topic. It is no wonder why this topic generates so much controversy; it is fueled by near-daily announcements of stores shuttered amid the COVID-19 and state-mandated stay-at-home orders. These stay-at-home orders compound ongoing changes in customer preferences spurred by the growing migration to online shopping alternatives. Some retail stores, such as grocery chains, may be likely to recover more quickly from the COVID-19 pandemic than their counterparts who are selling nonessential products. However, the accelerating trend toward ecommerce alternatives will significantly change the landscape of the demand for “bricks and sticks” commercial property in many regional markets.

As the core valuation issues are dissected and interpreted, proposed state legislation is introduced, and contentious courtroom battles emerge across the country, media coverage is feeding public opinion. Big Box retailers are often cast as the villains in the stories and images of the economic collateral damage of these vacated stores and shopping centers. The perception is that they’ve created significant erosion to the property tax budgets of local communities and have passed that additional tax burden on to the unsuspecting base of existing taxpayers.

However, often left out of these stories garnering headlines are the economic realities of the impacted companies. These companies are faced with property tax liabilities in excess of equitable assessment administration based on fair market value in exchange valuation principles. This can make it difficult to stay competitive in this rapidly evolving marketplace.

The result: expensive litigation, and stores that remain dark (pre and post COVID-19) until a viable use for that property attracts buyers in the specific markets. In the meantime, local economies continue to struggle, and a storm of confusion remains around the valuation fundamentals behind the dark store theory and around how companies can remain competitive in their communities.

In this post, I will share the foundational valuation premises that are at issue; perspectives from professionals in the appraisal and assessment communities; and some practical insights of some steps you may consider before legislation, litigation or common sense proposals are enacted.

Appraisal Theory

At the core of the dark store controversy are the underlying valuation principles that have served as the foundational bedrock of the appraisal profession for many years. The definition of marketing value, according to Uniform Standards of Professional Appraisal Practice formulated by the Appraisal Standards Board of The Appraisal Foundation is:

“The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.  Implicit in this definition is the consummation of a sale as of a specific date and the passing of title from the seller to buyer…”[1]

Most state statutes use a definition of market value in exchange similar to the above, which serves as the basis for the values subject to property taxation.  They include:

Fee simple estate: absolute ownership unencumbered by any other interest or estate subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, ad escheat. represents an unencumbered property right interest where the right of occupancy has been conveyed to another party.[2]

Leased Fee Interest: the ownership interest held by the lessor, which includes the right to receive the contract rent specified in the lease plus the reversionary right when the lease expires.[3]

Heart of the Controversy[4]

When it comes to the Dark Store Theory of property valuation, some assessors take the position that an occupied store always has more value than an unoccupied store. They advocate that a fully occupied store subject to a leased fee interest is the only appropriate basis for valuation. This is opposed to comparable sales of fee simple interest properties that may include reliance on the sales of properties that are not occupied at the time of sale.

The spotlight on the dark store theory gained momentum in a few states in the mid-2000s, and has garnered more attention in the past few years. After several high-profile Big Box retailers won some influential legal decisions, significant numbers of appeals have been filed.

Big Box retailers are the primary focus of this prevailing theory. They argue that stores were purchased subject to long-term agreements at the time of their original financing and construction agreements, many of which are no longer at market rates. They further contend that deed restrictions tagged to vacant properties are not significant deterrents to the sale of the vacant property.

The willing-buyer, willing-seller concept is a key premise of the most probable price that will be negotiated between these parties. In addition, the buyer will typically use the property according to its highest and best use. The date of the valuation is also an important consideration in the appraisal; conditions may be distinctly different than the date that the financing terms and rates that were applicable to the property’s original construction.

When a property that is subject to a lease encumbered by a leasehold estate is sold, that interest is called a leased fee interest. The controversy comes into play when the subject property is leased at rates no longer in equilibrium with the current market and subject to construction variations or uses that no longer comport with the first-generation property.  At issue is what a willing buyer would be willing to pay if the lease were consummated at market rates.

The appraiser must answer these questions directly from market value evidence for their assigned Big Box retail properties under appraisal, rather than any preconceived viewpoints of the differences between properties subject to leased fee or fee simple interest. Situs RERC conducted a survey of market participants during 2019 that included respondents from an array of positions: academics, commercial appraisers, assessors, asset managers, attorneys, brokers, investors, retail property owners and property tax practitioners. This comprehensive survey examined 740 transactions of Big Box properties from all over the country, segmented according to locational, physical, economic, and transactional demographic characteristics. The results provided a data set with substantial market evidence to support the difference between fee simple and leased fee properties noting the following key takeaways[5]:

  • There was no measurable decline in the value from deed restrictions for big box properties over 50,000 square feet.[6]
  • Market size is the most significant variable for both fee simple and leased fee sales of big box properties.
  • There is a clear relationship between most variables and their impact on sales price which is different for fee simple and leased fee sales.

What Can Be Done in this Current Period of Flux

For corporate tax departments, the dark store issue is not about just being a good corporate citizen. The companies that I have worked for are generally eager to pay their fair share. However, corporate tax departments also embrace sound state and local tax policy that adheres to recognized standards of appraising property with equity and fairness. The devastating economic ripple effects of the COVID-19 pandemic will likely accelerate the trend from traditional stores to e-commerce alternatives and the spotlight on the dark store controversy will continue to be the subject of appeals, litigation, and legislative proposals.

While several states are already moving forward with legislation around the dark store theory, the issue remains ambiguous across most of the country. This means that there is still hope for corporations to work with the assessment community and other parties to find a fair and balanced middle ground. Here are some steps you can take during this period of flux:

  • Continue to use recognized valuation principles, rely on market value evidence, and where appropriate engage appraisers and practitioners to support the values of your properties subject to property tax.
  • Become actively involved in the public discourse to educate parties on the valuation and financial realities of the industry and on the specific regional markets where you do business.
  • Participate actively during lease renewals, work closely with landlords and present market value evidence that reflects the current market conditions as of the valuation date.

As the implications of the dark store controversy and COVID-19 continue to unfold, the drain on internal resources will increase, and potential outcomes can be costly. Global Tax Management (GTM) is closely monitoring these developments and will continue to update you on any significant changes as they occur. For more information, please contact me at RButterbaugh@gtmtax.com.

About GTM’s Property Tax Services
Many companies may not recognize property tax as a controllable cost that impacts the bottom line. If not addressed properly, this can often lead to missed savings opportunities, including allowable deductions and exemptions for personal property tax and inflated assessments for real property. GTM provides property tax outsourcing and advisory services to ensure that companies are monitoring real property tax assessments and filing correctly and taking advantage of allowable savings opportunities for personal property tax. Our services include property tax compliance, valuation review and appeals, audit support, and fixed asset and reclassification reviews. Learn more about GTM’s Property Tax Services.

[1] The Appraisal Foundation, The Uniform Standards for Federal Land Acquisitions.

[2] Appraisal Institute, The Dictionary of Real Estate Appraisal, 4th edition.

[3] Appraisal Institute, The Dictionary of Real Estate Appraisal, 4th edition.

[4] For more in-depth position papers on the dark store theory and big box valuations, see the referenced position papers:

  • International Association of Assessment Officials, Commercial Big-Box Retail: A Guide to Market Based Valuation, published, September 2017.
  • The Appraisal Institute prepared an Exposure Draft of Proposed Guide Note (January 2019) to address the guidance for appraisers with leased fee and fee simple interest assignments which may involve big-box retailers.
  • Situs RERC published an IPT Sponsored Research project, Big Box Valuation Methodology, Sale Transaction Analysis, and Market Participant Survey, November, 2019 that was based upon research of the influencing factors of big box sales prices, practical applications and data analysis of transactions from a market participants’ perspectives.

[5] Situs RERC – IPT Sponsored Research project, Big Box Valuation Methodology, Sale Transaction Analysis, and Market Participant Survey, November 2019; page 60.

[6] Opponents of the use of vacant structures as sales comparables claim that they are not valid as most often have deed restrictions that severely limit their use.

About The Author(s)

Robert Butterbaugh
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As Director for GTM's Property Tax Services, Bob is responsible for oversight and delivery of all property tax outsourcing and advisory services offered by the...