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Volume 8 - Opinions of Counsel SBEA No. 65

Opinions of Counsel index

Assessments, generally (methods of valuation) (income approach - market vs. contract rent) - Real Property Tax Law, § 305:

In determining value using the income capitalization methodology, the courts prefer market rent data to actual contract rent in circumstances in which contract rent would yield distorted valuations.

The leading New York case on the use of actual rent vis-a-vis market rent for valuation of real property for assessment purposes is Merrick Holding Corp. v. Board of Assessors of the County of Nassau, 45 N.Y.2d 538, 382 N.E.2d 1341, 410 N.Y.S.2d 565. In this 1978 decision, the Court of Appeals reiterated the longstanding rule that, in the absence of reliable market data, alternative methods of valuation such as income capitalization or reproduction cost may be employed to value real property for assessment purposes. In using an income approach, the appraiser is required to exercise judgment to estimate the present worth of benefits to be gained from the subject property since “[t]he goal at all times remains full value.” (45 N.Y.S. at 542)

The Court concluded that market rental value is appropriate where 1) contract rents are arbitrarily set; 2) contract rents are the result of self-dealing or collusion; or 3) use of long-term contract rents would yield distorted valuations. Under such circumstances, the Court said that an assessor may apply compensatory measures calculated to adjust the contract rents to a point at which they become reliable indicators of full value. These adjustments are necessary in order to value all the interests in the property as a single “bundle of rights”, thereby including both the lessor’s and lessee’s interests in the property. The Court further reasoned that owners of taxable real property are required to pay taxes on the market value of the property taken as a whole and may not by independent contract “. . . shift part of his tax burden to the shoulders of his fellow taxpayers.” (Id. at 544)

In 5 Op.Counsel SBEA No. 62, we concluded that while actual rent realized is a significant factor in the valuation of income producing property, there are circumstances under which actual rents may be disregarded or discounted. We are now asked to reconcile Merrick and our earlier Opinion with four Appellate Division decisions. We consider the first to be inappropriate in that the subject property was a rent controlled building in the City of New York (Rockaway Crest Section I Inc. v. The Tax Commission of the City of New York, 38 A.D.2d 759, 329 N.Y.S.2d 620 (2d Dept. 1972)). The other three cases predate but are not inconsistent with Merrick and actually support our Opinion.

For example, in People ex rel. Gale v. Tax Commission of the City of New York, 17 A.D.2d 225, 233 N.Y.S.2d 501 (1st Dept. 1962), the property was leased in 1934 for a period of twenty-one years at an annual rental of $36,000 with an option for an additional twenty-one years at the same rental. The option was renewed in 1954. In concluding that the contract rent could not be used to determine the value of property for tax purposes, the court stated:

The amount of rental fixed by a lease, even though negotiated at arm’s length, could be very misleading, as to the true value of property, for it is well known that many rental contracts may be at excessive or inadequate rentals because of poor business judgment on the part of one party or another. Then, too, long term rental contracts may be made in boom times or in times of depression, so do not necessarily reflect true value on a change in times.

* * *

So, the existence of an outstanding lease at an unrealistically low rental for a long term, not representing the fair rental value of the property, is not to be used as a basis for calculating actual value. Thus, the true value of the property for assessment purposes is to be ascertained as if unencumbered by such a lease. [233 N.Y.S.2d at 506-507]

Also, in the case of Westbury Drive-1n v. Board of Assessors of the County of Nassau, 70 Misc.2d 1077, 335 N.Y.S.2d 361 (S.Ct., Nassau Co. 1972), aff’d 45 A.D.2d 821, 356 N.Y.S.2d 1017 (2d Dept. 1974), dismissed for failure of proof, the court made the following observation:

The court concludes that land value based solely upon a twelve year old ground lease and which, in the face of a rising land market in the area, wholly ignores current sales of comparable vacant land is not a proper basis for arriving at the “full value” of the subject property. Petitioner’s approach to land value by giving conclusive weight to the ground lease and ignoring sales of vacant land and improved property purchased for land use, flies in the face of the requirement that “in arriving at the true value for tax assessment purposes of real property subject to a lease, an appraisal is to be made of the property as a whole regardless of the effect of the lease upon the value of the owner’s interest” [citations omitted]. [335 N.Y.S.2d at 365]

As to the final case cited (Ernst v. The Board of Assessors of the City of Lockport, 58 Misc.2d 504, 295 N.Y.S.2d 712 (S.Ct., Niagara Co. 1968), aff’d 33 A.D.2d 655, 306 N.Y.S.2d 672 (4th Dept. 1969)), the petitioner’s expert testified that although the fair market value of the subject property was in excess of $1 million, due to a “deficient lease” the estimated present value was $740,000. The court stated that “Thus, in arriving at the fair market value of the subject property, the court must take into account its rental potential, both the fee and leasehold value, not just the actual rent charged.” [295 N.Y.S.2d at 716]

Perhaps the best rationale for the rule in New York is provided by Justice Fuchsberg in Merrick:

The net result is that a landlord, despite low income occasioned by below market leases, nevertheless remains obligated to pay taxes on the market value of the property taken as a whole. At first blush, this may appear to penalize the unsuccessful entrepreneur for a lack of business acumen. But it must always be remembered that an underlying aim of valuation is to assure that, in providing for public needs, the share reasonably to be borne by a particular property owner is based on an equitable proportioning of the fair value of his property vis-a-vis the fair value of all other taxable properties in the same tax jurisdiction. Otherwise, the landlord who fails to realize the fair potential of his property would, in effect, shift part of his burden to the shoulders of his fellow taxpayers. [45 N.Y.2d at 544]

January 18, 1985