SC Administrative Law Court Decisions

This is a contested case brought by Gaffney Properties as an affiliate of Boyd Management (hereinafter referred to as "taxpayer") against the Cherokee County Assessor (hereinafter referred to as "assessor") concerning a property valuation for property tax year 1994. The property owner has exhausted the prehearing remedies with the assessor and the Cherokee County Board of Assessment Appeals, and is now seeking a contested case hearing before the Administrative Law Judge Division (hereinafter referred to as "ALJD"). Jurisdiction is granted the ALJD by 1995 S.C. Acts 60, § 12-60-2540 with this matter having been heard on November 1, 1995. After considering all of the testimony and evidence, I conclude the property must be valued at $1,519,578.

Any issues raised in the proceedings or hearing of this case but not addressed in this Order are deemed denied. ALJD Rule 29(B). Further, the filing of a motion for reconsideration is not a prerequisite to any party filing a notice of appeal of this Order. ALJD Rule 29(C).

What is the value of the property for the tax year 1994?

1. Positions of Parties:

The assessor asserts the property must be valued by giving consideration to the market rents in the area without such value being limited by the actual rents being charged. Further, the assessor argues the value of the reduced mortgage interest rate and the tax shelter benefits granted to the owner must be considered in arriving at a value. From these two positions, the assessor believes a value should be established of between $1,300,000 to $1,600,000.

The taxpayer argues the property must be valued based upon the actual rents charged, since the property is legally restricted to a maximum rental charge to its tenants. Further, the taxpayer asserts the value of any intangibles such as interest subsidies and tax shelter benefits are not a part of the value of the real property, and thus, are not to be considered in valuing the property. The taxpayer asserts the value of the property is $816,100.

2. Findings of Fact:

I find, by a preponderance of the evidence, the following facts:

a. General

1. The taxpayer is the owner of real estate consisting of 4.27 acres of land with improvements used as a Farmers' Home Administration (FHmA), section 515, multifamily housing project.

2. The property is located in Cherokee County, South Carolina, is identified on the Cherokee County Tax Map as Tax Map # 098-00-00-096.001, and carries an address on Bonner Lake Road in Gaffney, South Carolina.

3. The property consists of 48 apartments built in 1989 known as Ryan Park Apartments, with 16 units being one-bedroom apartments and the remaining 32 units being two-bedroom apartments.

4. The one-bedroom units contain 641 square feet and the two-bedroom units contain 826 square feet.

5. The taxpayer asserts the property must be valued at $816,100 for the tax year 1994, while the assessor asserts a value within a range of $1,300,000 and $1,600,000 is warranted.

b. Valuation Methods

i. Market Sales

6. An appraisal by the taxpayer valued the property at $696,000 under a market sales method.

7. Two comparables were used by the taxpayer in the market sales approach, but neither comparable was the sale of subsidized property, neither was located in Cherokee County and neither has the same or similar amenities of the subject property.

8. The two sales are not reliable indicators of fair market value of the subject property.

ii. Cost Approach

9. The taxpayer valued the property using the cost method form of analysis and derived a value of $584,000.

10. Under the taxpayer's cost method, the improvements were valued at $486,318 and the land (including asphalt, sidewalks, and playground equipment) at $97,097.

11. The cost data used by the taxpayer in arriving at the $584,000 value is derived from the Marshall Valuation Service.

12. The property is classified for cost purposes as average.

13. The property includes reductions of 8% for physical depreciation.

14. The taxpayer determined economic obsolescence required a reduction of $654,545.

15. The taxpayer's economic obsolescence represents a reduction in value of 53% of the costs of the improvements.

16. The taxpayer's determination of economic obsolescence is premised upon the capitalization at 11% of an amount that purports to represent the rental income loss due to the restricted rental required by FHmA.

17. The cost approach is not a reliable indication of value of the subject property.

iii. Income Approach

18. The actual net operating income excluding depreciation, property taxes, and interest expense for 1993 was $73,448.

19. A capitalization rate of 9% is an appropriate capitalization rate for the property here under review as of December 31, 1993.

20. A capitalization rate of 9% produces the yield a purchaser would seek on the capital investment needed to purchase the subject property.

21. Under the direct capitalization of income approach, the value of the income stream produced by the subject property is $816,089 for the tax year 1994.

iv. Other Value Methodology

22. The debt owed on the property as of March 28, 1989, was $1,498,650, with a payment period of fifty years at a rate of 9%.

23. The taxpayer does not pay interest at 9%, but rather is allowed and is required to pay interest at 1%.

24. The debt was outstanding as of December 31, 1993.

25. Long term mortgages for apartment property for the last quarter of 1993 were available for 10.5%.

26. The value of the tax credits from the taxpayer's ownership of multi-family low income housing is $170,149.

3. Discussion

The issue in dispute is the value of the taxpayer's property for the tax year 1994. That value turns upon deciding whether the current use as a low-income housing project is the highest and best use for the property; and then deciding how, if at all, the typical valuation methods account for the advantages and detriments associated with subsidized rental housing.

a. Highest and Best Use

Under the General Assembly's mandated method of determining value, the proper value is found by establishing the price a willing buyer would pay to a willing seller for the taxpayer's property with both parties reasonably well informed as to the uses and purposes for which the property is capable of being used. S. C. Code Ann. § 12-37-930 (Supp. 1994). Such an approach determines the fair market value of the property with such value being the value for taxation purposes. Lindsey v. S.C. Tax Comm'n, 302 S.C. 504, 397 S.E.2d 95 (1990).

In arriving at fair market value, the highest and best use of the property must be employed. 72 Am. Jur. 2d, State and Local Taxation, §759 (1974). Highest and best use is the use which will most likely produce the highest market value, greatest financial return, or most profit from the use of a particular piece of real estate. State National Bank v. Planning and Zoning Comm'n., 239 A.2d 528 (Conn. 1968). The use cannot be purely speculative, but rather must be reasonable and practical. Masheter v. Ohio Holding Co., 313 N.E.2d 413 (Ohio 1973), cert denied, 419 O.S. 835 (1974). Further, a use that may give a greater value cannot be considered if that use is prohibited due to a restriction on the property. See Kensington Hills Dev. Co. v. Milford Township 159 N.W.2d 330 (Mich. App. 1968). Only where the use of property is restricted by self-imposed limitations are such limitations ignored in arriving at a value. NeBoShone Ass'n, Inc. v. State Tax Comm'n., 227 N.W.2d 358 (Mich. App. 1975).

In the instant case, the highest and best use of the property is the current use as a subsidized housing project. The primary limitation on the use of the property is that of requiring the owner to provide housing at a specified rental rate affordable to low-income tenants. The limitation prohibits the owner from charging a rental that the market as a whole might be willing to pay. Thus, the FHmA imposed limitation is a prohibition on the property prohibiting a potentially higher use of the property. Further, the limitation is imposed from outside the ownership, and is therefore not self-imposed by the owner. Accordingly, the highest and best use of the property is the current use as a low-income housing project.

b. Valuation of Subsidized Housing

i. General Observations

To encourage the construction and maintenance of adequate low-income housing, FHmA imposes restrictions and grants benefits to the owners of properties providing low-income housing. The benefits include the granting of a loan at the effective rate of 1% for a fifty year period to purchase the property, and the granting of income tax credits by the Internal Revenue Code. The limitations are that the owner is required to charge a rent that is lower than the rent the market would dictate, the owner is limited to an 8% return on equity, and the owner is not allowed to prepay the loan to relieve itself of the rental restriction until FHmA gives its consent. Against this background, a valuation method must consider both the detriments and the benefits.

ii. Market Sales

The evidence here provides no persuasive support for a value determination based upon a market sales approach. There is no evidence of the sales of similarly restricted rental properties. Rather, the only sales submitted are of unrestricted properties. A sale of an eight unit complex of duplexes and townhouses occurred in Gaffney on September 11, 1992, for $112,500, giving a value per unit of $14,063. A second sale occurred in Greenville in January 1991. This sale of 65 units constructed in 1972 sold for $13,308 per unit. After adjustments for age and location, a value per unit of the taxpayer's property of $11,977 was suggested. Since these sales are not of subsidized units, the market sales approach is not meaningful in valuing the current property.

iii. Cost Approach

Under the cost approach, the taxpayer arrived at a value of $584,000, with improvements accounting for approximately $554,000 and land approximately $30,000. The taxpayer determined the value by calculating the replacement cost for the improvements, subtracting an amount for depreciation, and adding the value of the land. In arriving at the $584,000 value, a $654,545 reduction for economic obsolescence was taken. The taxpayer's economic obsolescence represents a reduction in value of 53% of the costs of the improvements. The deduction was determined by capitalizing at 11% the difference between the market rent and the actual rent. The size of the deduction underscores the inadequacy of the cost method. The economic obsolescence results in the cost method being more dependent upon calculating value by an income approach than by the cost of the construction of the property. Accordingly, the cost approach is likewise not meaningful in valuing the current property.

iv. Income Approach

In the instant matter, the assessor and the taxpayer relied primarily upon the income approach to value the subject property. While the market approach and cost approach are both viable means of ascertaining value, the income analysis is recognized as a proper means for valuing property whose purpose is primarily the production of income from rent. Bornstein v. State Tax Comm'n, 176 A.2d 859 (Md. 1962). Accordingly, a proper method of valuation for the property in dispute must include the income approach.

The income approach is a practical one for "[p]eople in the market place dealing with the realities of the moment when they invest their money" and "it is the market place value of the real property which determines its value for ad valorem taxes." S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985). Thus, in applying the income approach, a prospective purchaser would value the property by determining the rental income stream produced by the actual income and expenses.

A buyer expects rental property to produce a stream of rental income. Capitalizing that stream of income is an essential element in determining the value of the property. See The Appraisal of Real Estate (American Institute of Real Estate Appraisers 10th ed.). In determining the rental income to be capitalized, a prospective buyer would utilize the actual income generated by the property, rather than potential economic or market rents where there is an encumbrance on the property that prevents generating the potential economic or market rents. S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985).

For the year ending December 31, 1993, I find the actual income and expense must be employed in arriving at a stream of income to be capitalized. The gross rent is capped by the FHmA, and thus the taxpayer has no ability to earn a greater income. For 1993, the income from the property was $135,261.25. A potential buyer would not value the property by using "market" rents when it is known that market rents are prohibited.

As to expenses, there is no persuasive evidence demonstrating that the expenses of operating the property are improper. It is established that subsidized housing is more expensive to operate than traditional properties when the expenses are expressed as a percentage of gross income. In the instant case, the expenses for the 1993 operating year total $61,812.60, excluding property taxes. I find these expenses are the amounts a potential buyer would use in determining the operating income of the property. Accordingly, $73,448.65 is the amount the evidence best supports as being the rental income subject to capitalization.

After determining the income to be capitalized, a capitalization rate, i.e. the desired yield a purchaser would seek on the capital investment, must be determined, which, when divided into the net operating income, produces an estimated value of the rental income abilities of the property. S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985). The taxpayer's calculation results in a 9% rate, while the assessor relies upon a rate of 10%. I find the taxpayer's rate more representative. The Appraiser News for January 1994 from the Appraisal Institute Research Department estimates that the capitalization rate for the last quarter of 1993 produced a range of 8.0 to 9.5% with an average of 8.7%. Accordingly, I find the 9% capitalization rate is proper. Applying a 9% capitalization rate to an income stream of $73,448.65 gives a value of the income stream of $816,096.

v. Other Value

If there were no other elements of worth for which a potential buyer would give value, the calculation of the income stream of actual income and expense would end the dispute. The rental income from a property, however, is not the only or even necessarily the controlling element considered in valuing property. 84 C.J.S. Taxation §411 (1954). Other elements of value of the subject property must be considered. In the instant case, two intangible factors influence the value of the property.

As a preliminary matter, I find that the addition of value to property due to an interest subsidy and due to federal income tax credits is not within the prohibition on taxation of intangible personal property identified by the S.C. Const. art. X, § 3(j). In the instant case, the intangibles themselves are not taxed, but rather are only factors that influence value much as other intangibles such as zoning status or a deed restriction may have an impact upon value. Meadowlanes Ltd. v. City of Holland, 473 N.W.2d 636 (Mich. 1991); Kankakee Cty. v. Property Tax Appeal Bd., 544 N.E.2d 762 (Ill. 1989).

vi. Interest Subsidy

Rights connected to a specified parcel of real property are required to be considered in the valuation of that property. 84 C.J.S. Taxation §411 (1954). Just as a limitation on property is relevant to value, so too is a benefit derived from the property. The elements of limitations and benefits are considered in the market place by potential purchasers and must be considered in tax valuations since it is "the market place value of the real property which determines its value for ad valorem taxes." S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985). The interest subsidy allows entrepreneurs in the low-income housing market to participate in the market and without such subsidies private construction of multi-family low-income housing would be significantly limited. Rebelwood, Ltd. v. Hinds County, 544 So.2d 1356 (Miss. 1989). Accordingly, the value of federal subsidies or benefits enjoyed by a taxpayer as a result of ownership of a federally subsidized low-income housing property must be considered in determining value for ad valorem taxes. Meadowlanes Ltd. v. City of Holland, 473 N.W.2d 636 (Mich. 1991); Rebelwood, Ltd. supra.

In the instant case, the taxpayer entered into an arrangement with FHmA in which the taxpayer became the owner of a low-income multi-family housing project and received the benefit of an interest subsidy. The amount of the subsidy is the difference between a 9% loan repaid over 50 years and that of a 1% loan repaid over the same period. In the instant case, the original loan was approximately $1.5 million. In return for the interest subsidy, the taxpayer gave up several of its rights with the most significant right relinquished being its right to charge market rents.

The issue of determining the value of the interest subsidy turns upon deciding the value a prospective purchaser of the property would attribute to the reduced interest rate. While the methodology that follows can be refined to consider numerous other factors that the market may analyze, the approach taken here provides an acceptable means of valuing the subsidy and is consistent with the evidence presented in this case.

On December 31, 1993, a prospective purchaser would have been allowed to assume the 1% debt, as long as the new owner agreed to continue to charge the FHmA rates. Instead of assuming an existing project, however, the prospective purchaser could construct a similar low-income housing project and charge "market" rents and borrow funds at the prevailing rates. On December 31, 1993, the market rents for a similar apartment complex were $325 for the 16 one-bedroom units (compared to $220 under FHmA rules), and $375 for the 32 two-bedroom units (compared to $240 under FHmA rules). If the potential purchaser constructed his own apartment complex with the same number of units as the subject property, he could maximize his rents (charge the $325 and the $375 amounts) and thus generate $6,000 additional income per month beyond that which the taxpayer could generate [16 units x $105 ( i.e. $325 minus $220) plus 32 units x $135 (i.e. $375 minus $240) equals $6,000]. However, the potential purchaser would not hold a 1% loan, but rather would acquire a market rate loan on December 31, 1993. The only evidence addressing private long-term mortgage rates in the market place for multi-family housing indicates a rate of 10.5%. A 10.5% loan on $1.5 million over 50 years produces a monthly payment of approximately $13,200, as opposed to the 1% loan which produces a monthly payment of approximately $3,200. Thus, the ability to raise rents of $6,000 (the unrestrained market rent) comes at a cost of incurring an increase of $10,000 in mortgage payments ($13,200 for market rate loan of 10.5% minus the $3,200 for a 1% FHmA loan). Therefore, the 1% loan has a value that is based upon saving $4,000 per month ($10,000 mortgage payment increase minus $6,000 additional rent) when compared to a cost of a 10.5% loan in the open market. The $4,000 per month is $48,000 annually and is equivalent to "rental income" generated by interest expense savings and is thus properly capitalized at the same 9% capitalization rate used to determine the stream of rental income from the property. The 9% rate yields a value of the interest subsidy of $533,333.

As can be seen, if the prevailing mortgage rates dropped to 6%, there would be no value to the interest subsidy (i.e. able to raise rental income by $6,000 while having an increased mortgage payment of only $4,700 ($7,900 at 6% rate minus $3,200 at 1% rate). Correspondingly, if the prevailing mortgage rate reached 15%, the interest subsidy would have great value (i.e. rents increased by $6,000, but with mortgage costs rising by $15,560 ($18,760 at 15% rate minus $3,200 at a 1% rate). The market place will dictate the value of the subsidy and that value may change from year to year. Further, one must recognize that the market rent may also change from year to year and also have an impact on the value of the interest subsidy. Each year must stand on its own. The only decision made here is that as of December 31, 1993, the interest subsidy contributed $533,333 to the value of the taxpayer's property.

vii. Tax Credits

The tax benefits of low-income housing property form a part of the value of that property for ad valorem tax purposes. Antisdale v. City of Galesburg, 362 N.W.2d 632 (Mich. 1984); In re Appeal of Johnstown Associates, 431 A.2d 932 (Pa. 1981). Again, just as with interest subsidies, the market place relies upon the value of the tax benefits produced by the property in deciding the value of the property.

In the instant case, the only evidence of the value of the tax credits is that presented by the taxpayer. The evidence demonstrates that the value of the tax credits cannot be applied on a dollar for dollar basis. Tax credits may result in a 50% loss of the credit, and in some circumstances, a recapture of the credit is required. Accordingly, I find the credits may not be established on a dollar for dollar basis, but rather must be applied at a 50% reduction. Further, the rate for discounting the value of the credits to present value should not be based upon 12%, as suggested by the taxpayer. Rather, rates of return for investments associated with apartment complexes range from a low of 10.5% to a high of 12%. I find a 10.5% rate of discount is appropriate here. Accordingly, the value of property due to its ability to produce low-income housing tax credits is $170,149.

4. Conclusions of Law

Based on the foregoing Findings of Fact and Discussion, I conclude the following as a matter of law:

1. All property shall be valued for taxation purposes at its true value in money which in all cases shall be held to be the price which the property would bring following reasonable exposure to the market, where both the seller and the buyer are willing, are not acting under compulsion, and are reasonably well informed as to the uses and purposes for which it is adapted and for which it is capable of being used. S. C. Code Ann. § 12-37-930 (Supp. 1994).

2. Fair market value is the measure of true value for taxation purposes. Lindsey v. S.C. Tax Comm'n, 302 S.C. 504, 397 S.E.2d 95 (1990).

3. In arriving at fair market value, the highest and best use of the property must be employed. 72 Am. Jur. 2d, State and Local Taxation, §759 (1974).

4. Highest and best use is the use which will most likely produce the highest market value, greatest financial return or most profit from the use of a particular piece of real estate. State National Bank v. Planning and Zoning Comm'n., 239 A.2d 528 (Conn. 1968).

5. The use cannot be purely speculative but rather must be reasonable and practical. Masheter v. Ohio Holding Co., 313 N.E.2d 413 (Ohio 1973).

6. Where a restriction is not self-imposed and where that restriction prohibits a use that may give a greater value, such use cannot be considered in determining the value of the restricted property. See Kensington Hills Dev. Co. v. Milford Township 159 N.W.2d 330 (Mich. App. 1968); NeBoShone Ass'n, Inc. v. State Tax Comm'n., 227 N.W.2d 358 (Mich. App. 1975).

7. The highest and best use of the subject property is as low-income multi-family subsidized housing.

8. While fair market value can be determined under the market approach and cost approach, an income analysis is a reliable means for valuing the income producing attributes of real property. Bornstein v. State Tax Comm'n, 176 A.2d 859 (Md. 1962).

9. The income approach seeks to determine the present value of future benefits of income production from property ownership, with such value based generally upon the net income an informed buyer believes the property will produce during its remaining useful life. See The Appraisal of Real Estate (American Institute of Real Estate Appraisers 10th ed.).

10. The actual earnings from a property are entitled to great consideration in valuation. S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985).

11. The capitalization rate is the desired yield a purchaser would seek on the capital investment. S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985).

12. The value of the income producing attributes of rental property is primarily based upon the average net operating income divided by the capitalization rate. S.C. Tax Comm'n v. S.C. Tax Bd. of Review, 287 S.C. 415, 339 S.E.2d 131 (1985).

13. The income producing attributes of the property identified as Cherokee County Tax Map # 098-00-00-096.001 is valued at $816,096 for tax year 1994.

14. The rental income from a property is not the only controlling element considered in valuing property. 84 C.J.S. Taxation §411 (1954).

15. The addition of value to real property due to an interest subsidy or due to federal income tax credits is not prohibited as the taxation of intangible personal property. S.C. Const. art. X, § 3(j).

16. Value to real property due to an interest subsidy or federal income tax credits is not a taxation of the interest subsidy or the tax credits, but rather are only factors that influence value much as other intangibles such as zoning status or deed restrictions influence value. Meadowlanes Ltd. v. City of Holland, 473 N.W.2d 636 (Mich. 1991); Kankakee Cty. v. Property Tax Appeal Bd., 544 N.E.2d 762 (Ill. 1989).

17. Rights such as interest subsidies and tax credits connected to a specified parcel of real property are required to be considered in the valuation of that property. 84 C.J.S. Taxation §411 (1954).

18. The value of federal subsidies and tax credits enjoyed by a taxpayer as a result of ownership of a federally subsidized low-income housing property must be considered in determining value for ad valorem taxes. Meadowlanes Ltd. v. City of Holland, 473 N.W.2d 636 (Mich. 1991); Rebelwood, Ltd. v. Hinds County, 544 So. 2d 1356 (Miss. 1989); Antisdale v. City of Galesburg, 362 N.W. 2d 632 (Mich. 1984); In re Appeal of Johnstown Associates, 431 A.2d 932 (Pa. 1981).

19. The value of the taxpayer's property identified as Cherokee County Tax Map # 098-00-00-096.001 is $1,519,578 for tax year 1994.

Based upon the foregoing Discussion, Findings of Fact, and Conclusions of Law, the following ORDER is issued:

The assessor is ordered to value the taxpayer's property identified as Cherokee County Tax Map # 098-00-00-096.001 at a value of $1,519,578 for tax year 1994.

IT IS SO ORDERED.

____________________________

RAY N. STEVENS

Administrative Law Judge

This 8th day of November, 1995.