Order LT95-02 - LT93029 - Property Appeal - Reliance Investments v. Minister of Finance (Mar 16, 1995)

IN THE MATTER of an appeal, to The Island Regulatory and Appeals Commission (the Commission), under Section 22 of the Real Property Assessment Act (the Act) by Reliance Investments Inc. (the Appellant) of Summerside, Prince Edward Island against a decision of the Minister of Finance (the Minister) with respect to the 1993 assessment of property (Provincial Property Number 309542) located in Summerside, P.E.I.

A Notice of Appeal in connection with the 1993 real property assessment of parcel number 309542-000 was filed on March 1, 1994 by J. Ulric Gallant on behalf of Reliance Investments Inc., owner of the property in question.

The property whose assessment is under appeal is located on the south side of Water Street in the downtown area of the Town of Summerside. It is located in a primarily commercial area and is occupied by a variety of retail and office tenants.

The property was formerly the Holman's Department Store (250 Water Street), contains approximately 1.58 acres of land and has approximately 238 feet fronting on Water Street. At the rear of the building is a paved parking area of approximately 3200 square yards.

The building itself has three main storeys and a basement. A part of the building has a fourth floor and smaller areas have only one or two floors.

Department Store	52,495 sq. ft.
Warehouse	34,552 sq. ft.
Finished Basement	6,546 sq. ft.
Unfinished Basement	19,766 sq. ft.
Shipping Dock	598 sq. ft.

Built in 1857, the building is brick and wood frame, mostly stone and brick foundation, brick exterior and predominantly tar and gravel roofing. In the retail office area interior wall finish is mostly gyproc, ceilings are mostly gyproc and suspended T-Bar, and floors are a mix of carpet, tile and linoleum. Heat is provided by an oil fired hot water system with two boilers, one new and one the Minister describes as "very old". Two elevators serve the building -- one passenger and one freight. Approximately 25% of the basement is well finished. The rest is unfinished storage area.

The Minister's description of the building states that "the overall condition of the building is considered poor to fair", that the building has an "antiquated design", and that the wiring requires considerable upgrading to bring it to modern standards.

Year	Comm. Realty	Non-Comm. Realty	Total	Inc/Dec%
1987	$656,000	$91,400	$747,400
1988	$696,600	$97,100	$793,700	+6.2%
1989	$750,600	$104,600	$855,200	+7.7%
June 14, 1989	$772,300	$107,600	$879,900	+2.9%
			(renovations)
1990	$772,300	$107,600	$879,900	+0%
Oct. 22, 1990	$797,100	$89,700	$886,800	+0.8%
			(renovations)
1991	$797,100	$89,700	$886,800	+0%
1992	$779,500	$87,300	$866,800	-2.3%
1993	$841,600	$94,300	$935,900	+8$
Revised 1993	$501,600	$21,000	$522,600	-44.2%
Recommended
1993 Variance	$612,100	$25,500	$637,600

Using the cost approach the Minister determined the property assessment to be $799,609. Using the Income Approach the indicated value was $637,600. The difference between this value and the "revised" 1993 assessment of $522,600 was explained as an error in the original calculation brought about by a failure to deduct $18,200 (the wage of Mr. Dyment) from the original wage expense.

The appeal was heard on September 28, 1994. William Found, Chief Assessor, Commercial & Special Purpose Property represented the Minister. J. Ulric Gallant represented the Appellant.

Further information was filed by the Appellant on October 14, 1994. This consisted of twenty pages of photocopied material, entitled "Income Approach to Value" from an unidentified source, plus a photocopy of an Assessment Notice and Tax Notice for the year ending December 31, 1992.

A further response, to the submission of the Appellant, was filed by the Department on October 20, 1994.

The position taken by Mr. Gallant on behalf of the Appellant was that the property is not worth its assessed value. He stated that in 1985 the owner paid approximately $275,000 for the building, which at that time was an asset of a business that had gone bankrupt. Since then the owner has tried to attract tenants to fill the property.

Some tenants pay percentage rent; some pay fixed rent, none pay common area charges, stated Mr. Gallant. Because of its location, age and condition it does not produce the income it should. He argued that a buyer would look at what the income from the property is, not at its potential.

He also argued that the $1.13/sq. ft. paid by the owner for his furniture business either should be ignored altogether or should be taken as is, even though this is extraordinarily low, because the owner is in the building simply to fill it up. Mr. Gallant stated that if the owner could rent the premises to a third party he would occupy much less than the 15,336 sq. ft. he now uses.

On the wages issue, Mr. Gallant argued that the owner himself has never taken "a cent". The manager is paid a wage and his son, Jack Dyment, is paid a wage to do a variety of jobs around the premises. For this reason both the management fee expense and the wage expense are proper deductions.

He also argued that market value for assessment purposes is different from market value for insurance or other purposes.

Mr. Gallant argued that prime retail space in Summerside rents for $10/sq. ft. The building in question is not in that category. He argued that the actual rents being charged reflect the economic rent for the building -- not a hypothetical number based upon potential earnings.

For the Minister, Mr. Found argued that while the building was not in good shape and needed a lot of work, the calculations made under the income approach reflected economic rent for the area.

He explained the assessment history as indicating frozen assessments for 1989-1991 (unless there were renovations or new construction), slightly reduced assessments in 1992, and 8% standard increases in 1993 to reflect the general improvement in the economy.

Mr. Found also stated he had thought that the owner and Mr. Gallant had agreed to the economic rent figures used by the Department. He pointed out that the actual vacancy rate was 3.8% and the actual reported bad debt rate was 2%, so the Department could have used 5.8% as the bad debt/vacancy rate in its calculation. However, a judgment call was made to increase this to 20% -- a benefit to the Appellant.

As for the deduction of property tax as an expense when calculating the capitalization of the building (argued by Mr. Gallant), Mr. Found took the position that was improper for determining assessed value, and that other appraisal firms agreed with him.

He explained that 4% was the standard management fee used when dealing with commercial properties. He also stated that Mrs. Montgomery (employee of the Appellant) told him that J. Dyment was paid $18,200 for managing the property. That is why his wages were deducted from the expense calculation: To use both the 4% and the actual management wage would have been double counting.

The capitalization rate of 12% used in the calculation by the Department was determined after an analysis of the occupants, the owner-occupied space, the outlook for improved occupancy, and the age and condition of the building. A lower capitalization rate (argued for by Mr. Gallant) would increase the market value and so was determined not to be fair. A newer facility with good occupancy would likely have a capitalization rate in the area of 10.5%.

As for the Appellant's argument that this is a unique property, Mr. Found stated that everyone says they are unique. This is a typical downtown property. The way it is run may not be typical but that is a management decision.

He pointed out that the Minister on this appeal is requesting an increase in the assessment as a result of the error found in the Department's calculations.

Overall the Commission affirms the methodology used by the Minister in determining the assessment of this property.

The Commission agrees that the property tax expense should not be deducted as an expense but should be added to the capitalization rate in determining the value of the property. To do otherwise would be circularly self-defeating: since part of the purpose of the calculation is to determine the assessment upon which tax will be based, including an actual dollar figure for the tax will always skew the results.

The 1994/95 Course Manual "Real Property Assessment, Year One", published by the University of British Columbia, puts it this way:

As well, the Commission agrees that a management fee and a management wage are duplicate expenses. The facts in this case are not as clear as we would like, but the best evidence on this comes from Mr. Found and we accept that he was told that $18,200 was paid to J. Dyment to manage the property and that this amount was left in the wage expense category erroneously. Mr. Gallant's evidence as to the role of Mr. Dyment was unclear and since neither the Appellant nor John Dyment appeared before us to clarify the issue, Mr. Found's evidence will be accepted.

The Commission notes the request of the Minister for an upward adjustment as a result of the error it found in its calculations. Such a request is unusual, and should be. An Appellant should not be intimidated from appealing a decision of the Minister out of the fear that the Minister will try to have the assessment increased during the course of an appeal.

However, we would not expect this to ever become a problem. For the Minister to argue for an increase in any but circumstances of "error" would be to argue that he did not carry out his responsibility to assess at market value.

In the case of legitimate error such as this we accept the Minister's request as reasonable. On such a review an error in the Appellant's favor would result in a readjustment of the assessment and we have seen this occur at appeal hearings. It would not appear equitable to refuse to accept a readjustment caused by inadvertent error simply because there is no benefit to the Appellant in doing so. Should this situation occur frequently, suggesting a failure of Department officials to pay proper attention to details prior to appeal -- knowing that "adjustments" can be made on appeal -- this matter would deserve reconsideration by the Commission.

However, overall acceptance of the Minister's methodology is not acceptance of all of the judgment calls made by the Department in its calculations.

Instead of using the actual income figures provided by the Appellant, the Department used what it determined to be economic rent figures. In principle this is an appropriate approach, preventing manipulation of assessment calculations by unrealistically low rents to related companies or preferred individuals.

However, the use of economic rents requires a balanced approach that also takes into consideration why actual income figures could not be used. For example, in the case of the 655 sq. ft. on the second floor that is vacant the economic rent figure used was $9.00 per square foot. In turn, this 655 sq. ft. was used in calculating the vacant space to be considered for an offsetting adjustment. This respects both the need to determine economic rent and the reality of not being able to actually rent all of the space.

Looking as well at the 3.8% actual vacancy for 1993, plus the 2% bad debt rate reported by Mrs. Montgomery, the Department concluded that an allowance of 20% for vacancy and bad debt would be used.

Clearly this is a judgment call. The Department has made an effort to reflect the difficulty of renting these premises, the age and the condition of the building. However, we feel that in the circumstances the adjustment is not sufficient.

No one at the hearing disagreed about the poor state of the building, and the amount of money/work it would take to improve it. While details were not given, the impression overall is of a building in poor condition very unlikely to attract tenants willing to pay anywhere near prime real estate rates. In the Department's own words, we have here a building of "antiquated design" in "poor to fair" condition.

The British Columbia Manual referred to earlier describes the approach to vacancy allowances as follows:

We consider the likelihood of leasing the 15,336 sq. ft. occupied by the owner at the economic rent value set by the Department to be highly unlikely. In other words, if it were leased, it is highly unlikely that it would ever generate the economic rent the Department has calculated. The use by the Department of a 20% vacancy/bad debt rate indicates the Department's awareness of this but does not deal fully with the space involved.

Overall, we conclude that the majority of the owner-occupied space must be considered to be vacant. At best, the first floor rear space of 1200 sq. ft. might be rented at its economic rent. The remaining space occupied by the owner, 14,136 sq. ft. on the second floor, is, in our view, essentially vacant space and likely to remain so for the foreseeable future. Again, viewed from the perspective of the likelihood of being leased at the economic rate set by the Department, the likelihood, in the present economic climate and given the poor condition of the building, is virtually nil.

We also consider space that had been vacant for twelve months at the time of the Department's analysis to be space that is unlikely to be rented at the economic rent level. This involved 655 sq. ft. on the second floor. Added to the 14,136 sq. ft. already dealt with we arrive at a vacancy allowance of 31%. Bad debts were considered by the Appellant not to be a problem.

When this figure is used in the Department's calculations it gives us the following:

Vacancy allowance (31%)	$105,185
Effective gross income	234,122

Net income	$ 63,927

Indicated Value by Income Approach =
$63,927 divided by .1588	= $402,600

WHEREAS Reliance Investments Inc. (the Appellant) appealed to The Island Regulatory and Appeals Commission (the Commission), in written notice dated March 1, 1994, a decision of the Minister of Finance;

AND WHEREAS the Commission heard the appeal at a public hearing conducted in Charlottetown, P.E.I. on September 28, 1994;

AND WHEREAS the Commission has made a decision in accordance with the stated reasons;