National retailers use sale-leaseback transactions to expand their businesses. In a typical sale-leaseback, a property owner sells real estate used in its business to an unrelated private investor or to an institutional investor. Simultaneously, the property is leased back to the seller for a mutually agreed-upon time period, usually 20-30 years. Lease payments typically are fixed to provide for amortization of the purchase price over the term of the lease plus a specified return rate on the buyer’s investment. The typical transaction is usually a triple-net-lease arrangement. Sale-leasebacks often include an option for the seller to renew its lease, and on occasion, repurchase the property.
The question is, are these atypical financing transactions indicative of market value for property tax assessment purposes? According to the Wisconsin Supreme Court in a case I tried years ago, the answer is a resounding no!
The Business Model
In Walgreens v. City of Madison, 752 N.W.2d 687 (Wis. 2008), the Wisconsin Supreme Court accurately described the most important aspects of the sale-leaseback business model. Under this model, the retailer identifies a prime business location in a high traffic area. The retailer then buys out the existing businesses and builds a store to fit the needs of the retailer. The retailer packages its hard and soft construction and due diligence costs, then offers investors the opportunity to purchase “certificates” representing a pro rata portion of the retailer’s overall expenses. As a part of the retailer’s lease payment to its investors, the “seller” compensates its buyer/investor for “all such financing, land acquisition, construction, development and financing costs, together with a profit margin.” Walgreens, 2008 WI 80, ¶ 6. Logically, the rent should be higher than normal because the investor is seeking to recover the original investment as well as a handsome return on its capital infusion into the retailer’s business model.
Valuing the Fee Simple Interest of the Real Estate
After establishing the business model of the sale-leaseback, the Walgreens court went on to discuss the framework for valuing the fee simple interest in the real estate under this business model. In the case in question, Walgreens pointed out the fundamental difference between real estate value and contract-derived “business investment” value – arguing that the increased value to the contractual rights associated with the leased fee estate was not a real estate but rather a contract “investment value.” Walgreens also pointed out that the duty of the assessor is to differentiate between the aspects of the contract that aren’t typical of the open real estate market. Walgreen’s argument was that the lessor’s rights in this case were contract rights associated with the leased fee estate and therefore not subject to evaluation for ad valorem property tax purposes.
Essentially, Walgreens maintained that the real property assessment should not be based on the above market rent that was paid due to its agreement with an investor. These conditions were not normal in the open market for real estate and didn’t reflect the market value of the fee simple absolute real estate at-issue. The high court agreed, stating that assessors should examine the financing terms in order to determine if the sale price reflects the market value of the real estate standing alone in the open market. The court continued, “If we were to expand the law in the direction the city requests, property assessments would in essence become business value assessments.” Id. ¶65.
The Wisconsin Supreme Court’s analysis in Walgreens applies equally to the valuation of all real estate subject to a sale-leaseback. In fact, Standard 5.9 of the International Association of Assessing Officers’ “Standard on Verification and Adjustment of Sales” provides: “Sales involving leasebacks are generally invalid because the sale price is unlikely to represent the market value of the property.” Hence, if your property is the subject of a sale-leaseback, you must make sure your local assessor is made aware of the terms and conditions of the business transaction. If you fail to do so, the assessor’s temptation to commingle the contract rents with the market rents can – and often will – result in an assessment well above the actual market value of the “sticks & bricks.”