STATE OF MINNESOTA
IN SUPREME COURT
A15-1605
Tax Court Anderson, J.
Took no part, Chutich, J.
Archway Marketing Services,
Respondent,
vs. Filed: July 27, 2016
Office of Appellate Courts
County of Hennepin,
Relator.
______________________
Douglass E. Turner, Hanbery & Turner, P.A., Minneapolis, Minnesota, for respondent.
Michael O. Freeman, Hennepin County Attorney, Jane N.B. Holzer, Thomas F. Pursell,
John J. March, Assistant Hennepin County Attorneys, Minneapolis, Minnesota, for
relator.
__________________
SYLLABUS
1. The tax court’s decision to reject the sales comparison approach and instead
rely exclusively on the income capitalization approach was contrary to the evidence and
not supported by adequate reasoning.
2. The tax court’s rejection of lease comparables used in the County’s income
capitalization analysis was not clearly erroneous, because it was undisputed that the lease
comparables did not reflect market rates.
1
3. The tax court’s rejection of the comparables used to calculate a
capitalization rate was not clearly erroneous, because the appraiser’s report and testimony
do not support the County’s argument that the appraiser’s underlying financial
assumptions were irrelevant to the calculation of the capitalization rate.
Reversed in part, vacated, and remanded.
Considered and decided by the court without oral argument.
OPINION
ANDERSON, Justice.
Respondent Archway Marketing Services (Archway) challenged relator Hennepin
County’s assessment of the market value of two bulk-distribution warehouses for the
assessment dates of January 2, 2009, and January 2, 2010. Following a trial, the tax court
adopted market valuations lower than the recent sale price of each subject property. The
County appealed, asserting that the tax court erred by rejecting the County’s sales
comparison analysis and a large portion of the County’s income capitalization analysis.
Although the tax court did not err in rejecting portions of the County’s income
capitalization analysis, the tax court failed to adequately explain its reasons for rejecting
the County’s sales comparison analysis. We therefore reverse the portion of the tax
court’s decision that rejects the County’s sales comparison analysis, vacate the tax court’s
order, and remand to the tax court for further proceedings consistent with this opinion.
I.
This appeal concerns the tax value of two neighboring warehouse properties as of
January 2, 2009, and January 2, 2010. Archway Phase I (Archway I) and Archway
2
Phase II (Archway II) are adjacent bulk-distribution warehouses in Rogers. Both were
constructed pursuant to build-to-suit leases held by AHL Services, Inc. (AHL), but are
occupied by AHL’s subsidiary, Archway. In 2010, the owner of the property sold the
fee-simple interest in Archway I for $19,700,000. The fee-simple interest in Archway II
sold for $18,870,051 in 2012.
For tax purposes, the Hennepin County Assessor valued Archway I at $18,663,000
as of January 2, 2009, and $18,326,000 as of January 2, 2010. The assessor valued
Archway II at $13,774,000 as of January 2, 2009, and $12,000,000 as of January 2, 2010.
Archway challenged these valuations, and the matter proceeded to trial before the tax
court. Archway retained Paul G. Bakken to prepare an appraisal, and Justin J. Massmann
prepared an appraisal on behalf of the County.
We have recognized three methods of real estate appraisal: (1) the sales
comparison approach, (2) the income capitalization approach, (3) and the cost approach.
Equitable Life Assurance Soc’y of the U.S. v. Cty. of Ramsey, 530 N.W.2d 544, 552
(Minn. 1995). Both appraisers employed the sales comparison approach and the income
capitalization approach. The parties later stipulated that the cost approach was not an
appropriate method for valuing the subject properties.
The tax court found that Archway had overcome the prima facie validity of the
Hennepin County Assessor’s valuation, and thus the tax court considered the input
provided by the parties’ expert appraisers. See Westling v. Cty. of Mille Lacs, 512
N.W.2d 863, 866 (Minn. 1994) (stating that a county assessor’s valuation of real property
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is prima facie valid).1 But the tax court found numerous problems with the appraisals
presented by the parties. First, the tax court rejected each appraiser’s sales comparison
analysis due to issues with the underlying data. The tax court then rejected much of the
data that the appraisers relied on for their income capitalization analyses.
With sparse data left to examine, the tax court completed its own income
capitalization analysis using data from surveys that were cited by the appraisers. The
court valued Archway I at $14,462,000 as of January 2, 2009, and $11,531,000 as of
January 2, 2010. The court valued Archway II at $12,286,000 as of January 2, 2009, and
$9,811,000 as of January 2, 2010. The assessed values, appraised values, and actual sale
prices of each subject property are summarized below.
Appraisal Actual Sale County County’s Archway’s Tax Court
Year Price Assessor Appraiser Appraiser Order
(Massmann) (Bakken)
Archway I
2009 - $18,663,000 $20,900,000 $12,900,000 $14,462,000
2010 $19,700,000 $18,326,000 $18,600,000 $12,700,000 $11,531,000
Archway II
2009 - $13,774,000 $15,100,000 $9,400,000 $12,286,000
2010 - $12,000,000 $14,300,000 $9,200,000 $9,811,000
2012 $18,870,051 - - - -
1
The County does not dispute that Archway overcame the prima facie validity of
the county assessor’s valuation.
4
All of the tax court’s valuations were within the range of values proposed by the
parties, except that the tax court’s valuation of Archway I as of January 2, 2010, was
lower than the values proposed by the parties and the county assessor. More
significantly, all of the tax court’s valuations were far lower than the actual sale price of
each property.
The County appealed the tax court’s decision, contending that the court provided
inadequate reasons for rejecting Massmann’s sales comparison analysis and for rejecting
much of the data underlying Massmann’s income capitalization analysis.
We will not overturn a tax court’s valuation of real property unless the valuation is
clearly erroneous. Equitable Life Assurance Soc’y, 530 N.W.2d at 552. The tax court’s
valuation is clearly erroneous when “the evidence as a whole does not reasonably support
the decision,” Lewis v. Cty. of Hennepin, 623 N.W.2d 258, 261 (Minn. 2001), and we are
“left with a definite and firm conviction that a mistake has been committed,” KCP
Hastings, LLC v. Cty. of Dakota, 868 N.W.2d 268, 273 (Minn. 2015) (internal quotation
marks omitted). But “we will not defer when the tax court has ‘clearly overvalued or
undervalued the property, or has completely failed to explain its reasoning.’ ” Beck v.
Cty. of Todd, 824 N.W.2d 636, 639 (Minn. 2013) (quoting Harold Chevrolet, Inc. v. Cty.
of Hennepin, 526 N.W.2d 54, 58 (Minn. 1995)). Accordingly, when the tax court arrives
at a value that is higher or lower than the range of values proposed by either party, the tax
court “should carefully explain its reasoning for rejecting the appraisal testimony and the
grounds for adopting a lower or higher value, and adequately describe the factual support
in the record for its determination.” Eden Prairie Mall, LLC v. Cty. of Hennepin, 797
5
N.W.2d 186, 194 (Minn. 2011); accord Guardian Energy, LLC v. Cty. of Waseca, 868
N.W.2d 253, 263-64 (Minn. 2015). We have warned that when the tax court fails to take
these analytical steps, “it runs the risk of having its determination overturned.” Eden
Prairie Mall, 797 N.W.2d at 194.
II.
We first consider the tax court’s rejection of Massmann’s sales comparison
analysis, which led the tax court to rely solely on the income capitalization approach in
valuing Archway I and II. The three valuation approaches “are neither exclusive nor
mandatory upon either the assessor or the factfinding court.” Equitable Life Assurance
Soc’y, 530 N.W.2d at 554 (quoting Alstores Realty, Inc. v. State, 286 Minn. 343, 352, 176
N.W.2d 112, 118 (1970)). The tax court may rely on a single method of appraisal when
the other methods are not supported by accurate and reliable data. See Nw. Racquet Swim
& Health Clubs, Inc. v. Cty. of Dakota, 557 N.W.2d 582, 587-88 (Minn. 1997). But,
whenever possible, the tax court should employ at least two methods to determine the
market value of a property, because the different methods can serve as checks on each
other. Am. Express Fin. Advisors, Inc. v. Cty. of Carver, 573 N.W.2d 651, 657 (Minn.
1998). When the tax court solely relies on one method, as here, it must “clearly explain
the weaknesses of the rejected approaches.” Equitable Life Assurance Soc’y, 530
N.W.2d at 554-55.
When a market exists for a property, an analysis of that market provides the most
straightforward way to support an opinion of market value. Continental Retail, LLC v.
Cty. of Hennepin, 801 N.W.2d 395, 402 (Minn. 2011). Thus, the sales comparison
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approach values property based on the sale price paid “in actual market transactions of
comparable properties,” with adjustments to the sale price as needed to reflect differences
between the comparable property and the subject property. Id. Massmann selected five
real estate sales—including the sales of the two subject properties—to use as
comparables in his analysis. The tax court found that three of these sales comparables
were entitled to no weight, then summarily rejected the remaining two. We address these
sales comparables in turn, beginning with those the tax court addressed in detail.2
Sales Comparable 2 (Uponor Distribution Center)
Massmann used the sale of the Uponor Distribution Center in Lakeville as Sales
Comparable 2. Massmann acknowledged that this sale took place between related parties
who were originally partners in a joint venture, but he explained that the partners were
planning to dissolve the partnership and that, after the property had been placed on the
market, one of the partners ultimately decided to purchase the property.
Sales between related parties, such as partners in a joint venture, generally are not
indicative of market value. See Appraisal Institute, The Appraisal of Real Estate 410
(14th ed. 2013); cf. Lewis & Harris v. Cty. of Hennepin, 516 N.W.2d 177, 179
(Minn. 1994) (explaining that some comparables “were not arms-length transactions
which reflected actual market value”). But Massmann’s report explained that both the
2
Archway’s expert, Bakken, did not perform a sales comparison analysis for 2009,
and the tax court gave no weight to or otherwise rejected the sales comparables Bakken
offered to support his 2010 analysis. Archway did not appeal these determinations, and
thus we are concerned only with the tax court’s consideration of the County’s sales
comparison analysis.
7
buyer and the seller were publicly traded real estate investment trusts. To satisfy its
investors, the seller needed to ensure that the property sold at market value. Accordingly,
the parties based their sale price on discussions with brokers, who confirmed that the sale
price was consistent with the value of the property in the current marketplace. Based on
these facts, Massmann concluded that Sales Comparable 2 was representative of an
arm’s-length market transaction.
Yet, “[a]fter a review of the record,” the tax court found that Massmann “did not
overcome the presumption that [Sales Comparable 2] was not an arm’s length
transaction.” The tax court did not discuss the evidence in the record or explain how
Massmann could have overcome the tax court’s presumption that Sales Comparable 2
“was not an arm’s length transaction.” The court neither evaluated Massmann’s
credibility nor discussed the relevance of the fact that both the buyer and the seller were
publicly traded real estate investment trusts. Rather, the tax court simply restated the
point Massmann had acknowledged—that Sales Comparable 2 was a related-party sale—
without addressing Massmann’s reasons for concluding that the transaction was
nevertheless indicative of actual market value.
Sales Comparable 3 (Archway I)
Massmann used the 2010 sale of Archway I itself as the third comparable,
reporting that the property “was listed by” a commercial real estate company and that the
“[b]uyer and seller both stated the sale was an open market, arm’s-length deal that was
exposed to the market.” Massmann observed that the tenants guaranteed the lease in
2006, which potentially could have affected the sale price. But Massmann reported that
8
the “[b]uyer stated the guarantee did not affect the sale price” and that the buyer “viewed
[the local market] as stable with anticipated near term demand.”
The tax court rejected Sales Comparable 3 due to its “unusual financing,” which
“Massmann did not adequately address . . . in his appraisal or trial testimony.” Based on
our careful review of the record, we conclude that the tax court’s determination is
contrary to the evidence. Massmann was aware of the financing, and he described the
steps he took to verify that the transaction was nonetheless at arm’s length. Put
differently, the tax court did not identify any additional facts or analysis that Massmann
needed to provide in order to “adequately address the property’s unusual financing.”
Moreover, Sales Comparable 3 was the 2010 sale of Archway I itself. Although
the sale price of the subject property should not be conclusive, it is an important fact to
consider when valuing real estate. Minn. Entm’t Enters., Inc. v. State, 306 Minn. 184,
188, 235 N.W.2d 390, 393 (1975). The tax court did not address the fact that it was
rejecting one of the subject properties, nor did the tax court explain why it was
impossible to adjust for what it called “unusual financing” in the subject transaction.
Sales Comparable 4 (Cardinal Health)
Sales Comparable 4 was the 2011 sale of the Cardinal Health warehouse in
Champlin. Cardinal Health was originally part of a national portfolio of properties, but
the buyer elected to purchase Cardinal Health in conjunction with only one other
property—in other words, as part of a smaller portfolio. According to Massmann, the
“[b]uyer stated the sale was an open market, arm’s length deal that was exposed to the
market.”
9
At trial, Archway confronted Massmann with a report of the Assessor Commercial
Exchange, which listed the code “allocated sale price” next to this transaction.3
Massmann explained that this code indicates that the sale included more than one
property and that the sale price of the entire portfolio is allocated between the individual
properties to arrive at an allocated sale price for each property. Although Massmann
testified that he had researched the sale, when asked whether he had verified the sale of
the national portfolio, Massmann said that he had not.
On rebuttal, Massmann explained that he had verified with the buyer that Sales
Comparable 4 was valued independently from the other property the buyer also
purchased. Yet, the tax court rejected Sales Comparable 4, in part because “Massmann
did not verify the sale.” The tax court did not discuss Massmann’s testimony regarding
his verification with the buyer. The County argues that the tax court misconstrued
Massmann’s testimony that he did not verify the whole sale—i.e., the national portfolio.
Archway contends that the tax court did not err, because Massmann should have verified
the sale of the national portfolio.
We conclude that the tax court should have addressed Massmann’s testimony that
he verified the sale. The tax court may have found Massmann’s verification to be
3
The County argues that the tax court erroneously relied on a code used by the
Assessor Commercial Exchange (ACE) to reject Massmann’s sales comparables. We
read the tax court’s order differently. The tax court did not rely on the rejection code but
cited the ACE reports for the propositions stated therein. The tax court’s error was not in
citing the ACE reports; rather, the court erred by failing to explain why Massmann’s
testimony did not adequately address the concerns raised by these reports, particularly
because Massmann testified that the ACE rejection code has limited relevance.
10
insufficient, as Archway contends. But we cannot determine from the tax court’s order
whether Massmann’s testimony was rejected or simply overlooked.
The Remaining Two Comparables
Massmann’s remaining two comparables were Sales Comparable 1 (the Walgreens
Distribution Warehouse in Rogers) and Sales Comparable 5 (Archway II, one of the
subject properties). The tax court rejected these two comparables without any individual
analysis. Although the tax court did not discuss any issues with these specific properties,
the court implied that its rejection was based on a credibility determination, stating,
“Given the issues that we have previously identified with Massmann’s market analysis,
we are unwilling to derive market values for the subject properties from the analysis of
only two comparable sales.”
Ordinarily, we defer to the tax court’s credibility determinations. Eden Prairie
Mall, LLC v. Cty. of Hennepin, 830 N.W.2d 16, 21 (Minn. 2013). But here, the
credibility determination was based on the unexplained rejection of three other sales
comparables. Indeed, the rejection of the last two comparables was not based on the
individual characteristics of those properties but rather the putative weaknesses of three
other unrelated comparable properties relied upon by Massmann.
And, significantly, Sales Comparable 5 was the recent sale of one of the subject
properties. Although the sale of the subject property is not conclusive, it is evidence that
is “reasonably . . . relied upon” and may be “one of the most important elements to be
considered” when valuing real property. Minn. Entm’t Enters., 306 Minn. at 188, 235
11
N.W.2d at 393. Yet, the tax court rejected Sales Comparable 5 (Archway II) without
explanation. This is an omission that we cannot overlook.
In conclusion, the tax court’s decision to reject Massmann’s sales comparison
approach was contrary to the evidence and not supported by adequate reasoning.
Accordingly, we remand to the tax court to more fully explain its reasoning. We leave it
to the tax court to determine whether to reopen the matter for an evidentiary hearing.
III.
We now turn to Massmann’s income capitalization analysis. Although the tax
court’s final valuation was solely based on the income capitalization approach, the tax
court rejected much of the income capitalization data presented by the appraisers.4
The income capitalization approach is an analysis of a property’s capacity to
generate future income. Appraisal Institute, supra, at 439. Because Archway I and II are
leased properties, market rent is the relevant measure of income. See Eden Prairie Mall,
797 N.W.2d at 195. Thus, the first step in an income capitalization analysis is to
calculate the market rents of Archway I and II. See id.; see also Appraisal Institute,
supra, at 465-66. The second step is to calculate a capitalization rate, which converts the
expected rental income into an indication of value. See Eden Prairie Mall, 830 N.W.2d
at 23.
4
The tax court also rejected many of Bakken’s lease comparables and the entirety
of Bakken’s capitalization rate analysis. Archway did not appeal any of these
determinations.
12
The County raises three issues related to Massmann’s income capitalization
analysis: (1) the tax court’s rejection of three of the lease comparables that Massmann
had used to calculate market rent; (2) the tax court’s rejection of four of Massmann’s
capitalization comparables, which Massmann had used to calculate a capitalization rate;
and (3) the tax court’s reliance on survey data to calculate its own capitalization rate. We
address each issue in turn.
A.
We begin with the first step of Massmann’s income capitalization analysis—
calculation of market rent. Market rent, or the rent that could be obtained in the open
market, may be different than the actual rent negotiated by the parties to a lease. See
Appraisal Institute, supra, at 447-51. To calculate the market rent of the subject property,
an appraiser often gathers, compares, and adjusts rental data from comparable properties.
See id. at 466. As with sales comparables, lease comparables should reflect arm’s-length
transactions. See Eden Prairie Mall, 797 N.W.2d at 195; see also Appraisal Institute,
supra, at 466 (stating that “lease renewals or extensions negotiated with existing tenants
should be used with caution” because existing tenants may be willing to pay higher rents
to avoid relocating or may be offered lower rents to avoid vacancies).
Massmann relied on eight lease comparables to calculate market rent. The tax
court rejected five of Massmann’s lease comparables, as well as several of Bakken’s
lease comparables, and used the remaining lease comparables of both appraisers to
complete its own income capitalization analysis.
13
The County challenges the tax court’s decision to reject three of Massmann’s lease
comparables.5 But these three comparables were lease renewals, and Massmann’s own
report acknowledges that not all of them reflected market rent. Further, Massmann did
not provide any support for using these lease renewals as comparables except for the
statements of parties to the leases, and many of these statements contradicted the
County’s argument that the lease renewals were arm’s-length transactions. On this
record, we cannot say that the tax court erred in rejecting Massmann’s lease comparables.
B.
We next address the tax court’s rejection of the capitalization comparables that
Massmann used to calculate a capitalization rate. A capitalization rate “capitalizes a
single year’s income expectancy into an indication of value.” Eden Prairie Mall, 830
N.W.2d at 23. Capitalization rates are often derived from comparable market sales.
Appraisal Institute, supra, at 493-95
To develop a capitalization rate, Massmann primarily relied on data from the sales
of six comparable leased properties. Additionally, Massmann analyzed national and local
survey data. The tax court rejected four of Massmann’s capitalization comparables.
After finding that the remaining two capitalization comparables did not “provide a large
enough sample to determine a credible capitalization rate,” the tax court rejected
5
Although the County listed “lease comparables 4, 5, 6, or 7” in its brief, the
County did not explain why the tax court erred in rejecting Lease Comparable 4, and it is
unclear whether the County intended to appeal the tax court’s rejection of Lease
Comparable 4.
14
Massmann’s income capitalization analysis entirely. The County appeals the tax court’s
rejection of Massmann’s capitalization comparables.
First, the tax court rejected Capitalization Comparables 2, 3, and 4 because they
were derived from the three sales comparables that the tax court had rejected earlier in its
analysis. Capitalization Comparable 2 is the same property as Sales Comparable 2
(Uponor); Capitalization Comparable 3 is the same property as Sales Comparable 3
(Archway I); and Capitalization Comparable 4 is the same property as Sales
Comparable 4 (Cardinal Health). Because we reverse the decision on these three sales
comparables and remand for further explanation, the tax court may, in its discretion,
decide to address its rejection of the three corresponding capitalization comparables.
Next, the tax court rejected Capitalization Comparable 5 because “Massmann was
unable to verify many of his financial assumptions for the lease with the buyer.” Without
verification, the tax court was uncertain whether the information Massmann provided for
Capitalization Comparable 5 was reliable. The County concedes that Massmann did not
verify his financial assumptions with the buyer, but argues that the unverified information
was irrelevant to Massmann’s calculations.
The County’s argument is not supported by Massmann’s report. When
introducing the capitalization comparables, Massmann stated that “[e]ach comparable[]
will be presented with the corresponding components utilized to develop each rate.”
Moreover, the County’s argument—that underlying financial assumptions are irrelevant
to the calculation of capitalization rates—is not generally accepted. See Appraisal
Institute, supra, at 495 (“Data [for capitalization rates] must be drawn from properties
15
that are physically similar to the property being appraised and from similar (preferably
competing) markets. When a comparable property has significant differences, it may be
afforded less weight or may be discarded entirely.”).
The County concedes that Massmann did not verify his financial assumptions for
Capitalization Comparable 5, and nothing in Massmann’s report or testimony indicates
that these underlying assumptions were irrelevant to his analysis. Accordingly, we
conclude that the tax court did not err by rejecting Capitalization Comparable 5.
C.
Because the two remaining capitalization comparables would “not provide a large
enough sample to determine a credible capitalization rate,” the tax court “place[d] no
weight on Massmann’s market-derived capitalization rate.” The tax court also rejected
Bakken’s capitalization rate. Having rejected each appraiser’s capitalization rate, the tax
court completed its income capitalization analysis based solely on survey data that both
appraisers had used as secondary support.
According to The Appraisal of Real Estate, real estate surveys may be used in
combination with other methods of calculating capitalization rates. Appraisal Institute,
supra, at 499. But “surveys are generally used as support rather than as primary evidence
of a capitalization rate.” Id.; see also Carson Pirie Scott & Co. (Ridgedale) v. Cty. of
Hennepin, 576 N.W.2d 445, 451 (Minn. 1998) (observing that the tax court’s
capitalization rate was based “in part” on expert opinions about a national survey of mall
properties). The County challenges the tax court’s reliance on the survey data, arguing
that survey data is inferior to an analysis based on actual comparative sales.
16
Having rejected much of the underlying data relied on by both parties, the tax
court was left with little to rely on but survey data. Because we conclude a remand is
necessary, we need not decide whether the tax court erred by relying solely on survey
data to determine a capitalization rate. On remand, however, the tax court may
reconsider its rejection of Massmann’s sales comparison analysis, as well as its rejection
of Capitalization Comparables 2, 3, and 4. If it does so, the tax court may well find it
unnecessary to rely solely on survey data.
IV.
To summarize, we conclude that the tax court failed to adequately explain its
reasons for rejecting Massmann’s sales comparison analysis and instead relying
exclusively on the income capitalization approach. This error is compounded by the tax
court’s failure to address why its valuation is far below the actual sale price of each
subject property. Archway I sold for a price of $19,700,000 in 2010; yet, the tax court
valued Archway I at $11,531,000—59% of the actual sale price—for the valuation date
of January 2, 2010. Similarly, whereas Archway II sold at $18,870,051 in 2012, the tax
court valued it at $9,811,000—52% of the actual sale price—for the valuation date of
January 2, 2010. Moreover, the tax court’s estimate of the 2010 value of Archway I is
below the estimates of both parties, as well as that of the Hennepin County Assessor.
Accordingly, we reverse the portion of the tax court’s decision that rejected Massmann’s
sales comparison analysis, vacate the tax court’s order, and remand for further
proceedings. We leave it to the tax court to decide whether to re-open the record on
remand.
17
Reversed in part, vacated, and remanded.
CHUTICH, J., not having been a member of this court at the time of submission,
took no part in the consideration or decision of this case.
18