Texas Real Estate Business

OCT 2017

Texas Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in Texas.

Issue link: http://texasrealestatebusiness.epubxp.com/i/885420

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www.REBusinessOnline.com Texas Real Estate Business • October 2017 • 49 T he retail sector is experiencing its darkest period ever, and taxing entities must come to grips with declining shopping center values. News reports confirm that national retailers are closing stores at a record pace. In 2017 alone, retail mainstays such as JC Penney, Sears and Macy's have shuttered hundreds of stores. Leading market analysts including Credit Suisse and Cushman & Wake- field have predicted the closing of some 10,000 brick-and-mortar stores. Even worse, many national retailers are filing for bankruptcy protection, with several others on analysts' watch lists. The more than 300 retailers re- ported to have filed for bankruptcy protection in 2017 include several ma- jor brands, from Payless ShoeSource to Gymboree and Wet Seal. These dire conditions have spurred some econo- mists to describe the ongoing blood- bath as a retail apocalypse. Double Trouble There are two main reasons for the retail sector's decline: First, consumer preferences are mi- grating from shopping at brick-and- mortar stores to more online shop- ping. Online sales increased by about $40 billion in 2016 and accounted for nearly 42 percent of all retail sales growth that year. Amazon alone ac- counted for 53 percent of that growth, reportedly quintupling its North American sales to $80 billion in 2016 from $16 billion in 2010. Second, today's consumers would rather spend their money on experi- ences than on material goods. They prefer dining out, going to movies and travel over buying more shoes, jeans, and electronics. And when they buy goods, they are increasingly likely to buy them online. These ongoing changes in consumer behavior have resulted in a disturb- ingly high inventory of vacant retail space, made worse by years of over- building in the sector. The United States reportedly has 40 percent more retail space per person than Canada, five times more than the United King- dom and 10 times more than Europe. Shopping malls have been particu- larly affected. Once popular desti- nations, many regional malls now scramble to find quality tenants and to attract shoppers. To survive, some malls have taken desperate measures to steer customers to their stores, such as hosting amusement parks and con- certs. Sadly, analysts predict 20 to 25 percent of U.S. shopping malls will close within the next five years. The market is simply oversaturated. Value Questions Consequently, retail property value has plummeted. What once was seen as a safe investment is now fraught with risk. Suffering national retailers have made retail real estate riskier as the chances of store closures and tenant bankruptcies have increased. Investors only value retail properties highly when those assets are gener- ating a reliable stream of rental pay- ments from high-quality tenants. But with department stores, electronics retailers and apparel shops boarding up, there is insufficient demand to sustain the rental rates and occupancy levels necessary for many properties to support historical values. Unfortunately, tax assessors are turning a blind eye to this new real- ity, continuing to assume that there is a viable market with robust buyer demand for this property type. In many jurisdictions, tax assessors have even raised taxable values on retail properties. This has obviously created confusion among property owners, as the values assessed by tax- ing jurisdictions conflict with selling prices that owners can garner on the open market. When vacant properties go up for sale, they may linger on the market for years. And when they do sell, they are often sold to unconvention- al users, such as hospitals, trampo- line parks, call centers, churches and schools. These buyers know that they can leverage the market oversupply to achieve low acquisition prices. When owners point to sales of comparable – and often vacant – re- tail properties as evidence of market value, tax assessors accuse them of applying the "Dark Store Theory," which many assessors have mischar- acterized as a tax loophole. Assessors have even convinced news media organizations of this misconception, evidenced by headlines such as "Sin- ister-Sounding Dark Store Theory Is Corporate Welfare" and "How Big- Box Retailers Weaponize Old Stores." This has fueled an ongoing debate concerning how to properly value the fee-simple interest in income-produc- ing property, which in most jurisdic- tions is the taxable value. In essence, tax assessors claim that retail property owners are trying to escape taxation by calculating taxable value based on the asking rents and sales of vacant retail locations, rather than on actual rents and sales of occu- pied properties. Tax assessors contend that property owners are comparing apples to oranges. Property owners counter that asses- sors are overstating real estate value by capturing the additional value of non-taxable assets, such as long-term leases with brand-name retailers. Despite this debate, there is no hid- ing the fact that retail is going dark. Shopping malls and over-sized big box stores have become largely obso- lete, bankruptcies and store closures plague the industry, and the glut of retail space grows. Preferences for on- line shopping and consumer purchas- ing patterns are here to stay. We are reaching a point where the "dark store" is the norm. The mar- ket has turned previous assumptions about variables such as market expo- sure, vacancy, capitalization rates and market rents on their heads, resulting in a retail meltdown. It may be difficult for many observ- ers to watch American institutions like the shopping mall and freestand- ing retail center slide into obsoles- cence. But to maintain the integrity of our property tax system, tax assessors must accept this new reality. Daniel R. Smith is a principal with and general counsel for Austin, Texas law firm Popp Hutcheson PLLC, the Texas member of American Property Tax Counsel, the national affiliation of property tax attorneys. James Johnson is a graduate student at Texas A&M University's Real Estate Center and tax ana- lyst for Popp Hutcheson. They may be reached at daniel.smith@property-tax.com. Daniel R. Smith Principal, General Counsel Popp Hutcheson PLLC James Johnson Tax Analyst Popp Hutcheson PLLC Visit our Booth @ ICSC Texas Conference & Deal Making Dallas, TX (Booth #253) PROPERTY TAXES SHOULD REFLECT RETAIL'S APOCALYPTIC TIMES Instead, assessors continue to ignore the clear fact that brick-and-mortar retail is in massive decline. By Daniel R. Smith, Esq. and James Johnson

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