Taxation--valuation--capitalization rate--findings not sufficient
A decision of the North Carolina Property Tax Commission
appraising certain commercial warehouses was reversed and
remanded where the Commission used the income capitalization
appraisal method but failed to specify in its final decision the
capitalization rate utilized and there was an absence in the
record of evidence sustaining the rate apparently employed by the
Commission. On remand, the Commission was to rely on the
existing record and hear additional arguments as it deemed
appropriate. Appeal by Rutherford County from the final decision of the
North Carolina Property Tax Commission entered 14 November 1997.
Heard in the Court of Appeals 22 October 1998.
County of Rutherford, by County of Rutherford Attorney Laura
J. Bridges and Shelley T. Eason, for appellant.
J. Thomas Davis, for appellee.
JOHN, Judge.
Appellant County of Rutherford (the County) appeals a final
decision of the North Carolina Property Tax Commission (the
Commission) appraising certain commercial warehouses owned by
appellees Charles D. Owens, Jr. (Owens), and John F. Padgett
(Padgett) (jointly “Taxpayers”). The County argues the
Commission erred by: 1) rendering findings of fact, conclusions
of law and an order “unsupported by competent, material and
substantial evidence in view of the entire record;” 2) denying
the County's motion for dismissal at the close of Taxpayers'
evidence; and 3) “denying the County's motion for discovery
sanctions and in ordering the matter to be heard on its merits.”
For the reasons set forth herein, we reverse the decision of the
Commission.
Relevant facts and procedural history include the following:
In 1994, the County conducted a reappraisal and reassessment ofTaxpayers' small industrial park in Rutherford County. Taxpayers
appealed the County's assessment to the Rutherford County Board
of Equalization and Review which affirmed the County's appraisal.
On 20 October 1994, Taxpayers appealed to the Property Tax
Commission and filed required Applications for Hearing 21
November 1994.
At the 26 September 1997 hearing before the Commission, the
primary issue was the valuation of nine (9) parcels (the
property) in Taxpayers' industrial park upon each of which had
been constructed a prefabricated metal warehouse. Taxpayers
leased the warehouses to commercial tenants at a rate of
approximately $1.50 per square foot per month.
Taxpayers maintained to the Commission that the County's
values were too high because they were based upon “replacement
cost and the income approach,” and that a more accurate valuation
would be “what it had cost [the Taxpayers] to build” the
buildings. The income approach was inappropriate, Taxpayers
continued, because sales of highly comparable properties in
Rutherford County were lacking, thus precluding determination of
a proper capitalization rate for use of the income approach of
appraisal. Finally, Taxpayers concluded, no reasonable person
would purchase the property at the County's values because the
maximum rent obtainable would not produce sufficient income tojustify such a purchase, i.e., unimproved property could be
purchased and identical new buildings placed thereon for a sum
less than the County's valuation of the property.
The County conceded direct comparable sales evidence was
lacking and that the comparable sales approach to valuation “was
given the least amount of consideration.” Instead, it was the
County's position that the property “highly lend[s itself] to a
cost approach methodology but [should be] adjusted through the
income approach.” In its final analysis, and “in reconciling
[the] valuation estimate, [the County] placed most emphasis on
the income approach because of the nature of the property” as
income producing.
In applying the income approach of valuation, the County
capitalize[d the] buildings based upon
mortgage equity capitalization principles
which [is a yield capitalization method and]
takes into consideration typical financing of
buildings.
Specifically, County expert witness Charles Long (Long) stated:
We use a 75 percent loan to value ratio with
25 percent of the balance. The equity
position that the--the investor will assume
will be their portion at a 12 percent equity
yield rate. . . . This is also based on a
typical 25-year term at eight and one-quarter
percent borrowing rate. And again, one other
component to consider in that rate is a 10-
year holding period, which is the typical
amount of time the investor would hold that
building before considering a sale. When youtake those elements into consideration, that
gives a basis of ten and a half percent
(10.5%) for a capitalization rate. Then we
added, based on the age of the--of the
building . . . twenty-five one-hundredths of
a percent for each age that the building
exists. So a brand new building will be ten
and a half percent (10.5%), a two to three-
year old building 10.75 percent, and then
adding one-quarter of one percent for each
two years of age that a building existed.
Long further testified on cross-examination as follows:
Q: And that equity capitalization rate
requires comparable sales, doesn't it, to
determine?
A: You can--you can determine that equity
capitalization rate through comparable sales
and that must be highly comparable. . . .
They are not required; however, they can be
proven in the marketplace as to what the
equity yield is. And you can get that
information just from lending practices.
Q: Well, are you familiar with what is
termed the American Institute of Real Estate
Appraisers [and their textbook, The Appraisal
of Real Estate]?
A: That's correct.
. . . .
Q: Doesn't it say in the volume that I
have--that equity capitalization rates are
derived from comparable sales by dividing the
pretax--pretax cash flow of each sale by the
equity invested?
A: That is what that says in that section,
that's correct.
Q: Now, you've already testified thoughthat you had a lack of comparable sales in
regard to this type property, isn't that
correct?
A: That's correct.
Q: So your capital rate would be distorted
in regard to whatever means that you used to
get those comparable sales necessary to
capitalize--to make your capitalization rate?
A: No, the information that we used was
secondary information; and those equity
capitalization rates were derived using
comparable sales.
Q: . . . That means [the information] came
from other areas other than Rutherford
County, isn't that correct?
A: That's correct.
On 14 November 1997, the Commission announced its final
written decision, providing in relevant part that:
5. The County's appraisal of [Taxpayers']
properties substantially exceeded the true
value in money of the properties as of
January 1, 1994.
6. Of the three appraisal methods
recognized by the Commission, cost approach,
comparable sales approach, and income
approach, the Commission finds that no
probative evidence was offered regarding the
comparable sales and cost approaches. Even
though the Commission considered all three of
the appraisal methods, the Commission relied
on the income approach to determine the
values of the subject properties.
7. Under the income approach method, the
value of property is determined by dividing
the net income by an appropriatecapitalization rate. The Taxpayer presented
evidence showing the monthly rental income
regarding each of the subject properties. . .
. After accepting the Taxpayer's income as
market income and adjusting the annual gross
income of the properties for expenses and
vacancy, the resulting net income was
capitalized into an indication of market
value for each of the subject properties.
The following table reflects the Commission's final
appraisal of the nine parcels, as well as the corresponding
values asserted by Taxpayers and the County.
| Bldg # |
Tax Parcel # |
Square Footage |
Annual Rent in Dollars |
County Value in Dollars |
Taxpayer Value in Dollars |
Commission Value in Dollars |
| 23 | 245-1-1H | 60,000 | 90,000.00 | 580,700.00 | 441,000.00 | 450,000.00 |
| 5 | 245-1-55 | 30,000 | 42.999.96 | 254,700.00 | 190,000.00 | 215,000.00 |
| 14 | 245-1-68 | 30,000 | 37,500.00 | 272,300.00 | 190,000.00 | 187,560.00 |
| 2 | 245-1-69 | 20,000 | 24,999.96 | 156,200.00 | 120,000.00 | 125,000.00 |
| 3 | 245-1-71 | 20,000 | 24,999.96 | 166,200.00 | 120,000.00 | 125,000.00 |
| 4 | 245-1-71A | 25,000 | 37,500.00 | 201,900.00 | 151,900.00 | 187,560.00 |
| 17 | 245-1-1F | 30,000 | 45,000.00 | 296,600.00 | 210,000.00 | 225,000.00 |
| 15 | 245-1-1E | 67,500 | 84,375.00 | 614,000.00 | 420,470.00 | 421,867.00 |
| 15A | 245-1-2C | 25,000 | 30,000.00 | 231,500.00 | 155,730.00 | 187,560.00 |
substantial rights . . . have been prejudiced
because the Commission's findings,
inferences, conclusions or decisions are . .
. [u]nsupported by competent, material and
substantial evidence in view of the entire
record as submitted.
We conclude the County's argument has merit.
Our review of a final decision of the Commission is governed
by N.C.G.S. § 105-345.2 (b) (1997), which states:
(b) So far as necessary to the decision and
where presented, the court shall decide all
relevant questions of law, interpret
constitutional and statutory provisions, and
determine the meaning and applicability of
the terms of any Commission action. The
court may affirm or reverse the decision of
the Commission, declare the same null and
void, or remand the case for further
proceedings; or it may reverse or modify the
decision if the substantial rights of the
appellants have been prejudiced because the
Commission's findings, inferences,
conclusions or decisions are:
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(1) In violation of constitutional
provisions; or
(2) In excess of statutory authority or
jurisdiction of the Commission; or
(3) Made upon unlawful proceedings; or
(4) Affected by other errors of law; or
(5) Unsupported by competent, material and
substantial evidence in view of the entire
record as submitted; or
(6) Arbitrary or capricious.
Upon challenge to a decision of the Commission under
subsection (5) above, we are to review the “whole record.”
N.C.G.S. § 105-345.2(c) (1997); see also Mao/Pines Assoc. v. New
Hanover Bd. of Equalization, 116 N.C. App. 551, 556, 449 S.E.2d
196, 199 (1994). The “whole record” test is not a tool of
judicial intrusion; “instead, it merely gives a reviewing court
the capability to determine whether an administrative decisionhas a rational basis in the evidence.” In re Rogers, 297 N.C.
48, 65, 253 S.E.2d 912, 922 (1979).
In addition, certain other principles apply: (1) a
reviewing court is neither free to weigh the evidence presented
to the Commission nor to substitute its own evaluation of the
evidence for that of the Commission; (2) ad valorem tax
assessments are presumed to be correct; and (3) “the correctness
of tax assessments, the good faith of tax assessors and the
validity of their actions are presumed.” In re McElwee, 304 N.C.
68, 75, 283 S.E.2d 115, 120 (1981).
The General Assembly requires all property in this State be
appraised for ad valorem tax purposes in accordance with N.C.G.S.
§ 105-283 (1997) which provides in pertinent part:
[a]ll property . . . shall as far as
practicable be appraised or valued at its
true value in money. When used in this
Subchapter, the words, “true value” shall be
interpreted as meaning market value, that is,
the price estimated in terms of money at
which the property would change hands between
a willing and financially able buyer and a
willing seller, neither being under any
compulsion to buy or to sell and both having
reasonable knowledge of all the uses to which
the property is adapted and for which it is
capable of being used.
Under N.C.G.S. § 105-317(a) (1997), the following specific
factors are to be considered in arriving at “true value”:
Whenever any real property is appraisedit shall be the duty of the persons making
appraisals:
. . . .
(2) In determining the true value of a
building or other improvement, to consider at
least its location; type of construction;
age; replacement cost; cost; adaptability for
residence, commercial, industrial, or other
uses; past income; probable future income;
and any other factors that may affect its
value.
The County contends it complied with the foregoing
provisions in employing an income approach to the valuation of
the property. We have previously commented “the income approach
is the most reliable method in reaching the market value of
investment property.” In re Appeal of Belk-Broome Co., 119 N.C.
App. 470, 474, 458 S.E.2d 921, 924, aff'd, 342 N.C. 890, 467
S.E.2d 242 (1996). “The income approach to value is based on the
principle that something is worth what it will earn.” In re
Southern Railway, 313 N.C. 177, 185, 328 S.E.2d 235, 241 (1985).
The capitalized value of a given income
stream varies directly with the amount of
income and inversely with the capitalization
rate . . . and [s]light variations in the
capitalization rate can result in large
variations in value.
Id.
The parties agree that there are two principal income
capitalization appraisal methods--direct capitalization and yieldcapitalization. Indeed, both parties cite and rely upon a
textbook produced by the Institute of Appraisers, The Appraisal
of Real Estate. Although not binding upon this Court, this
source summarizes the two methods of capitalization as follows:
Direct capitalization is . . . used to
convert an estimate of a single year's income
expectancy, or an annual average of several
years' income expectancies, into an
indication of value in one direct step--
either by dividing the income estimate by an
appropriate income rate or by multiplying the
income estimate by an appropriate factor. . .
. The rate or factor selected represents the
relationship between income and value
observed in the market and is derived through
comparable sales analysis.
. . . .
Yield capitalization is . . . used to convert
future benefits to present value by
discounting each future benefit at an
appropriate yield rate or by developing an
overall rate that explicitly reflects the
investment's income pattern, value change,
and yield rate. . . . The method is profit-or
yield-oriented, simulating typical investor
assumptions with formulas that calculate the
present value of expected benefits assuming
specified profit or yield requirements.
. . . .
Direct capitalization is simple and easily
understood. The capitalization rate or
factor is derived directly from the market. .
. . Yield capitalization, on the other hand,
tends to be complex, requiring the use of
special tables, calculators, or computer
programs [and the] formulas and factors
[used] can be obtained from financial tables.. . .
According to the testimony of Long, the County utilized a
mortgage-equity capitalization approach, a variety of yield
capitalization, to value the property. In the absence of
evidence of direct comparable sales within Rutherford County, the
County determined the capitalization rate by looking to “the
marketplace as to what the equity yield [was]. And [the County
derived] that information just from lending practices.” The only
comparable sales information was from areas outside Rutherford
County and was “secondary information,” and not “highly
comparable.” Ultimately, the County established the appropriate
capitalization rate as being between ten and one-half percent
(10.5%) and twelve and three-quarters percent (12.75%), depending
upon the age of the warehouse.
Taxpayers did not address an appropriate capitalization rate
in their evidence in view of their contention that valuation
should be based upon the cost of constructing the improvements on
the property.
In its final decision, the Commission indicated it valued
the property by “dividing the net income by an appropriate
capitalization rate.” The Commission thus relied upon the
direct capitalization method, see Appraisal of Real Estate,
rather than the yield capitalization approach employed by theCounty or the cost approach advocated by Taxpayers. However, the
Commission's final decision fails to disclose the specific
capitalization rate it utilized. Moreover, review of the “whole
record,” see G.S. § 105-345.2(c), does not reveal any evidence
supporting the ultimate capitalization rate apparently employed
by the Commission.
Taxpayers maintain the Commission's capitalization rate may
be determined mathematically by dividing the annual income
produced by a particular parcel into the corresponding appraisal
value assigned to that parcel by the Commission. Such
calculations suggest a twenty percent (20%) rate was utilized by
the Commission. Notwithstanding, “[i]t is difficult, if not
impossible, for an appellate court to divine the decision making
process of an administrative agency unless the agency clearly
sets it out in its order.” Southern Railway, 313 N.C. at 183,
328 S.E.2d at 240.
Taxpayers respond by pointing to the testimony of Padgett
who noted Taxpayers sought an annual gross return of twenty-one
percent (21%) on their investment, and who expressed the opinion
that an investor would require a similar return if purchasing the
property. However, as stated in Taxpayers' brief:
[Under the direct capitalization approach],
the capitalization rate or factor is derived
directly from the market and no distinctionis made between return on and return of
capital. Direct capitalization does not
explain value in terms of specific investor
assumptions.
Appraisal of Real Estate (emphasis added).
Significantly, the capitalization rate under the direct
capitalization approach is “derived through comparable sales
analysis,” see id., and both the County and Taxpayers acknowledge
that “highly comparable” sales information was lacking in the
instant case. Moreover, the Commission found that “no probative
evidence was offered regarding the comparable sales and cost
approaches.” Accordingly, we cannot “divine the decision making
process” of the Commission, Southern Railway, 313 N.C. at 183,
328 S.E.2d at 240, in particular its choice of an “appropriate”
capitalization rate, nor may we substitute our own “evaluation of
the evidence for that of the [Commission].” McElwee, 304 N.C. at
75, 283 S.E.2d at 120.
We therefore uphold the County's argument that the
Commission's findings are unsupported by “competent, material and
substantial evidence in view of the entire record,” G.S. § 105-
345.2(b)(5), in view of its failure to specify in its final
decision the “appropriate” capitalization rate utilized, and in
view of the absence in the record of evidence sustaining the rate
apparently employed by the Commission. Accordingly, the finaldecision of the Commission is reversed and this matter remanded
to the Commission for entry of a new final decision containing
findings of fact supported by evidence in the record. On remand,
the Commission shall rely upon the existing record and hear
additional arguments as it deems appropriate. See G.S. § 105-
345.2(b) (“court may affirm or reverse the decision of the
Commission, declare the same null and void, or remand the case
for further proceedings”); see also Brock v. Tax Commission, 290
N.C. 731, 737, 228 S.E.2d 254, 258 (1976) (where Commission's
findings are not supported by competent, material and substantial
evidence, “the case will be remanded for further proceedings”).
Prior to conclusion, we note the County also argues that the
Commission erred in denying the County's motion for dismissal at
the close of Taxpayers' evidence, and that the Commission abused
its discretion by failing to impose sanctions and hearing
Taxpayers' appeal on the merits in light of Taxpayers' willful
failure to comply with a discovery order. Suffice it to state we
have carefully reviewed the record and determined these
contentions are unfounded.
Reversed and remanded.
Judges GREENE and McGEE concur.