Beach Properties, Inc. v. Town of Ferrisburg

BEACH_PROPERTIES_V_TOWN_OF_FERRISBURG.92-478; 161 Vt. 368; 640 A.2d 50

[Filed 28-Feb-1994]

 NOTICE:  This opinion is subject to motions for reargument under V.R.A.P. 40
 as well as formal revision before publication in the Vermont Reports.
 Readers are requested to notify the Reporter of Decisions, Vermont Supreme
 Court, 109 State Street, Montpelier, Vermont 05609-0801 of any errors in
 order that corrections may be made before this opinion goes to press.


                                 No. 92-478


 Beach Properties, Inc.                       Supreme Court

                                              On Appeal from
      v.                                      Property Valuation
                                                and Review Division

 Town of Ferrisburg                           June Term, 1993



 Wayne W. Potter, Chair

 Patricia E. Dilley of Downs Rachlin & Martin, Burlington, for plaintiff-
   appellee

 Donald R. Powers of Powers, English & Carroll, Ltd., Middlebury, for
 defendant-appellant



 PRESENT:  Allen, C.J., Gibson, Dooley, Morse and Johnson, JJ.



      JOHNSON, J.     The Town of Ferrisburg appeals from a decision of the
 State Board of Appraisers that reversed the decision of the Ferrisburg
 Board of Civil Authority and declared that the taxpayer's property should
 be listed in the 1991 grand list for $3,850,000, rather than $4,806,000.  We
 reverse.
      The subject property is the Basin Harbor Club, a summer resort and
 convention center on 584.3 acres of land along the easterly shore of Lake
 Champlain.  The property has 136 guest cottages and rooms, restaurants, a
 developed waterfront, airport runway, tennis courts, swimming pool, 18-hole

 

 golf course, conference and banquet facilities, as well as other
 recreational facilities.  It has approximately 4,000 feet of shoreline on
 Lake Champlain and about 10,000 feet of frontage on public highways in the
 area.
      The taxpayer, Beach Properties, Inc., is wholly owned by members of the
 Beach family, who have owned and operated the property as the Basin Harbor
 Club since 1886.  In 1990, Robert H. Beach, Jr. and Ann P. Beach Morris, who
 are managers of the property and employees and stockholders of the
 corporation, became its sole owners by acquiring all of the stock of the
 corporation then owned by other family members.  The purchase price for the
 acquired stock was derived from a theoretical sale price for the entire
 property.
      To determine the property's value, the Town relied on a combination of
 the cost approach and market sales comparison approach.  The cost approach
 adjusted for time, location, physical characteristics and depreciation, to
 determine the contributory value of buildings and improvements.  The market
 sales comparison approach developed a schedule of land values and Lake
 Champlain shore frontage values derived from actual sales data.  The Town
 also contended that its valuation of $4,806,000 was confirmed by a
 consideration of potential and prospective uses of the property.
 Specifically, the Town argued that the property's existing waterfront
 cottages could be sold to individual owners through various forms of
 ownership without affecting the core resort's viability as a commercial
 enterprise.
      In response to the Town's assessment, the taxpayer had the property
 appraised.  The taxpayer's appraisal supported a property value of

 

 $3,850,000, which reflected a value of the Basin Harbor Club of $4,600,000
 minus $750,000 for furnishings, fixtures and equipment.  The appraiser
 arrived at this value by using an income capitalization analysis, derived
 from the net income for a single year, 1990, the sale price of the intra-
 family stock transfer, and a market sales comparison analysis, using two
 out-of-state resort sales as comparables.
      The Board of Appraisers found for the taxpayer, concluding that the
 intra-family sale price of the stock and the income capitalization method
 provided the most compelling indication of the 1991 fair market value.  The
 Town appealed, claiming the Board of Appraisers erred by making findings
 that were so devoid of evidentiary support as to be clearly erroneous.
                                     I.
      In the present case, all issues were hotly contested.  Serious
 questions were raised by the Town about the validity of the methodology used
 in the taxpayer's appraisal report and the lack of any indicia of
 reliability about the income figures that were at the heart of the
 taxpayer's analysis.  The taxpayer, in turn, questioned the Town's cost
 approach on the ground that the Town did not adequately assess depreciation
 of the buildings.  The taxpayer also took issue with the speculative nature
 of the Town's proposed scheme for division of the property.
      Before addressing the Town's substantive attack on the evidence, we
 briefly review the role of the Board of Appraisers in contested hearings.
 Appeals to the Board of Appraisers are hearings de novo, 32 V.S.A. { 4467,
 and the Board is required to make findings of fact supporting its ultimate
 determination.  Manganelli v. Town of Proctor, 144 Vt. 451, 453, 479 A.2d 155, 156 (1984).  Where conflicting evidence has been presented, the Board

 

 must state clearly what evidence it credits and why, so that the parties and
 this Court will know how the decision was reached.  Corrette v. Town of St.
 Johnsbury, 140 Vt. 315, 316, 437 A.2d 1112, 1113 (1981).  Although a
 tribunal may accept the testimony of specific witnesses or specific requests
 for findings and adopt the content of that testimony or those requests as
 the findings of the court, Bonanno v. Bonanno, 148 Vt. 248, 250, 531 A.2d 602, 603 (1987), "[a] recitation of the testimony is not a finding of fact,
 and such a recitation will not support a judgment."  Corrette, 140 Vt. at
 316, 437 A.2d  at 1113-14.  Unless the Board's determination of value is
 supported by adequate findings, it will not be affirmed.  Sondergeld v. Town
 of Hubbardton, 150 Vt. 565, 570, 556 A.2d 64, 67 (1988).
      In finding for the taxpayer, the Board made virtually no findings of
 its own, but rather described and summarized the dispute between the
 parties.  The Board's mere reference to the documentary submissions of each
 of the parties as its findings does not support its judgment.  New England
 Power Co. v. Town of Barnet, 134 Vt. 498, 502-03, 367 A.2d 1363, 1366
 (1976).  While the Board's decision is reversible for lack of findings
 alone, this is not a case in which a remand for adequate findings would
 cure the errors below because we also hold that the Board's conclusions are
 insupportable on the evidence presented.
                                     II.
                                     A.
      The Board's determination of fair market value relied on taxpayer's
 income capitalization method.  The capitalization, or income approach,
 "restates market value by converting the future benefits of property
 ownership into an expression of present worth."  International Ass'n of

 

 Assessing Officers, Property Assessment Valuation 231 (1977).  On a purely
 theoretical basis, income capitalization is probably the most accurate way
 to establish value, at least as to commercial properties, because it values
 property on the basis of what income it will yield to the purchaser -- and
 income is the very reason for the purchaser to acquire the property.  Id. at
 253.  We have accepted the use of this approach as a means of determining
 fair market value.  New England Power Co., 134 Vt. at 505, 367 A.2d  at 1368.
 But the methodology used to calculate the capitalization rate in this case
 was so flawed that it rendered the taxpayer's evidence on this point
 meaningless.
      The income approach is based on the proposition that a rational
 investor would pay the fair market value for a piece of property, which is
 the price (P) that, when multiplied by the rate of return available from
 alternative investments of comparable risk (the capitalization rate or R),
 is equal to the property's expected net income (I).  In other words, if the
 known factors are capitalization rate and net income, the price of the
 property may be calculated by dividing the net income by the capitalization
 rate: P = I/R.(FN1) International Ass'n, supra, at 231 - 234.
      In application, however, income capitalization has serious, inherent
 difficulties.  As noted above, there are two figures to the price
 calculation.  The first is the appropriate capitalization rate or the

 

 expected rate of return on investment.  It is derived from an analysis of
 factors external to the investment for which fair market value must be
 determined.  Thus, the validity of the capitalization rate depends on an
 adequate analysis of the market.  Since "[a] rate that indicates the return
 required to attract investment capital is the connection between the future
 income and a value indication, . . . selection of [the] rate is of paramount
 importance in the capitalization process."  Id. at 231.  Relatively small
 variations in the rate will significantly change the fair market value.(FN2)
 The key is comparability, and economists and other experts will frequently
 differ, at times widely, as to what comparable investments will yield, even
 where there is agreement on what constitutes comparability.
      An even greater difficulty may attend the calculation of the second
 component of the calculation, the expected net income.  Unlike the
 capitalization rate, it is derived from the internal numbers of the
 investment under appraisal.  In a property such as the Basin Harbor Club,
 income depends on a wide variety of factors, ranging from the competence of
 management to the economic climate experienced by the establishment's
 customer base to the weather.  Because relatively small adjustments to net
 income will significantly alter the resulting fair market value, it is
 important that expenses leading to net income be subject to scrutiny by the
 trier of fact.(FN3)

 

      In this case, the taxpayer's evidence as to both the capitalization
 rate and the property's expected net income was insufficient to provide the
 basis for a valid income capitalization calculation.  First, there was no
 external validity, by comparison with the rate of return of similar
 businesses, to the capitalization rate the taxpayer suggests.  The
 taxpayer's capitalization rate was determined wholly with reference to
 "internal" numbers.  It was derived by dividing the net profits of the Basin
 Harbor Club from a single year, 1990, by the theoretical sale price upon
 which the intra-family stock transfer was based, postulated for these
 purposes as the fair market value.(FN4)  This is a meaningless calculation
 because it derived a capitalization rate from a postulated fair market value
 for the property under appraisal, rather than deriving fair market value
 from a postulated capitalization rate based on investments with similar
 risk.
      Second, the net income component of the equation was not supported by
 sufficient evidence.  The taxpayer submitted the net income figure from a

 

 single year, 1990, of $457,432.  Because of the number of variables that
 affect net income, it is generally expected that a "stabilized annual net
 income" reflecting more than one year's set of figures will be used as the
 basis for income capitalization.  District of Columbia v. Washington
 Sheraton Corp., 499 A.2d 109, 113-14 (D.C. 1985) (quoting Rock Creek Plaza-
 Woodner Ltd. v. District of Columbia, 466 A.2d 857, 858 (D.C. 1983)).
 Moreover, the fair market value should be based on the property's potential
 for earning income as well.  Springfield Marine Bank v. Property Tax Appeal
 Bd., 256 N.E.2d 334, 336 (Ill. 1970) ("[I]t is the capacity for earning
 income, rather than the income actually derived, which reflects 'fair cash
 value' for taxation purposes.").  Net income was increasing for this
 business.  As the taxpayer's appraisal showed, net income increased in 1991
 to $510,878, and the appraisal report predicted "a modest, but steady
 increase."     
      The use of a single year's income is even more perilous here because
 the income figure is based on taxpayer's internal, unaudited financial
 statements.  This figure might have been acceptable if it had been
 sufficiently itemized to permit the Board to question the items that
 affected the bottom line.  Itemization, however, was limited to broad
 categories within the headings of departmental expenses of $2,239,001 and
 undistributed operating expenses of $1,521,178.  Significantly, there is no
 breakdown showing compensation to owners that would have allowed the Board
 to determine if the amount of salary or other distributions to family-member
 employees unduly affected net profits.  As the Town points out, there is
 every incentive in a family-owned business to distribute profits in the form
 of compensation and reduce corporate net income.  The Board had insufficient

 

 evidence before it to determine the reliability of the 1990 net income
 figure.
                                     B.
       Central to the Board's acceptance of the taxpayer's income
 capitalization analysis is whether the 1990 transfer of stock from various
 family members to the present owners reliably reflected the property's fair
 market value.  The capitalization rate used to derive the taxpayer's
 appraisal value is based solely on that sale.  The Board recognized that
 intra-family transfers are not ordinarily a reliable reflection of fair
 market value, but found that the sale was at arm's length.  Even if we were
 to accept the taxpayer's income capitalization methodology, the record does
 not support the conclusion that the sale was at arm's length.
       The taxpayer argues that the sale was adversarial within the family
 and that the Town is relying on innuendo and conjecture, without proof, to
 raise questions that the intra-family sale was not at arm's length.  The
 fact that the sale may have been adversarial within the family, while
 protecting common family interests, simply does not prove the sale was at
 arm's length.  The question is not whether the Town proved the sale was not
 at arm's length, but whether the taxpayer proved it was.  See New England
 Power Co., 134 Vt. at 508, 367 A.2d  at 1369 (the burden of persuasion "as to
 contested issues in a { 4467 hearing remains at all times with the
 taxpayer").
      "An arm's length sale is characterized by these elements: it is
 voluntary, i.e., without compulsion or duress; it generally takes place in
 an open market; and the parties act in their own self-interest."  Walters v.
 Knox County Bd. of Revision, 546 N.E.2d 932, 935 (Ohio 1989).  While there

 

 is no doubt the sale was voluntary, it did not occur in an open market and
 the price was negotiated by the parties without an appraisal.  The remaining
 evidence is inadequate to show that self-interest prevailed over common
 family interests and predilections.
      The only evidence offered that the family sale was at arm's length
 came from Ann P. Beach Morris.  Her testimony, however, belies the notion of
 self-interest between buyer and seller, and in fact lends weight to the
 opposite conclusion:
      Anybody who doesn't believe this was an armslength transaction
      doesn't know much about anything, because it was.  Mr. Chairman,
      I'd like to say that through the history of the Basin Harbor
      property, the control of the Beach family, which has become Beach
      Properties, Inc., I think it's been made clear that we're not in
      this for the money.  A lot of money changes hands here in the
      course of the year, but not very much of it sticks to our hands.
      I think if you look back through the history of how we've
      husbanded it, the land, when the Woods houses were sold off . . .
      those are the lots that abut our property to the south between
      here and Button Bay on the lakeshore, our grandmother . . . there
      wasn't any zoning then, so there could have been eighth-acre lots. 
      You could have had fifty houses down there instead of 20. He
      wasn't in it really for the money.  He was in it to create an
      aesthetic place where people wanted to be.  We had sold some other
      lots to people over the course of time and we've bought all those
      back. The property is here as it is today because my family
      inherently resists change . . . .


 (Emphasis added.)  The testimony continues in the same vein, reiterating
 the difficulty in getting all family members to agree on changes that might
 be made to the property and reaffirming that the Beach family wished to
 maintain the property in its present use.  This goal has been accomplished
 by retaining control and ownership within the family.  Indeed, there was no
 dispute that the Beach family has rejected previous offers and inquiries
 from outsiders, including an offer of $4,500,000 in 1986, and another in the

 

 same year for $3,300,000 and management contracts and substantial interests
 in land and resort privileges to the Beach family.
      In addition, the appraisal report submitted by the taxpayer reveals
 that the intra-family sale secured the rights of various members of the
 Beach family to live on the property and have access to its facilities and
 dockage.  Ann P. Beach Morris has a perpetual land lease for one dollar to
 accommodate her personal residence.  David Beach has a life estate and a
 residence developed in 1990.  Four properties owned by Beach family members
 or their heirs have water and sewage disposal rights and the right to adapt
 to alternate water and sewage systems as provided by the property.  Thus,
 even if the intra-family stock sale was an arm's length sale, it was clear
 error to use that transaction price as a proxy for market value without
 considering the value of the retained rights and perquisites of family
 members.  See Irving Saunders Trust v. Board of Assessors of Boston, 533 N.E.2d 234, 237-38 & n.2 (Mass. App. Ct. 1989) (below-market rental to
 relative of one of owners indicated that such space was "patently
 underutilized" and was not put to highest and best use).
      In light of our decision, it is unnecessary to reach other issues
 raised by the Town.
      Reversed and remanded.
                                    FOR THE COURT:



                                    _______________________________
                                    Associate Justice


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                               Footnotes

FN1.  For example, if the appropriate capitalization rate for an investment
 is eight per cent and the net income is $100,000, the fair market value of
 the property is $100,000 divided by .08 or $1,250,000.  For a general
 discussion of the income approach to property valuation, including
 calculation of the capitalization rate and analysis of expenses, see
 International Ass'n of Assessing Officers, Property Assessment Valuation
 203-275 (1977).  While our description here is an oversimplification of a
 complicated process, it is sufficient to illustrate taxpayer's analysis.

FN2.  From footnote 1, we know that if the capitalization rate is 8% and the
 property's net income is $100,000, then the price is $1,250,000.  If the
 capitalization rate is 1% higher, 9%, the price is only $1,111,111.

FN3.  For example, if the capitalization rate is 8% and the property's net
 income is $100,000, the price is $1,250,000.  If the expected net income is
 estimated to be $10,000 higher, $110,000, the price increases to $1,375,000.

FN4.  When taxpayer's expert (Keller) was questioned by a Board member
 (Cole) about where the capitalization rate came from, the following exchange
 occurred:
     Cole:     What you're doing . . . is you're using the price that Bob
               and Pennie paid --
     Keller:   There's nothing else out there.
     Cole:     But, that's where your cap rate came from is what they paid
               for it.
     Keller:   That's right. . . .
     Cole:     So, what you're really doing is backing into it a cap rate
               reflecting that sale.
     Keller:   Right.