Supervisor of Assessments v. Ort Children Trust Four

Rodowsky, J., delivered the opinion of the Court. This appeal involves the 1979-80 assessment for real estate taxes of an income producing property. The property is saddled with a long term lease at a flat rent which was reflective of the market when the contract was made in 1962. Unique to this case is mutual agreement that in January 1979, the property could have commanded a rent more than twice that actually reserved under the lease, if the property had been available to be let at that time.

The Maryland Tax Court acknowledged in its written opinion that it gave consideration to the actual rent in reducing the assessment as established by the supervisor of assessments for the county. In so doing, the assessor says the Tax Court erred as a matter of law. For reasons herein set forth, we shall conclude that there was no error. The property involved is 4.373 acres of land, improved by a warehouse building, in LaVale, Allegany County.

It is owned by The Ort Children Trust Four (the Trust). Predecessors in title to the Trust constructed the warehouse under a build and lease agreement of August 29, 1962 with Sears, Roebuck & Co. (Sears). The lease commenced in 1963 for an initial term of 20 years. Sears holds, at its option, the right to extend the lease for four additional terms, each of five years, under the same lease provisions applicable to the initial 20 year term.

If all options are exercised, the right of Sears to occupy the property will extend to the year 2003. ¹⁹⁷ The rent is a fixed amount, payable monthly, and totals $22,444.56 per year. Real estate taxes, public liability insurance, fire and extended coverage insurance and structural maintenance, including the roof, are the landlord’s obligation at its expense. The rent established in 1962 converts to approximately $.55/s.f. (the contract rent). 1 It is conceded that as of January 1, 1979 comparable property rented for $1.25 to $1.75/s.f.

(the economic rent). 2 The Supervisor of Assessments for Allegany County (Supervisor) valued the land at $46,850 and the improvements at $292,000 as of the applicable date of finality, January 1, 1979. The improvements were valued by the cost of reproduction method, with a 41% depreciation allowance. This total valuation of $338,850 resulted in an assessment of $169,425 under the assessment to value ratio of 50%. The Trust pursued its challenge of the assessment to the level of the Maryland Tax Court, where a real estate expert for the taxpayer testified that the value of the property was $80,000.

His opinion utilized the contract rent and also reflected the cost to the owner of a new roof which the building required, for which an estimate of $68,500 had been received. This expert presented four variations of an income approach, all of which started with net rental income of ¹⁹⁸ approximately $18,000 per year, arrived at by deducting expenses representing insurance, maintenance, reserve for replacement, management, legal and accounting. All of his methods used a capitalization rate of 13.25%. In a direct capitalization approach the indicated value would be $69,600 if the cost of the roof were deducted from the product of capitalizing the net rent.

If an amount required to amortize the cost of a new roof over a 20 year period at 10.5% were deducted from the net rent before capitalization, the indicated value would be $76,100. Taxpayer’s expert then utilized the "Inwood” annuity approach and undertook to express the present worth of the right to receive the net contract rent for 24.5 years plus the value of the property at the end of the lease term, all discounted at 13.25%. A figure of $418,000 was used in this computation as the value of the property at the end of the lease term, based upon 1979 economic rent. If the cost of the roof were deducted from the product of discounting, the indicated value of the property would be $80,700.

If amortized roof repair cost were deducted from the annual, net, contract rent before discounting to present worth, the "Inwood” approach would indicate a value of $90,200. The assessor in the Tax Court presented, as a check on his cost of reproduction appraisal, an income approach to value. It utilized $1.25/s.f. as the gross rent. This was the lower end of the economic rent range.

The lower end of that range was used because the assessor gave consideration to contract rent "to a certain extent.” Net income was determined after deducting only for insurance. A return at 9.395% attributable to the land, at the assessor’s land valuation, was computed and deducted from the net economic rent to determine that portion of the net economic rent attributable to the improvements. This in turn was capitalized at 11.395%. By this approach a total valuation of land and improvements of $401,220 was indicated to the assessor.

This confirmed, in his opinion, the total assessment developed by the reproduction cost method. The Tax Court reduced the assessor’s valuation to $246,850 or, in dollars of assessment, to $123,425, effected ¹⁹⁹ by a $46,000 reduction in the assessment on the improvements. In its written opinion the Tax Court does not specifically set forth how its valuation was determined. It found, however, "that the present lease terms which specify the rent to be paid and other conditions should have been accorded more weight by the Supervisor and that this assessment appealed from should be reduced.” The Tax Court also made the following findings: In the instant case, if any increment in value has occurred since the lease began in 1963, such increment has inured to the benefit of the [lessee], Sears, and the leasehold interest of the tenant is not subject to taxation in Maryland and what is taxed to the owner is the fair maket value of his property.

No testimony has been introduced by the Supervisor to indicate that the rental entered into at the time of the lease’s beginning in 1963 was not the proper rental as of that time. The value arrived at by the Supervisor is based upon a rent which does not exist and this valuation also fails to recognize the cost of replacing the roof which is the responsibility of the owner. The Petitioner’s presentation is based upon facts, most importantly the lease rental and terms which would primarily control the purchase price this property could expect to produce if placed on the open market for sale. The Supervisor appealed to the Circuit Court for Allegany County which affirmed the Tax Court.

Appeal was taken by the Supervisor to the Court of Special Appeals. We granted the Supervisor’s petition for a writ of certiorari prior to consideration of the case by the intermediate appellate court. As refined by oral argument in this Court, the position of the Supervisor is that the Maryland Tax Court could not, as a matter of law, give any consideration to the contract rent received by the Trust, because there was no dispute that the ²⁰⁰ contract rent was less than the economic rent on the date of finality. Our task on this appeal is to determine whether the Circuit Court for Allegany County erred in affirming the Maryland Tax Court.

The standard of review of Tax Court orders by a circuit court is set forth in Md. Code (1957, 1980 Repl. Vol.), Art. 81, § 229 (o): [T]he circuit court . .. shall determine the matter upon the record made in the Maryland Tax Court. The circuit court . .. shall affirm the Tax Court order if it is not erroneous as a matter of law and if it is supported by substantial evidence appearing in the record. In other cases, the circuit court... may affirm, reverse, remand, or modify the order appealed from.

By subsection (h) of § 229, the Maryland Tax Court is empowered to assess anew, classify anew, abate, modify, change or alter any valuation [or] assessment .. . appealed from, provided that in the absence of any affirmative evidence to the contrary or of any error apparent on the face of the proceedings, the assessment. . . appealed from shall be affirmed. There is no contention in this case that the assessment made by the Maryland Tax Court is unsupported by the record, if the Tax Court could legally take the effect of the contract rent into consideration in arriving at its valuation. But for the legal point advanced by the Supervisor, this case would simply be the Tax Court resolution of a dispute over valuation. Article 81, § 14 (b) (1) (i) provides that "[a]ll real property required by this article to be assessed shall be valued at its full cash value on the date of finality.” Section 14 (b) (1) (ii)l states that "[f]ull cash value means current value.” In Schley v. Montgomery County, 106 Md. 407, 410 , 67 A. 250, 251-52 (1907), a case involving the valuation of shares ²⁰¹ of stock, we said that "[t]he value of an article is ordinarily what it will bring at a fair sale in the market, unless it be of so special a nature that no market for it exists and then its intrinsic value must be ascertained by a consideration of its cost, nature, utility and other characteristics.” Thereafter, when interpreting "full cash value” as applied to the assessment of real property for ordinary taxes, this Court said in Rogan v. Commissioners of Calvert County, 194 Md. 299, 311 , 71 A.2d 47, 52 (1950): Ordinarily the cash value of property is the market value.

Schley v. Montgomery County Com’rs., 106 Md. 407, 410 , 67 A. 250 . But, as Justice White said in San Francisco National Bank v. Dodge, 197 U.S. 70 , 25 S. Ct. 384, 386 , 49 L. Ed. 669 , the market value of property is the value a willing purchaser will pay for it to a willing seller in open market, eliminating exceptional and extraordinary conditions giving the property temporarily an abnormal value. The Court cannot rule as a matter of law that assessing authorities must be guided entirely by current market prices in making the assessments, regardless of how "thin” the "spot market” may be or how much it may be affected by conditions believed to be temporary and abnormal. The willing purchaser-willing seller standard as the ordinary mode of measuring full cash value has been repeatedly enunciated.

See Samet v. Supervisor of Assessments, 290 Md. 357, 359-60 , 430 A.2d 73, 74 (1981); Shell Oil Co. v. Supervisor, 278 Md. 659, 666 , 366 A.2d 369, 373-74 (1976); State Department of Assessments and Taxation v. Greyhound Computer Corp., 271 Md. 575, 586 , 320 A.2d 40, 45-46 (1974) (a tangible personal property tax assessment); Fairchild Hiller Corp. v. Supervisor, 267 Md. 519, 521 , 298 A.2d 148, 149 (1973); Weil v. Supervisor of Assessments, 266 Md. 238, 246 , 292 A.2d 68, 72 (1972); and State Tax Commission v. Brandt Cabinet Works, 202 Md. 533, 545 , 97 A.2d 290, 295 (1953). ²⁰² Furthermore, our cases have long recognized that capitalization of income is a relevant factor to be considered by the assessing authorities, particularly in assessing income producing properties. This is no more than a recognition of the reality that income producing properties are bought and sold on the basis of the income which they actually produce. Bornstein v. State Tax Commission, 227 Md. 331, 337 , 176 A.2d 859, 861-62 (1962) makes the point through testimony given by the assessor in that case. The purpose is, of course, to ascertain the full cash value ....

Ordinarily the cash value would be the current market value, or what a willing purchaser would pay to a willing seller in the open market.... Mr. Allen, Supervisor of Assessments for Montgomery County, testified that, based upon his long experience, he had found that a prospective buyer invariably considered income. "He always had to be shown the income, with his own determination of net, before he purchased. I have never heard of [an apartment house] being built without determining what income he would get, and that determines the value of the property as a whole.” It is firmly established in this State that the relative weight to be accorded to any relevant factor in a particular case is for the assessing authorities and not for the courts.

In Bornstein , the assessment as finally determined by the then State Tax Commission resulted from a number of approaches to value, including the capitalization of gross contract income and, by utilizing exhibits relating to operating expenses, the capitalization of net contract income. In Meade Heights v. State Tax Commission, 202 Md. 20 , 95 A.2d 280 (1953), the assessment under consideration in this Court concerned rental housing units built by the taxpayer on land leased by it from the United States. In addition to using the reproduction cost method, the assessors undertook to find value by capitalizing "the gross subrents received,” i.e., the contract rents paid by tenants of the ²⁰³ housing units. Id. at 31 , 95 A.2d at 285-86 .

The assessment was affirmed. Despite the uncontrovertible fact that a willing buyer of income producing property will look to the history of contract rent, and to the potential rent, whether contract or economic, in arriving at the price which he will pay for a given property, and despite the recognition in our cases of the use of contract rent in the income approach to valuation for assessment purposes, the Supervisor contends that there is a legal principle, operative here, which bars any consideration of contract rent because in this case it is undisputed that the contract rent on the subject property is below economic rent. We shall call that differential, as suggested by the Trust, the "leasehold advantage.” In support of his position, the Supervisor cites a number of decisions from other states. 3 Typically the cases relied upon by the Supervisor present an effort by the taxpayer to have a court reverse an administrative determination because the assessing authority is claimed either to have failed to give any weight to, or to have given insufficient weight to, contract rent. Illustrative is Springfield Marine Bank v. Property Tax Appeal Board, 44 Ill. 2d 428 , 256 N.E.2d 334 (1970).

There a circuit court reversed the administrative determination and adopted lower assessment figures arrived at through consideration of contract rent on ²⁰⁴ long term leases which were unfavorable to the lessor. The Illinois Supreme Court reversed the circuit court and directed reinstatement of the administratively determined assessment. The court said ( 44 Ill. 2d at 430-31 , 256 N.E.2d at 336 ): It is clearly the value of the "tract or lot of real property” which is assessed, rather than the value of the interest presently held by the owner. In determining the value of the property, rental income may of course be a relevant factor ....

However, it cannot be the controlling factor, particularly where it is admittedly misleading as to the fair cash value of the property involved. The relevance of rental income in this instance has been so diminished by the change in the property’s value since the rents were established that it was properly disregarded. In such a situation, earning capacity is properly regarded as the most significant element in arriving at "fair cash value”. As we have recognized in the past, many factors may prevent a property owner from realizing an income from property which accurately reflects its true earning capacity; but it is the capacity for earning income, rather than the income actually derived, which reflects "fair cash value” for taxation purposes....

After an extensive examination of this issue, the New York Supreme Court reached an identical conclusion, stating, "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.” People ex rel. Gale v. Tax Commission of City of New York (Sup.Ct. 1962), 17 A.D.2d 225 , 233 N.Y.S.2d 501, 507 . This Court has held that earning capacity is properly ²⁰⁵ recognized in assessing property.

In Easter v. Department of Assessments, 228 Md. 547 , 180 A.2d 700 (1962), appeal dismissed and cert. denied, 371 U.S. 235 , 83 S. Ct. 326 , 9 L. Ed. 2d 495 (1963), vacant land was assessed comparably with adjacent income