Dark Store Theory - Whose Theory is it Anyway?
Lately there has been a lot of media coverage of “Dark Store Theory”. It is presented as a loophole used by unscrupulous taxpayers to evade paying their property taxes.
In truth - it isn’t the taxpayers that are advancing anything new. Basic valuation requires that you look at all relevant comparables. If you are in a market with a large number of vacant stores, ignoring them in the valuation would be an error.
By labeling standard valuation practice as some sinister “theory”, taxing authorities and assessors distort the issue, reducing the credibility of the taxpayer’s expert. It makes it sound like the taxpayer has retained some vulture who is using a sketchy theory in an attempt to pad their client’s bottom line. In reality, it is those who seek to ignore “dark stores” who are being intellectually dishonest.
Here is a simple way of looking at it. Imagine two identical buildings, side by side. One is vacant, and has been for a long time. It has been listed for sale at $1,000,000, and in a year has only had one interested party, who walked away because the price was too high. Next door is an operating business (insert favorite bad-guy retailer name here). The local assessor has valued this building at $2,000,000. They have a value based on the income approach supporting this value, although the vacancy rate seems suspiciously low in their calculations. Or maybe they have a cost approach value, showing minimal depreciation, producing a value much higher than on the vacant building.
How can this be? Business value, that’s how. Certain businesses are capable of driving people in to the stores, and they can thrive when others fail. Much like how a movie star can boost the ticket sales of a mediocre movie, so certain brands can boost the revenues of buildings, even in troubled markets. During challenging economic times, even relatively new buildings might not be worth what they cost to build.
To many, though, it seems unfair to value a fully leased store packed with customers with the same value as its dark and quiet neighbor. But the problem is - in most jurisdictions in Canada and the US, intangibles (like business value) are not to be taxed. Property tax is a wealth tax (based on owned value of tangible assets) not an income tax. When good management, branding and marketing allow a business to generate more income than their competitors, it drives up their income tax, not property tax. If the buildings are the same, then their property tax assessment should be the same. The solution isn’t to resort to the cost approach. Cost is the valuation approach of last resort, historically used by assessors on complex industrial properties which don’t lend themselves to any other method. The income approach is what is best used on properties which are generally leased, but it only works if you actually use real market data - not just that data which fits the assessor’s preconceptions.
The next time you read of some sinister but profitable company getting a property tax reduction due to the presence of similar vacant properties, remember, this is how the system is designed. A similar issue comes up in industrial properties when we consider external obsolescence, often referred to as economic obsolescence. That will be discussed in a later post.