Opinion ID: 2622017
Heading Depth: 1
Heading Rank: 8

Heading: The income capitalization method as applied to Olen Residential's properties

Text: Here, because the properties at issue are income-producing properties, the Assessor correctly compared the properties' full cash values with their cost-based taxable values under NRS 361.227(5)(c), utilizing the income capitalization approach. Olen Residential contends, however, that the income capitalization approach inadequately takes into account its properties' constructional defects, asserting that the defects render any present determination regarding the value of its properties' future income too speculative because those defects will cause the properties' future income to decrease. But the income capitalization approach takes into account the effect of property improvement conditions, including constructional defects, on a property's taxable value through adjustments to the capitalization rate. In this case, although the Assessor acknowledged that he did not account for any constructional defects when considering the properties' condition to derive a capitalization rate, [27] any defects in the properties were speculative. Since Olen Residential's constructional defect litigation was ongoing, the State Board properly accounted for the constructional defects in light of Olen Residential's subsequent constructional defect by increasing the Assessor's capitalization rate by 2.25 percent. Raising Olen Residential's income-producing properties' capitalization rates to reflect any constructional defects was proper since, as noted, an income-producing property's capitalization rate is determined by, among other factors, the property's condition, depreciation, and investment risk, which conceivably include any constructional defects in the property's improvements. Further, because an income-producing property's value is calculated by dividing its net operating income by its capitalization rate, by increasing a property's capitalization rate, the derived taxable value necessarily decreases. Nevertheless, Olen Residential asserts that the Assessor should have used a different method for establishing the full cash value of its propertiessimply deducting the amount of the constructional defect judgments, at least to the extent that the judgments reflect remediation costs, from the replacement cost of the improvements on the land. [28] That argument appears related to NRS 361.227(1)(b)'s requirement that the Assessor must value any improvements on land by subtracting obsolescence from the cost to replace the improvements. But Olen Residential's argument fails, as the following example illustrates. The Assessor valued Desert Club, one of Olen Residential's apartment complexes, at approximately $36 million, without considering any constructional defects. Under Olen Residential's argument, the Desert Club's approximately $28 million constructional defect judgment must be deducted from the Assessor's derived value, resulting in an approximately $8 million taxable value for Desert Club. Put differently, according to Olen Residential, a buyer would not pay more than $8 million for Desert Club. However, at least in the recent past, Desert Club has generated approximately $3 million annually in net operating income, notwithstanding its defects. Because Desert Club has continued to generate substantial income despite its constructional defects, a buyer likely would be willing to invest more than $8 million in the purchase of Desert Club in light of the substantial return on its investment. [29] Moreover, even if constructional defects increasingly affect Desert Club's income production over time, such changes can be accounted for in Desert Club's capitalization rate and its net operating income under the income capitalization approach to valuing real property. Indeed, the State Board attempted to account for Olen Residential's constructional defects by adding 2.25 percent to the Assessor's capitalization rate. In so doing, the State Board effectively decreased the assessed value of Olen Residential's property specifically to account for the properties' constructional defects. Thus, because the State Board's use of the income capitalization approach to determine the full cash value of Olen Residential's properties accounts for the properties' constructional defects, Olen Residential failed to demonstrate that the State Board applied a fundamentally wrong principle. [30]