Judge Finds Flaws in Minnesota Retail Mall Appraisals

In the past several years, Judge Sheryl Ramstad has decided no less than seven cases in favor of government. Not only did those cases go against the taxpayer - Judge Ramstad actually increased the assessment to values higher than were estimated by assessors!  Most were decided on her own application of the data and approaches used by individual appraisers representing a particular side of the argument. In some cases, she selectively used portions of opposing appraiser's viewpoints.  A prime example is Eden Prairie Mall LLC v. County of Hennepin, 2009 Minn. Tax LEXIS 22 (Minn. T.C. Oct. 13, 2009).

In the instant case, the subject of the appeal was the main mall building and one of the anchor stores. The Eden Prairie Mall was originally built in 1975 and was updated with a new food court and other interior finish in 1989. In 1999, General Growth acquired the mall and promptly gutted the interior and rebuilt all public and tenant space.

The Hennepin County Assessor estimated the value of the mall at $90 million and $100 million respectively for the 2005 and 2006 tax years. For the anchor store, the values were set at $8.9 million and $9.4 million respectively. In support of his assessment the assessor hired an appraiser, Jason Messner, who estimated the value for the mall and anchor at $110 million and $10 million for 2005 and $118.5 million and $10.5 million for 2006. Here the appraiser relied on all three approaches to value.

Eden Prairie Mall and the anchor hired their own appraiser, David Lennhoff. Their appraiser estimated the values of the mall and the anchor at $68.75 million and $3.95 million respectively for 2005. For 2006, he estimated $60.55 million and $4.75 million, respectively. The taxpayer's appraiser used only the income approach to value.

An outline of Ramstad's approach to this case will follow. First, however, a brief background on the Honorable Sheryl Ramstad. She graduated from North Dakota's law school in 1975 and worked in private practice for a number of years. Ms. Ramstad once ran for County Attorney against now Minnesota Senator Amy Kloubuchar and lost by less than one percentage point. Jesse "The Governor" Ventura appointed her as the Commissioner of the Minnesota Department of Corrections in the 1990's. She stayed there until her brother, a congressman, began to push for her to become a judge. The Honorable Sheryl Ramstad was appointed to the Minnesota Tax Court in 2003.

Ramstad relied largely on the Income Approach to Value based on the perspectives brought out in testimony by each appraiser. In the Appraisal Institute's Second Edition of Shopping Center Appraisal and Analysis, the author indicates (page 197) that "Estimating market value for a shopping center with the income capitalization approach is a two part process. The appraiser first prepares an estimate of cash flows from the asset and then selects a method for capitalizing these benefits into a value estimate." The authors go on to say that malls owned by investors are purchased or evaluated largely using a Discounted Cash Flow (DCF) model because the income stream from a large population of tenants can vary the income stream. DCF evaluates the income stream and associated expenses over a holding period consistent with that of the typical investor. Direct Capitalization, on the other hand, uses only one year of income and expenses.

"The various components of a typical [mall] income stream include base rents, additional rents accruing from percentage [rents] expense recoveries, revenue from other services provided by the center operator and miscellaneous income." Simply stated, it would be prudent for an appraiser to use the DCF method versus the Direct Capitalization method when valuing a shopping mall with many tenants. Similarly, when choosing an appropriate capitalization rate, one must consider that (Shopping Center Appraisal and Analysis page 198) "the income stream can vary in their reliability and hence their perceived risk..." There are many variables the appraiser must analyze when evaluating the many tenants of a particular mall.

In this case, neither appraiser completely followed the conceptual framework as outlined above, and as such, neither did Ramstad! First, Messner chose Direct Capitalization to value the subject! Judge Ramstad agreed and cited Jason Messner's reasoning as the basis for her choice: ".... There was stabilized occupancy"! Contradicting their choice of approaches, however, Messner indicated that "Mall sales generally increased." If mall sales increased, that would mean that rents from percentage rent clauses would increase. How could the income be stable in light of that fact?

Lennhoff chose the DCF model, which appears to be a more appropriate method to account for the variability in the income stream. With that said, there is no detail in the opinion on neither how each appraiser arrives at an initial Gross Income nor whether it comports itself with the market. In fact, a major component missing from the discussion of the case is the fact that any of the analyses and resulting value conclusions agree with the current market and the value definition of Market Value in the Minnesota Statutes!

One concept missing in this case was the treatment of intangible assets within the context of the overall value of the enterprise. Lennhoff made an attempt at it, but Judge Ramstad did not even acknowledge it. One can imagine how Ramstad summarily dismissed the concept in choosing her own approach to value the subject. Lennhoff prefaced his valuation with the idea that there is more than just real estate when valuing a mall in identifying it as an assignment that includes a "going-concern" value.

In the last chapter of Shopping Center Appraisal and Analysis, the authors leave the concept of business enterprise value within the context of shopping centers as an open question. While it is clear that there are several schools of thought regarding the subject, it is irresponsible for Ramstad to ignore it.

Ramstad evaluates each appraiser's use of income and expenses within their respective income approaches then goes on to calculate her own opinion of value. First, in her calculation of income she uses income from all sources including non-real estate related items such as kiosk income. Again, there is no comment that indicates that income is consistent with market rates --- a must when using Market Value as the definition of value.

Next, Judge Ramstad tackled the estimate of expenses. Interestingly, she did not include expenses for insurance, advertising, maintenance, leasing commissions or an allowance for replacements - all as outlined in Shopping Center Appraisal and Analysis (pp. 223 through 226)!

Lastly, in choosing a capitalization rate Judge Ramstad relied on a rate from Mr. Messner and his rating of the subject as a "B+" mall. Messner obtained his capitalization rate from Korpacz, a quarterly publication that details capitalization rates for several categories of property and geographies. Use of this publication is widespread amongst appraisers, but there is some subjectivity in choosing the rate. Messner chose a rate that significantly overstates the desirability of the subject mall, considering it is minutes from the Mall of America. Most investors would ascribe greater risk as a result of the proximity to the premier mall in the United States. Judge Ramstad did not even mention the fact that the market is all but controlled by the Mall of America.

Judge Ramstad concluded that the Eden Prairie Mall was worth almost $123 million for 2005 and just over $120 million for 2006. These value conclusions are based bits and pieces of two opposing appraiser viewpoints. To compound the matter, the resulting values chosen by Judge Ramstad do not represent sound or complete accepted professional appraisal practice.