Opinion ID: 349243
Heading Depth: 2
Heading Rank: 3

Heading: the rentals

Text: 40 Rentals in these transactions were apparently geared to return the Trust's advances plus interest. To achieve such a result, the rentals for the primary term were set at a predetermined figure. According to R. Paul Henry, who negotiated these transactions for Sunray, the rental value was fixed by formula based on a twenty-five year period to enable the Trust to recover the amount of money advanced for the properties plus a reasonable agreed amount for what would be comparable to interest. And then, should the leases be terminated prior to the end of the twenty-five year primary term, an added amount would be paid to G.E. (the Trust) because this was a rather awkward type transaction. 8 41 Additional evidence in the record indicates that the rentals do not reflect the market value of the properties. We think it significant that the Trust determined the fair rental value for the properties by merely treating the transaction as an investment alternative, rather than applying the capitalization of earnings method as an accepted appraisal method. Mr. Pope, the Commissioner's expert, prepared a valuation report for the properties which is in the record. It reveals that the rentals fixed for the primary term are quite high. 9 A fair rental value for a non-wasting asset such as unimproved land to a lessee with Sunray's high credit standing would be the cost of money times the investment. Mr. Pope's valuation report reveals that in October 1964, Government bonds were yielding 4.15 percent, triple A utility bonds were paying 43.8 percent, and top grade corporate bonds were paying 4.52 percent. Effective mortgage rates ranged from 5.5 percent to 6.1 percent, depending upon the lending institution. Although the annual rate of return due under the transactions with the Trust was 6.79 percent, Mr. Pope revealed that a reasonable rate of return would have been 45.8 percent, the interest rate specified in the lease agreement, without the amortization of the cost of the land. The amortization of unimproved land as part of the rental, represented by the difference of 2.144 percent, is not a common practice in the marketplace. In short, the rentals were mathematically geared to amortize the moneys advanced by the Trust at the agreed annual rate of 4 5/8 percent over the primary 25 year term of the lease or through the exercise of Sunray's repurchase rights; they bear little resemblance to the true economic value of the properties. 42 Also supporting the Commissioner's contention that the rentals do not reflect market value but were merely based on a formula which included the current interest rate plus an amortization factor is the underlying Schedule of Direct Reduction Loan attached to the leases which sets forth in typical loan arrangement form the interest rate, the amount of the principal loan, the term of years, the payment number and the apportionment of the quarterly payments between principal and interest. This schedule of payments is identical to the procedures utilized in conventional direct reduction mortgage loans which became popular in this country during the Great Depression of the 1930's. Likewise, in their negotiations, the parties frequently referred to the payment of interest and principal, to standby fees and loan commitment fees, terms common in mortgage financing and not in the traditional relationships between lessor and lessee. 10 43 In the letter dated September 21, 1974, to Eastman Dillon, Sunray's counsel also points out that in the twenty-sixth year of the proposed lease, the unencumbered appraised value would probably exceed the original investment if present inflationary trends continue. Notwithstanding his conception of the increased value in the land and his prophetic view of inflationary trends, the rentals payable in the twenty-sixth year and thereafter during the next sixty-four years of the thirteen extended terms do not increase but are sharply reduced. The quarter annual rents drop from $1015.38 to $375.00 for the first two extended terms and then drop again to $225.00 for the next eleven extended terms. Thus, Sunray having paid for the properties in full during the primary term, was entitled to remain in possession for the next sixty-five years at nominal rents. If it exercised all of its options for each of the extended terms, the additional cost therefor, as the Tax Court recognized, 11 was merely to increase the Trust's return from 4 5/8 percent per annum to 5 1/2 percent. It is hardly conceivable that an owner of real estate especially a large sophisticated trust concerned with a fair rental on its land rather than a return of its loan and interest, would enter into a lease with sharply declining rentals for sixty-five years following the conclusion of the primary term on December 31, 1989. The extended term features of the lease further indicate to us that the Trust, as a lender, was only looking to a return at a fixed rate on its advances, and not to a reasonable return on the fair market value of property which it held as owner.