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Malls Are More Than Real Estate

It is a simple fact that regional and super regional shopping centers are over assessed and over taxed. In the Chicago area, for instance, real estate taxes on these properties can go as high as $20 per square foot for in-line mall space. That's approximately $10 per square foot higher than the real estate taxes on downtown Class A office buildings.

The ever-increasing needs of local government contribute significantly to higher taxes. However, the failure of assessing authorities to implement a valuation model that takes into account the complex nature and operation of regional and super regional malls is the prime culprit.

The Proper Valuation Model

The Appraisal Institute provided a valuation model in its 2002 Edition of The Appraisal of Real Estate. It recognizes a specific class of real estate-integrated businesses where the real estate is only one asset that contributes to the financial success of the enterprise. Full service hotels provide the prototypical example of this business class. One of its principal assets is clearly the real estate, which provides the venue for an ongoing hospitality business, but the rates and occupancy of that hotel do not depend solely on the real estate. A skilled management team, a trained workforce in place, a sophisticated reservation and marketing program, and a trusted and tried brand name all contribute to the productivity of that business.

By law, real estate taxes can be based only on the economic contribution of the “sticks and bricks” of an operation, and not on the revenue generated by the creativity and energy of those responsible for the planning, management, and operation of the business.

The Appraisal Institute's valuation model identifies and values the real estate assets, the furniture, fixtures, and equipment, and the intangible, non-real estate assets, which together comprise an integrated real estate business.

Assessors, to varying degrees, acknowledge the unique character of hotels as hospitality businesses. They have not been willing to accept regional shopping malls as ongoing businesses that require a similar analysis that strips the real estate assets from its non-real estate assets. Assessors treat malls more like office buildings and apartment buildings, where the business is the leasing of real estate.

Real Vs. Non-Real

Shopping Centers aren't office buildings. They don't merely lease space; on the contrary, they are complex retail businesses whose sole focus is the sale of merchandise. Their development, management, and operations demonstrate that singular focus.

The esteemed Korpacz Quarterly Survey of Real Estate rates malls on their sales per square foot, not their rental rates per square foot. The reason is very simple. Base rental rates aren't determined on the basis of leased space, but on the merchant's projected sales per square foot. The market value of a particular space isn't the criteria for rent, rather it's the selling power of the merchant. It's not unusual to see similar size spaces in close proximity of one another bring very different rental rates. The selling power of the merchant and the merchant's contribution to the entire enterprise remains the criteria for generating fees.

Once assessors recognize that malls are retail businesses, the task at hand is to identify and value its real estate assets and its non-real estate assets, just as its done with a hotel.

From its inception through its mature operations, the presence of non-real estate business components in the regional shopping center is essential to its very existence. A developer must secure a commitment from anchor department stores before ever committing to construction. The agreement between anchors and developers is the first step in the establishment of the retail business. It is that agreement that allows the developer to attract other national retailers to the mall as the next phase of the business plan.

Empirical studies demonstrate that the status and image of the anchor department stores can be responsible for as much as 25percent of the economic value generated by the mall business.

Owner's Challenge

In appealing an assessment, owners must demonstrate that a regional shopping center depends on a number of contributing assets. There must be an attractive, convenient environment (the real estate). There must be an owner with the managerial skills to populate the real estate with the proper mix of anchor department stores and national and local inline merchants (non-real estate elements). The contributions of both those elements attract and maintain the customer base (the value of the entire enterprise). A tax professional familiar with regional malls can aid the owner in the complex task of allocating the value of the mall to the real estate assets and the non-real estate elements.



James P. Regan is the managing partner of the Chicago law firm of Fisk Kart Katz and Regan, Ltd., the Illinois member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at: [email protected]

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