WESTWOOD LANES, INC. v. GARWOOD BOROUGH

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF

THE TAX COURT COMMITTEE ON OPINIONS

___________________________________ TAX COURT OF NEW JERSEY

WESTWOOD LANES, INC., ) DOCKET NOS. 004258-2006

) 005200-2007

Plaintiff, )

)

Approved for Publication

In the New Jersey

Tax Court Reports

v. )

)

GARWOOD BOROUGH, )

)

Defendant. )

___________________________________ )

Decided: August 8, 2008

Michael M. Stadler for plaintiff

(Michael M. Stadler, P.A., attorney).

Robert F. Renaud for defendant

(Palumbo & Renaud, attorneys).

SMALL, P.J.T.C.

The above-captioned appeals of the tax assessments of a catering hall in Garwood, New Jersey raise three major questions of fact and law: (1) Should the matters have been dismissed at the end of plaintiff s case? (2) In using the cost approach to value, should entrepreneurial profit have been added to the cost of construction using the Marshall and Swift method of calculating the value of improvements? and (3) Because the inadequate parking on the property constitutes functional obsolescence, if the property s highest and *

best use is as a catering hall how is that functional obsolescence to be calculated? Additional and less important issues regarding the comparability of sales of land and proper adjustments to those sales and the proper calculation of the cost of construction of the improvements are also presented for determination.

At the end of plaintiff s case, defendant moved for judgment. I denied that motion, but defendant has asked me, under R. 4:49-2, to reconsider my determination on that motion prior to ruling on the other issues. I have concluded that it was appropriate to deny defendant s motion at the end of plaintiff s case and accordingly, deny the motion to reconsider that determination. Although plaintiff has made no better case than it did at the end of its case, the standards by which its evidence must be judged at the end of its case and at the end of both parties cases are different. Passarella v. Township of Wall, 22 N.J. Tax 600, 603 (App. Div. 2004). On defendant s motion at the end of plaintiff s case, all inferences must be drawn in plaintiff s favor. After both parties have put in their case and rested, the plaintiff is no longer entitled to those favorable inferences. Defendant s burden of persuasion at that stage of the litigation is easier. Accordingly, after having heard all of the evidence, reexamining my denial of defendant s motion at the end of plaintiff s case would serve no practical purpose other than perhaps limiting the evidence to be considered were an appeal taken from my determination after hearing all of the evidence. I am persuaded by the defendant s case on the merits, as a matter of law and fact; I find it appropriate to decide the matter by analyzing all of the evidence rather than simply dismissing plaintiff s case for a failure of proof.

I also have concluded that entrepreneurial profit should be added to the cost of construction. And, I have concluded that although there is functional obsolescence because of the lack of adequate parking adjacent to the subject property, plaintiff s method of calculating that obsolescence is not supported by appraisal literature and is inherently illogical. Accordingly, I have calculated appropriate values of the subject property on the assessing dates and determined that for both years the ratios of the assessments to the fair market value fall within the common level of the Chapter 123 corridor and that therefore the assessments made by the municipal assessor must be affirmed.

The subject property is a 31,843 square foot catering facility with a basement of 6,026 square feet and a separate warehouse of 1,176 square feet. It sits on 60,000 square feet of land. It is adjacent to another 60,000 square foot property, which is leased by the owner of the subject property for parking in order to accommodate the needs of the subject property for adequate parking in running its catering business.

3 For both years 2006 and 2007, the subject property comprising several lots and blocks in Garwood was assessed as follows

Land $ 463,300

Improvements 1,484,400

$1,947,700

3 The Chapter 123 ratios (L. 1973, c. 123, N.J.S.A. 54:51A-6) for each year are as follows: for 2006 - 34.17% with a lower limit of 29.04% and an upper limit of 39.30%; and for 2007 - 30.77% with a lower limit of 26.15% and an upper limit of 35.39%. Plaintiff s expert valued the subject property at $3,089,141 for 2006 and $3,672,060 for 2007. Defendant s expert valued the subject property at $6,020,879 for 2006 and $6,293,530 for 2007. Each expert relied principally on the cost approach to value. Plaintiff s expert did a comparable sales analysis but ultimately concluded that it was of no use. Similarly, defendant s expert used a comparable sales analysis and concluded that it was only useful in confirming his conclusions based on the cost method.

The comparable sales analysis was deemed unreliable because the experts comparable sales involved the sale of real estate as well as furniture, fixtures and equipment and the associated business. The value assigned to the real estate was an allocation made by the buyer and seller and not something determined separately in the market. An allocation such as this is unreliable for setting a market price of the real estate alone. See Worden-Hoidal Funeral Homes, Inc. v. Borough of Red Bank, 21 N.J. Tax336, 344-45 (Tax 2004) (noting that because many of the comparable sales testified to by both [the] plaintiff s and [the] defendant s experts [were] based on agreements by the parties to the transactions as to the allocation of the sales prices between the real estate and the [funeral home] business[,] . . . [t]he sales price allocated to the real estate [might] not, therefore, reflect market value with any degree of precision ).

I.

Comparison of Experts Calculations

The two experts opinions of value using the cost method were calculated as follows

Tax Year 2006

Plaintiff s Expert

Defendant s Expert

Land Value

$1,500,000

($25.00/sq. ft.)

$2,160,000

($36.00/sq. ft.)

Replacement Cost

New of Improvements

$4,627,344

$5,161,603

Entrepreneurial

Profit

----

516,160

Cost New of Improvements

$4,627,344

$5,677,763

Less

Physical

Depreciation

(1,203,109) (26%)

(1,532,996) (27%)

Functional Obsolescence

(185,094) (4%)

(283,888) (5%)

(includes inadequate parking)

Economic Obsolescence

(inadequate parking)

(1,650,000)

----

Total

(Land and Improvements)

$3,089,141

$6,020,879

Tax Year 2007

Plaintiff s Expert

Defendant s Expert

Land Value

$1,890,000

($26.50/sq. ft.)

$2,250,000

($37.50/sq. ft.)

Replacement Cost

New of Improvements

$5,044,371

$5,569,601

Entrepreneurial

Profit

----

556,960

Cost New of Improvements

$5,044,371

$6,126,561

Less

Physical

Depreciation

(1,311,536) (26%)

(1,776,703) (29%)

Functional Obsolescence

(201,775) (4%)

(306,328) (5%)

(includes inadequate parking)

Economic Obsolescence

(inadequate parking)

(1,749,000)

----

Total

(Land and Improvements)

$3,672,060

$6,293,530

I will discuss each element of value.

II.

Land Value

Each expert selected comparable vacant land sales, and adjusted them to the subject to conclude a per square foot value of land. Plaintiff s expert used two land sales in Garwood and one in Mountainside. Through cross-examination, defendant s attorney demonstrated that land sale #1 was for eventual development as a shopping center. Plaintiff s land sale #2 was for eventual use as residential and retail. Plaintiff s land sale #3 was for eventual use as a restaurant. All three uses were different than the conclusion of plaintiff s expert that the highest and best use of the subject was a catering hall. On that basis alone, defendant s attorney argued that plaintiff s evidence was inadequate to rebut the presumption of correctness that attaches to the assessment. See Pantasote Co. v. City of Passaic, 6 N.J. Tax 34, 39 (Tax 1983), aff d, 7 N.J. Tax 663, 664 (App. Div. 1984), aff d, 100 N.J. 408, 412-13 (1985) (citing Aetna Life Ins. Co. v. City of Newark, 10 N.J.99, 105 (1952)) (see discussion at page 2 of this slip opinion). I find, after examining all of the evidence, that although plaintiff produced evidence that was probably insufficient to overcome the presumed correctness attached to the original assessment and thus showed no right to relief; and under R. 4:37-2, it might have been appropriate to have dismissed the case. I nevertheless will examine all of the evidence. I am mindful that our Supreme Court has instructed this court not to place too heavy a burden of proof on taxpayers and that the standards of proof are different at the end of plaintiff s case than at the conclusion of the trial. See Glen Wall Assocs. v. Township of Wall, 99 N.J. 265, 284 (1985); see also Passarella, supra, 22 N.J. Tax at 603.

Defendant s expert used comparable land sales. Two were for restaurant use, one of which (defendant s land sale #3) had also been used by plaintiff s expert (plaintiff s land sale #3). The other three were used as branch banks. Thus, neither expert found a single comparable land sale of the seven different land sales selected that was purchased for use as a catering hall. Again mindful of our Supreme Court s admonition in Glen Wall, supra, 99 N.J. at 284, and in Ford Motor Co. v. Township of Edison, 127 N.J. 290, 314-15 (1992), I choose to analyze the two experts land sales as follows.

Plaintiff s expert s time and other gross adjustments ranged between 46% and 51%. Defendant s expert s gross adjustments ranged between 20% and 45%. On the one property they selected in common, the gross adjustments of plaintiff s expert were 51% with a net adjustment of negative 19%. The gross adjustments of defendant s expert were 45% with a net positive adjustment of 25%. The difference in these percentages was mainly due to the experts location adjustments. Defendant s expert found the subject location 10% superior to the Mountainside location and plaintiff s expert found it 25% inferior to the Mountainside location. Although the subject location might have been inferior to land sale #3 as a restaurant, I am persuaded that the subject s location as a catering hall was superior to the Mountainside location because of its proximity to Westfield and Cranford and the fact that a catering hall (unlike a restaurant) need not be on a high traffic highway with great visibility. Had plaintiff s expert concluded that the highest and best use of the subject were as a restaurant, I might have been persuaded by his adjustments; however, having concluded that the highest and best use was as a catering hall, which was essential to his single highest reduction in value, see Part VII infra (discussing obsolescence due to inadequate parking), his adjustment of negative 25% from his land sale # 3 is unsupported. Accordingly, I find defendant s expert s conclusion of land value more persuasive than that of plaintiff s expert.

III.

Cost New

The two experts concluded the value of the subject s improvements new based on the use of the Marshall and Swift cost calculator. Plaintiff s expert fed information into a computer model. The defendant s expert relied on a manual lookup from published tables. The defendant s expert made much of the fact that in adding the component values together, plaintiff s expert failed to include the elevator. This was corrected at trial and I find it to be the result of no more than a careless review of the calculations by plaintiff s expert. Plaintiff s expert failed to include the actual computer printouts from Marshall and Swift or have them copied into his report. He ascribed this to the fact that Marshall and Swift was a PC computer system, his offices report writing system is Apple based and the two systems are incompatible. This is a weak argument. He could have photocopied the Marshall and Swift printout just as he photocopied photographs that appear in his report. Defendant argued that if he was merely copying he would not have failed to include the elevator in his final calculation. Defendant also argued that the computer was a black box and that, having failed to include the computer s printouts, plaintiff's expert's opinion of value was a net opinion or, at best, not based on a fully disclosed calculation tracing back to the Marshall and Swift formulas unit values.

Plaintiff argued that the undisclosed computerized system was more up to date than was the manual system of the defendant s expert. In the end, the difference between the two experts conclusions of the value of the undepreciated improvements was no greater than 9%. Because the basis of the calculations of defendant s expert was disclosed and because he made no apparent errors in calculations, I find his conclusion of undepreciated value to be more persuasive than that of plaintiff s expert. This is not to say that the manual system is more accurate or to be preferred to the computerized system. However, when using a computerized system, more must be included in the expert s testimony and report than his inputs and the computer output; at a minimum, the expert should have included data as input to the Marshall and Swift Program and its output in the form of the original, or photocopies of the original Marshall and Swift input and output sheets. In this instance, the facts on which the defendant s expert relied and the method by which he calculated cost new of the improvements stands on much more solid ground than does plaintiff s expert s and I will adopt his calculations.

IV.

Entrepreneurial Profit

Plaintiff s expert did not add entrepreneurial or developer s profit to his construction costs, arguing that a custom-built building should not include such an expense. Defendant s expert added 10% entrepreneurial profit because it was his opinion that entrepreneurial profit should be added in all instances where the cost method of valuation was used.

Entrepreneurial profit is [a] market-derived figure that represents the amount an entrepreneur receives for his or her contribution to a project and risk; [equaling] the difference between the total cost of a property (cost of development) and its market value (property value after completion) . . . . Appraisal Institute, Appraisal of Real Estate, 360 (12th ed. 2001).1 As the tables at the end of this Part demonstrate, New Jersey courts include entrepreneurial profit within the market value of property where the developer or owner-operator makes improvements to property with the anticipation of realizing a profit on its subsequent resale. See Lawrence Assocs. v. Township of Lawrence, 5 N.J. Tax 481, 535 (Tax 1983). Such entrepreneurial incentive2 is [a] market-derived figure that represents the amount an entrepreneur expects to receive for his or her contribution to a project and risk. Appraisal of Real Estate, supra, at 360. Whether called entrepreneurial profit or entrepreneurial incentive, it represents the difference between the total of (1) the cost of acquiring land plus (2) the cost of constructing an improvement and the improved property s market value.

New Jersey courts do not consider the status of the builder (as developer or owner-operator) dispositive to the determination of whether to include entrepreneurial profit within market value. See Beneficial Facilities Corp. v. Borough of Peapack & Gladstone, 11 N.J. Tax 359, 381 (Tax 1990), aff d, 13 N.J. Tax 112 (App. Div.), certif. denied, 130 N.J. 397 (1992) (including entrepreneurial profit within market value of an owner-constructed and owner-occupied building because the principle of uniformity requires such property to be treated in the same manner as investment or speculation type property ).

Additionally, although they generally do not recognize entrepreneurial profit where there is no market data supporting its inclusion within market value, see, e.g., Brae Assocs. c/o Hertz Realty v. Borough of Park Ridge, 19 N.J. Tax 306, 314 (App. Div.), certif. denied, 170 N.J. 87 (2001); B.F. Goodrich Co. v. Township of Oldmans, 17 N.J. Tax 114, 122-23 (Tax 1997), aff'd, 323 N.J. Super. 550 (App. Div. 1999); Badische Corp., supra, 11 N.J. Tax at 402; Litton Business Systems, Inc. v. Borough of Morris Plains, 8 N.J. Tax 520, 533 (Tax 1986), aff'd, 9 N.J. Tax 65 (App. Div. 1988); Berkley Arms Apartment Corp. v. City of Hackensack, 6 N.J. Tax 260, 272-73 (Tax 1983),New Jersey courts may still infer entrepreneurial incentive, and thus recognize and include entrepreneurial profit within a property s value, if they find, despite the absence of supporting market-evidence, that such property would not be improved but for the likely compensation of a developer s or owner-operator s efforts. See Twin Oaks Assoc. & Health Res. v. Town of Morristown, 9 N.J. Tax 386, 397 (Tax 1987) (determining that [a]lthough there [was] no acceptable market-derived evidence of the price that the subject property [would] sell for in the market, on an unencumbered basis, from which to determine the difference between the replacement cost and the market value, . . . this nursing home would not be built, with all of the permits and licenses required, unless the developer could be assured that his efforts would be compensated. ), aff'd, 11 N.J. Tax 94 (App. Div.), certif. denied, 117 N.J. 155 (1989).

Plaintiff s expert concluded that entrepreneurial profit should be excluded from the market value because the catering hall is uniquely designed, with special construction features and layouts that restrict its utility to the use for which it was built such that only specific users (i.e. other catering halls or buyers with uses similar to those of catering halls) will pay the full cost of improvements; this, plaintiff s expert asserts, causes immediate functional obsolescence. Plaintiff s expert next concluded that entrepreneurial profit should be excluded from the market value because catering halls are not constructed by developers in the expectation of profit on sale but rather are constructed by owner-operators for use in their businesses without any entrepreneurial incentive in mind. Defendant s expert concludes that entrepreneurial profit should be included in the market value of the catering hall.

The first conclusion of plaintiff s expert that the catering hall being custom-built for purposes of a specific type of owner-operator precludes entrepreneurial profit directly contradicts the discussion in the Appraisal of Real Estate, which states, the value of custom-built properties should also reflect an entrepreneurial profit. Appraisal of Real Estate, supra, at 362 (comparing the treatment of custom-built properties to those built by developers on speculation). Even if such argument were attributed weight, plaintiff s expert incorrectly relies on functional obsolescence as support for excluding entrepreneurial profit from market value where New Jersey courts make such determinations independently. See American Cyanamid Co. v. Township of Wayne, 17 N.J. Tax 542, 560-61 (Tax 1998) (stating that [b]ased upon the [Appraisal of Real Estate], I conclude that a factor for entrepreneurial profit should initially be included in the cost approach analysis for the subject property, although the impact of such factor could be nullified by a later deduction for external obsolescence attributable to weak market conditions. ), aff'd, 19 N.J. Tax 46 (App. Div. 2000).

The second conclusion of plaintiff s expert that catering halls are not constructed by developers in expectation of profit on resale is contradicted by New Jersey case law and the facts in issue, both of which indicate that there is sufficient market evidence to support the owner-operator s entrepreneurial incentive, and thus inclusion of entrepreneurial profit within market value. In Sears Roebuck & Co. v. Township of Rockaway, 12 N.J. Tax 381, 390 (Tax 1992), this court considered the location of the subject property in a thriving regional mall, despite the absence of sales volume information, to be sufficient market evidence supporting a reasonable inference of expected profit and thus inclusion of entrepreneurial profit within market value. The court stated

Further, the fact that this is an apparently successful department store in a well-located and successful regional mall, and the absence of sales volume information, give rise to an inference that the market would recognize a profit for the developer. This justifies the inclusion of entrepreneurial profit in the cost approach based on a reasonable estimate of the profit entrepreneurs expect in the development of similar projects.

[Ibid.]

Here, the catering hall is located near an expanding district of mixed (commercial and non-commercial) use property. The catering hall is located on a commercial roadway, and the immediate surrounding area is comprised of commercial occupants such as: ShopRite Supermarket, Westfield Lumber, the Crafty Kitchen, Gold Medal Fitness, the Mattress Factory, Manufacturing Equipment Salesmen, Hess Gasoline Station, Independence Community Bank, Robert s Steak House, Garwood Plaza and CVS Center, Garwood Lanes, Burger King and McDonald s. Also located in close proximity to the catering hall are: the Cranford Business district (3/4 mile east of subject property), country clubs, recreation centers, public transportation (train station), schools, and various condominiums and town homes. Defendant s expert states that local construction and population trends have been increasing. Such market evidence positions the catering hall in a thriving location comparable to that of the subject property in Sears Roebuck. The catering hall s location in an expanding district may, like the Sears Roebuck project, give rise to an inference of profit. It follows that plaintiff s substantial renovations to the property in 2002 and 2003 (which increased the catering hall s useful life by 20+ years), were made in part in anticipation of realizing a profit on resale of the hall at some point in the future.

Additionally, the conclusion of plaintiff s expert - that the catering hall being custom-built and attractive only for purchasers with similar anticipated uses precludes entrepreneurial profit - does not negate the owner-operator s entrepreneurial incentive; it is reasonably foreseeable that the owner-operator in this case would consider it likely that a buyer would purchase the hall and then renovate it into an alternate use, similar to plaintiff s third comparable sale, in which Petsmart purchased a banquet hall and renovated it to fit an alternate use. This scenario is especially plausible in expanding commercial districts, in which businesses buy and renovate properties to secure a competitive advantage.

Even without such specific market evidence, I find, consistent with the holding in Twin Oaks Assocs., supra, that entrepreneurial incentive should be added where an owner-operator of a catering hall, with many required permits and licenses, would not substantially renovate and improve the property but for the assurance that he or it would be compensated therefor. Cf. Twin Oaks Assoc., supra, 9 N.J. Tax at 397.

For the reasons discussed above, I find that entrepreneurial profit should be included in calculating the catering hall s market value because there is sufficient market evidence, as well as inferences that may be drawn therefrom, that demonstrate the owner-operator of the catering hall most likely purchased and made improvements to the property in light of his or her entrepreneurial incentive.

As no other conflicting evidence of the amount of entrepreneurial profit has been placed in the record, I accept the 10% of construction costs quantification of defendant s expert.

The following tables summarize cases of the Tax Court of New Jersey which have included and excluded entrepreneurial profit when applying the cost method to valuation.

Cases Which Include Entrepreneurial Profit

Case and Type of

Facility

Includes? (Yes/No)

If yes, amount (%)

Reason

Inclusion of Entrepreneurial Profit Disputed by the Parties?

Facts

1) Beneficial Facilities Corp. v. Borough of Peapack & Gladstone, 11 N.J. Tax 359, 381 (Tax 1990), aff d, 13 N.J. Tax 112 (App. Div.), certif. denied, 130 N.J. 397 (1992)

(corporate headquarters).

Yes (10%).

Entrepreneurial profit is justified, even for an owner-constructed and owner-occupied building because the principle of uniformity requires such property to be treated in the same manner as investment or speculation type property. Id. at 381.

No.

The taxpayer s appraisal expert did not add for entrepreneurial profit, stating that this element was to be added only for buildings built on speculation, not those built for owner use. Id. at 370. The taxing district s appraisal expert also did not include entrepreneurial profit in his cost based value estimate. Id. at 374-75.

Property is: a single-user corporate headquarters.

Village-style grouping of brick two- and three-story office buildings that includes two multilevel garage structures, a co-generation energy building, employee gasoline service station, two tennis courts, guard house, clock/water tower, underground garages and brick-lined underground corridors.

Buildings used principally as office space, improvements include: executive office bldg., cafeteria, co. store, barber shop, bank, workout room, and medical facilities (fit for 1100 employees).

Unique Italian style architecture.

Subject property was not built for sale, but it was actually sold, and there was substantial profit to Beneficial.

Appraisal Expert used three methods in cost approach (1) Marshall Valuation Service cost figures, (2) construction costs of other office buildings, and (3) trending up the actual Turner construction cost of subject improvements. Plaintiff s expert did not include entrepreneurial profit. (claimed entrepreneurial profit was only to be added for buildings built on speculation, not those built for owner use.)

2) Lawrence Associates v. Township of Lawrence, 5 N.J. Tax 481, 535 (Tax 1983) (shopping mall).

Yes (10%) as to the Mall, but no as to the adjacent highway overpass.

[P]laintiff Lawrence Associates anticipated a substantial profit as the developer of Quaker Bridge Mall and that the amount of that profit is reflected in the market value of the Mall. Id. at 535.

Entrepreneurial profit did not apply to the highway overpass because the overpass per se is not a commercial venture which an entrepreneur would be induced to construct with the expectation of earning a profit separate from that derived from the Mall itself. Id. at 538.

Yes.

The taxpayer s appraisal expert contended the cost based value estimate should not include entrepreneurial profit whereas the defendant s appraisal expert added 10% to the cost based value estimate for entrepreneurial profit. Id. at 534-35. One of the most significant disputes between the parties regarding the reproduction cost approach involves the concept of entrepreneurial profit. Plaintiff contends that there is no such profit that may be valued for ad valorem tax purposes yet both of defendant s experts valued it at approximately 10% of their improvement value derived from the reproduction cost method. Ibid.

Subject property is a super regional shopping center known as Quaker Bridge Mall, and consists of four major department stores and 130 specialty shops.

Plaintiff Lawrence Associates was organized to develop, construct and operate Quaker Bridge Mall.

By the time institutional financing had been obtained the [partner] interests had advanced a total of from $2,500,000 to $5,000,000 of their own funds. . . . The . . . principals would not have placed up to $5,000,000 of their own funds at risk unless they felt there was a very good probability that they would make a substantial profit as a result of the development of Quaker Bridge Mall. Id. at 537.

Further, the developer s profit could only be recouped upon the resale of the Mall.

The overpass goes from one of plaintiff's two tracts to the other and it was certainly a cost incurred by plaintiff in the development of its property.

Much of the overpass is physically over Route 1, a public way, and it is unclear from the proofs exactly where the foundations of the overpass are located.

The structure does not belong to the State or local government and it must be assessed to its owner because it is not exempted by statute.

3) McGinley Mills, Inc. v. Town of Phillipsburg, 9 N.J. Tax 508 (Tax 1988) (user-developed industrial facility).

Yes (5%).

[I]t is necessary to include a figure which reflects the time, effort, and incidental expense of the owner in the development of the property. Id. at 517.

Yes.

The taxpayer s appraisal expert did not include entrepreneurial profit in his cost based value estimate whereas the taxing district s appraisal expert did include entrepreneurial profit within his cost based value estimate. Id. at 513.

Subject property is a well-maintained textile manufacturing plant.

Property contains six interconnected one-and two-story buildings located on the property. Buildings used for office space, manufacturing and loading dock.

Taxpayer s appraisal expert described the property

the property could not be rented to more than one occupant without major renovations, and features of the buildings, specifically, the loading dock, central heating system and the overall design of the buildings, make the property unattractive for investment purposes, and attractive only for purchase by an owner-user. Id. at 512.

4) Glen Pointe Assocs. v. Township of Teaneck, 10 N.J. Tax 506, 515-16 (Tax 1989) (office buildings), aff'd, 12 N.J. Tax 127 (App. Div. 1991).

Yes (10%).

Sound appraisal practice as well as common sense dictate that the developer s profit be calculated by taking into account his entire acquisition cost, not just the cost of the improvements. Id. at 516.

Yes.

The taxpayer s appraisal expert included entrepreneurial profit in his replacement cost estimate of the improvement, exclusive of the land. Id. at 515. The defendant s appraisal expert

purported to rely upon the cost approach in the two earlier years and made adjustments for entrepreneurial profit and the cost of tenant finishes, [but] it appears that he ultimately relied upon stabilized, income-derived values for 1986 and 1987 and trended those values back to 1984 and 1985 on the basis of the percentage of completion of the East Office Building on the assessing dates for those years. Id. at 513.

Subject property is a seven-story office building, which includes rentable space of 240,000 square feet. The lobby level included a landscaped mall connecting the retail shops, a hotel, and health club.

Plaintiff left rental space in an unfinished shell condition until the space was leased, at which point tenant fit-ups were completed. Other improvements were the responsibility of the tenants.

5) Twin Oaks Assoc. & Health Res. v. Town of Morristown, 9 N.J. Tax 386, 397 (Tax 1987) (regulated nursing home).

Yes (10%).

Although there is no acceptable market-derived evidence of the price that the subject property will sell for in the market, on an unencumbered basis, from which to determine the difference between the replacement cost and the market value, I must assume that this nursing home would not be built, with all of the permits and licenses required, unless the developer could be assured that his efforts would be compensated. Id. at 397.

Yes.

The taxpayer s appraisal expert did not include entrepreneurial profit in the cost-based value estimate and the defendant s appraisal expert added 15% for entrepreneurial profit. Id. at 396.

Subject property is a 304-bed proprietary nursing home.

Property consists of 161 guest rooms (18 of which are private), a lobby-reception area, dining room, kitchen, living room, general offices and three elevators. Basement is improved with a chapel, recreation room, beauty parlor, therapy rooms, employee lounge, laundry, storage and maintenance rooms.

Twin Oaks Associates was the tenant under a ground lease. Health Resources of Morristown, Inc. was parent to the partnership that owned and leased the property to Twin Oaks.

Taxpayer s appraisal expert used two methods: estimate of value based on NJ Medicaid facilities allowances and reimbursements, and an income approach deriving the rental income from the actual lease of December 31, 1984.

There is a limited market for proprietary nursing homes, and the real estate has limited alternate uses. The ability of the nursing home property to produce income is the source of the value of the real estate.

6) Abe Schrader Corp. v. Town of Secaucus, 8 N.J. Tax 390, 395 (Tax 1986) (warehouse/ retail outlet building).

Yes 10% (cash on cash equity return).

Failure to reflect entrepreneurial profit, the most substantial of these indirect costs [engineering and architect s charges, financing, insurance and permits, taxes, management and other overheard and entrepreneurial profit], in his cost estimate is fatal to the probative utility of the expert s cost approach. Id. at 395.

No.

The taxpayer s appraisal expert did not include entrepreneurial profit in the income and cost-based value estimate, and the defendant s appraisal expert also did not include entrepreneurial profit in his income based value estimate. Id. at 393-95.

Subject property is a one-story masonry and steel-framed building, characteristic of a warehouse retail outlet structures erected by Hartz Mountain Industries (owner) in 1976.

The property was located in the midst of an active and continually growing industrial market with ready access to highways leading to NYC and heavily industrialized metropolitan areas in northern NJ.

Cases Which do not Include Entrepreneurial Profit

Case and type of

facility

Includes? (Yes/No)

Reason

Inclusion of Entrepreneurial Profit Disputed

By the Parties?

Facts

1) Brae Assocs. c/o Hertz Realty v. Borough of Park Ridge, 19 N.J. Tax 306 (App. Div.) (office building), certif. denied, 170 N.J. 87 (2001).

No.

The Appellate Division rejected appellant s contention that the judge erred in excluding entrepreneurial profit as a factor in the property s development costs. In the absence of market data demonstrating that entrepreneurial profit should be included, the judge properly excluded it. Id. at 314 (emphasis supplied).

Yes.

The taxpayer s appraisal expert did not include entrepreneurial profit in the cost-based value estimate but the defendant s appraisal expert contended entrepreneurial profit should be included as a factor in the property s development costs. Id. at 314.

Subject property was improved with an office building. The building was especially designed for plaintiff taxpayer s (Hertz) use, it was constructed to allow future modification for multi-tenant use. Brae Associates v. Borough of Park Ridge, 17 N.J. Tax 187, 198 (Tax 1998).

In this case, taxpayer s expert concludes no entrepreneurial profit to exist as opposed to no evidence of same submitted by the municipality. Therefore, this court finds, as did the court in Badische, that there was no evidence before this court to support the inclusion of an entrepreneurial profit factor. Id. at 198.

2) B.F. Goodrich Co. v. Township of Oldmans, 17 N.J. Tax 114 (Tax 1997) (manufacturing and warehouse facility), aff'd, 323 N.J. Super. 550 (App. Div. 1999).

No.

There was no market data demonstrating that entrepreneurial profit should be included as an additional cost in this case. As such, entrepreneurial profit will not be considered in valuing the subject property. Id. at 123 (emphasis supplied).

No.

Both parties appraisal experts arrive[d] at a total reproduction cost estimate of each component, taking into consideration an analysis of contingency costs, direct or hard costs, indirect or soft costs, entrepreneurial profit, and physical depreciation, functional and economic/external obsolescence. Id. at 117 (emphasis supplied).

Subject property had been part of a larger tract of 102.92 acres, which taxpayer owned and upon which it operated a single facility with various processes.

The property is improved with a 35,000 sq. foot multi-story latex manufacturing and warehouse building with subsequent additions, site improvements, and tanks.

The property is located in an Industrial Zone.

Rinaldi s explanation that solely because the subject facility was not built for rental or resale but rather for use by the owner, there is no basis for entrepreneurial profit, falls wide of the mark. Municipality, however, did not present sufficient proofs in this case for the court to draw the inference that the market would recognize a profit for a developer of this property based on reasonable estimate of profit that entrepreneurs would expect in development of similar projects. Id. at 122-23.

3) Badische Corp. v. Town of Kearny, 11 N.J. Tax 385, 402 (Tax 1990) (owner-occupied chemical plant).

No.

Appraisal theory appears to dictate consideration of entrepreneurial profit because it motivates developers to construct improvements. In the instant case, however, no proofs of entrepreneurial profit were offered. Hence, the court can make no finding in that regard. Id. at 402 (emphasis supplied) (citation omitted).

Yes.

Neither parties appraisal expert included entrepreneurial profit within their cost-based value estimate although defendant argued that entrepreneurial profit should be added to the value determined under the cost approach. Id. at 402.

Subject property was an owner-occupied chemical plant consisting of 27 buildings that contained, in the aggregate, 147,787 square feet, 73 chemical storage tanks, site improvements consisting of cast iron piping, fire hydrants, steam lines, plant water lines, roadway paving, concrete paved walkways, truck scale, perimeter and interior fencing.

None of the experts added entrepreneurial profit to their cost-based value estimates.

4) Berkley Arms Apartment Corp. v. City of Hackensack, 6 N.J. Tax 260, 272-73 (Tax 1983) (apartment building).

No.

Entrepreneurial profit was not a motivation for the seller s efforts. In the instant situation, . . . a single structure, used for a quarter of a century for residential purposes, simply underwent a change in the form of ownership. Id. at 272-73 (emphasis supplied).

Yes.

The taxpayer s appraisal expert did not include entrepreneurial profit in the cost-based value estimate

but the city s [expert] witness added a profit of 25% ($ 2,257,720) to his reproduction cost, although the testimony clearly indicated that the construction cost manuals already include soft costs which include builders profit. Id. at 272.

Subject property was an apartment building consisting of 120 units. There are 60 one-bedroom and 60 two-bedroom apartments virtually identical to all others in the same bedroom category.

Property was conveyed to plaintiff taxpayer in 1981 for $2.7 million. Prior to this conveyance, the property was operated exclusively as a rental/investor-type property. The purpose of the conveyance was to convert ownership from income-producing to cooperative ownership. The conversion did not change the use of the building.

The extent and the nature of marketing Berkley s shares of stock defies comparison with the work required in Lawrence Assocs., supra.

There was no marketing of individual units.

5) Litton Business Systems, Inc. v. Borough of Morris Plains, 8 N.J. Tax 520, 536 (Tax 1986) (two-story office building), aff'd, 9 N.J. Tax 651 (App. Div. 1988).

No.

The income and market approaches supported no increment in value for entrepreneurial profit. Id. at 536.

Yes.

The taxpayer s appraisal expert did not include entrepreneurial profit in the cost-based value estimate but the taxing district add[ed] . . . entrepreneurial profit, the compensation to the builder-developer for his time, energy and initiative. . . . Id. at 533.

Subject property was a complex of three, steel frame and masonry, two-story office buildings located on a 28.242-acre panel of land.

The property was located in Limited-Industrial Zone.

Market data, which taxing district s appraisal expert used as the basis for adding entrepreneurial profit to the cost, was not a valid nor reliable indicator of value.

6) Texas Eastern Transmission Corp. v. Township of East Amwell, 13 N.J. Tax 24, 25-26 (Tax 1992) (pipeline), aff'd, 18 N.J. Tax 126 (App. Div. 1999).

No.

The segments of interstate natural gas transmission pipeline at issue are . . . a kind of property for which entrepreneurial profit or loss analysis is inappropriate. There is simply no indication of any market against which to compare replacement cost. Pipeline is not constructed by developers in the expectation of profit on its sale. Id. at 26-27 (emphasis supplied).

Yes.

The taxpayer s appraiser did not include entrepreneurial profit in the cost-based value estimate while the appraiser for the taxing districts add[ed] an entrepreneurial profit factor of 10% of all replacement costs . Id. at 40.

Subject property was interstate natural gas transmission pipeline.

There is no indication of any market against which to compare replacement cost. Pipeline is not constructed by developers in the expectation of profit on its sale. It is exclusively constructed by regulated operating companies for use in their business at costs which are passed through to the ratepayers.

The expert for the taxing districts produced no market data in this case, and his reliance on the taxpayer s expectation of profit from the operation of the pipeline confuses business profit with development reward. Id. at 27.

Thus those cases which did not add entrepreneurial profit to cost method calculations are distinguishable from this case because of a lack of proof or the very unique nature (pipelines) of the property. None of those distinguishing factors is present is this case.

V.

Physical Depreciation

The experts total depreciation of the subject property is as follows: plaintiff s expert determined 26% for both years, and defendant s expert determined 27% for 2006 and 29% for 2007. Because the depreciation of defendant s expert appears to be more precise, and because his work is generally more accurate and verifiable than that of plaintiff s expert, I adopt his conclusion of effective age of 12 and 13 years over a 45 year useful life. I note that his physical depreciation conclusions were greater than plaintiff s expert s conclusions for both years.

VI.

Obsolescence Other Than Parking

Plaintiff subtracted an additional 4% depreciation for functional obsolescence for layout and lack of a canopy or portecochere. Defendant subtracted an additional 5% because of the layout and inadequate parking. I adopt the 4% figure of plaintiff s expert for the physical detriments of the subject s improvements and discuss the appropriate deduction to be taken for inadequate parking in Part VII infra.

VII.

Obsolescence Due to Inadequate Parking

There is no question, because both experts agree, that the subject property lacks adequate parking for its highest and best use as a catering hall. However, there is a tremendous difference in the experts calculations of the deduction to be taken for that defect. Defendant s expert includes the defect within his 5% functional obsolescence calculation of $283,888 for 2006, and $306,328 for 2007. If I accept plaintiff s 4% functional obsolescence conclusion for the inadequacies of the improvements other than the parking - the conclusion of defendant s expert is only 1% of construction costs for inadequate parking - $56,778 for 2006, and $61,266 for 2007. Plaintiff s expert concludes that obsolescence due to inadequate parking is $1,650,000 for 2006 and $1,749,000 for 2007, his estimates of the cost to cure the inadequate parking (calculated at the market price to purchase the adjoining vacant lot, currently used by plaintiff to park cars, plus a 10% premium over that cost because plaintiff would be forced to buy an adjacent lot).

This argument fails for two reasons. First, it is unsupported by appraisal theory. Second, as a practical matter, it makes no sense.

Appraisal Theory

1. The Property s Low Parking Ratio is Curable, Functional Obsolescence

Functional obsolescence is caused by a flaw in the structure, materials, or design of the improvement when compared with the highest and best use and most cost-effective functional design requirements at the time of the appraisal. . . . Functional obsolescence, which may be curable or incurable, can be caused by a deficiency, which means that some aspect of the subject property is below standard in respect to market norms. The Appraisal of Real Estate (12th ed. 2001), supra, at 403. External obsolescence on the other hand is a temporary or permanent impairment of the utility or salability of an improvement or property due to negative influences outside the property. Id. at 363. External obsolescence is often incurable. Id. at 412. It is generally caused by outside economic factors, such as an oversupplied market, or locational factors, such as a property s proximity to an environmental disaster. Ibid. Whether the obsolescence is curable is important because curable obsolescence can be measured in terms of cost, whereas incurable obsolescence must be estimated in terms of a percentage. RCA Corp. v. Township of East Windsor, 1 N.J. Tax 481, 502 (Tax 1980).

In this case, the property s low parking ratio is a deficiency properly classified as curable, functional obsolescence. The factor driving the obsolescence is not external in nature, as the deficiency is not caused by external economic or market forces, or by the property s location next to an environmental disaster. Rather, the subject property suffers functional obsolescence because it lacks something that other properties in the market have, i.e., an adequate parking ratio. Appraisal of Real Estate, supra, at 404. Additionally, the property s deficiency is curable because it may be remedied through the leasing or purchase of additional parking space, as the catering hall s owner-operator has done in this case by leasing the neighboring parking lot. Thus defendant s appraisal expert correctly classified the property s low parking ratio as curable functional obsolescence, which should be measured in terms of cost rather than percentage, where possible. Cf. RCA Corp., supra, 1 N.J. Tax at 502.

2. Accepted Methods for Valuing Functional Obsolescence

There are several generally accepted methods for valuing functional obsolescence. The Appraisal of Real Estate sets forth a five-step method that can be used in certain circumstances to calculate functional obsolescence, whether curable or incurable. See Appraisal of Real Estate, supra, at 406-12. Functional obsolescence is calculated under this method using the following equation

Procedure for Estimating All Forms of Functional Obsolescence

3 Step 1.

Cost of existing item.

3 Step 2.

Less:

3 Step 3.

Plus: Cost to cure (all costs), or value of the loss

3 Step 4.

Less:

3 Step 5.

Equals: Depreciation for functional obsolescence.

However, this method may not correctly measure functional obsolescence in every instance. For example, [t]his five-step formula indicates the correct result only when the replacement cost depreciation deduction related to the functional obsolescence is appropriately zero. Joseph A. Laronge, Solving the Functional Obsolescence Calculation Question?, Appraisal Journal 327, 337 (July 2000).

Other accepted methods for valuing functional obsolescence include the two-step, four-step, and replacement and reproduction cost methods. Joseph Laronge addresses the weaknesses of the two- and four-step methods in his article

[The] two-step method[,] which simply deducts the cost to cure (or value of the loss, if less), has little applicability. Where the depreciated replacement costs are less than the depreciated reproduction costs, simply deducting the cost to cure fails to recognize the additional cost savings in the cost-effective comparison property. Also when the depreciated replacement costs are more than the depreciated reproduction costs, which occurs when the anticipated net present value increase in cash flow justifies the added capital costs, simply deducting the cost to cure fails to recognize that the buyer of the comparison property only benefits from the net between the additional capital costs and the cost to cure (or value of the loss, if less). When the buyer increases anticipated probability at the comparison property for an added cost, that additional investment must be accounted for when calculating reproduction functional obsolescence.

. . .

The [four-step method], sometimes proposed[,] deducts for the cost to cure and the depreciated reproduction cost of the existing item when the deficiency requires substitution or modernization (defect). This four-step method always fails to reflect market realities since, while appropriately deducting a depreciated cost for the existing item, it recognizes only a zero value for the replacement item which has at least the same utility as the existing item and may produce even more cash flow. This method will always indicate a windfall to a buyer equal to the depreciated replacement cost of the curing replacement item. If the buyer paid the indicated price from that method and then spent the cost to cure, curing the property, the buyer would have obtained the subject property as cured while investing less than its market value. . . . The market does not allow systemic windfalls since the price of the subject property would be bid up until there is not a windfall and equilibrium is reached.

[Laronge, supra, at 337-38 (emphasis supplied).]

It would appear that plaintiff s expert used the two-step analysis in this case.

The replacement and reproduction cost methods appear to escape the inadequacies of the methods discussed above, and should provide a correct calculation for both functional obsolescence and the market value of the subject property in this case. New Jersey courts recognize as a reliable calculator of a property s market value both the replacement cost method, E.g. Transcon. Gas Pipe Line Corp. v. Township of Bernards, 111 N.J.507, 516-17 (1988); American Cyanamid Co. v. Township of Wayne, 17 N.J. Tax542 (Tax 1998), aff d, 19 N.J. Tax46 (App. Div. 2000); Best Foods v. Borough of Englewood Cliffs, 19 N.J. Tax266, 276 (Tax 2001);MCI Telecommunications Corp. v. Township of West Orange, 18 N.J. Tax 26, 36-37 (Tax 1998), aff'd, 19 N.J. Tax 114 (App. Div. 2000); Sears Roebuck & Co. v. Township of Rockaway, 12 N.J. Tax381, 383 (Tax 1992), and the reproduction cost method. E.g. B.F. Goodrich Co. v. Township of Oldmans, 17 N.J. Tax114, 118-24 (Tax 1997), aff'd, 323 N.J. Super. 550 (App. Div. 1999); Riegel Products Corp. v. Milford Bor., 13 N.J. Tax546, 554-58 (Tax 1994); Badische Corp. v. Town of Kearny, 11 N.J. Tax385, 394 (Tax 1990); Brockway Glass Co. v. Township of Freehold, 10 N.J. Tax356, 369 (Tax 1989), aff'd, 12 N.J. Tax 263 (App. Div. 1991).

B. Experts Calculations of Obsolescence

It does not appear that plaintiff s expert used any of the sophisticated techniques suggested in the literature but instead simply deducted the full cost of purchasing the parking lot which is currently leased by plaintiff. His method most resembles the two-step method which is described and criticized by Laronge in the above-reproduced quotations. This single calculation, though calculated correctly, makes no sense, and the quotations from the Laronge article relating to the two-step method indicate its inadequacy.

First, when obsolescence, as estimated by plaintiff s expert, is more than 33% of the estimated value of the property before obsolescence and more than 50% of the final estimate of value, serious questions are raised about the expert s conclusion of highest and best use. If a property valued as a catering hall is worth $3,000,000 but separately as land plus bricks and mortar is worth $4,800,000 (plaintiff s expert s value without subtracting functional obsolescence), perhaps its highest and best use is not as a catering hall but for some other use which does not require such a large investment to cure its functional obsolescence.

Second, plaintiff s expert s method of calculating the property s economic obsolescence is to deduct the cost of purchasing the adjoining lot with a 10% premium. Of course, if that property (the parking lot) were purchased, the subject property would be free of economic obsolescence. And the owner would have to own the second property which would be worth its purchase price. Thus, before the transaction the owner of Westwood Lanes would have a property worth (in plaintiff s expert s opinion) only $3,089,141. But, by spending $1,650,000 he would have two properties worth $6,389,141, calculated as follows

$3,089,141 catering hall without parking

+ 1,650,000 cured functional obsolescence

4,739,141 catering hall with parking

+ 1,650,000 purchased parking lot

$6,389,141

Thus, by purchasing the parking lot for $1,650,000, the owner of Westwood Lanes would instantly double his investment. This makes no sense.

Plaintiff s expert s method of calculating economic obsolescence has no basis in fact, in the real world, or in the appraisal literature. Calculations designed to estimate value must have a basis in reality. Plaintiff s calculation of economic obsolescence is rejected. Because I have no basis in the record for selecting a deduction for economic obsolescence other than the opinions of the two experts and because I have rejected plaintiff s expert s opinion, I am left with no basis in the record other than to accept defendant s expert s opinion and not allow any other deduction for functional obsolescence.

VIII.

Summary and Conclusions

The following table summarizes my conclusions discussed above.

Tax Year 2006

Tax Year 2007

Land Values

$2,160,000

$2,250,000

Improvements

$5,161,603

$5,569,601

Plus: Entrepreneurial

Profit (10%)

516,160

556,960

$5,677,763

$6,126,561

Less: Physical

Depreciation

(27% and 29%)

(1,532,996)

(1,776,702)

Less: Functional Obsolescence (5%)

(283,888)

(306,328)

Value of Improvements

3,860,879

4,043,531

Total Land and Improvements

$6,020,8793

$6,293,5313

These values are compared to the common level ratio for 2006 and 2007 as follows

assessment = ratio

true value

Tax Year 2006

$1,947,700 = .3235

$6,020,879

3 The chapter 123 common level ratio for 2006 was .3417 with an upper limit of .3930 and a lower limit of .2904. Since the calculated ratio is within the common level range, the 2006 assessment will be affirmed.

Tax Year 2007

$1,947,700 = .3095

$6,293,531

3 The chapter 123 common level ratio for 2007 was .3077 with an upper limit of .3539 and a lower limit of .2615. Since the calculated ratio is within the common level range, the 2007 assessment will be affirmed.

Judgments will be entered affirming both the 2006 and 2007 assessments.

1 Appraisal theory appears to dictate consideration of entrepreneurial profit because it motivates developers to construct improvements. Badische Corp. v. Town of Kearny, 11 N.J. Tax 385, 402 (Tax 1990) (citing Appraisal of Real Estate (9th ed. 1987)).

2 Entrepreneurial incentive was first formally distinguished from entrepreneurial profit and developer s fee (profit) in The Appraisal Institute, Appraisal of Real Estate, 327n.1 (10th ed. 1992). It defined entrepreneurial incentive as that amount which reflects the projected return that is required to attract an entrepreneur to invest capital in a project, based on market expectations. [It] may be expressed as a rate or percentage of cost. Ibid. The concept of developer s fee [or entrepreneurial profit] is distinct from entrepreneurial incentive. It represents compensation for the time, energy, and experience a developer invests in a project as well as a reward for the risks the developer takes. The developer s fee is equivalent to the salary the developer might otherwise obtain. Ibid. Further, [t]o avoid confusion, it is advisable to define entrepreneurial profit and developer s fee specifically in the appraisal report . . . [because] [s]ometimes the terms are used interchangeably. Ibid. Interesting to note, The Appraisal Institute, Appraisal of Real Estate, 268 (7th ed. 1978) first alluded to the concept of entrepreneurial incentive when it defined entrepreneurial or developer s profit collectively as the profit potential [that] offers the incentive for much new construction which may be derived from a comparison of the value indicated by the cost approach with the value indications derived from the market data and income approaches. Ibid. (emphasis supplied).

3 The bottom line is that on each and every point, I have accepted the defendant s expert s opinion, and my conclusions of value in effect adopt the defendant s expert s opinion of value.