Court Opinion

ID: 9733054
Source: CourtListenerOpinion
Date Created: 2023-08-26 16:51:44.515096+00
Date Added: 2024-06-11T18:26:38.065173
License: Public Domain

WUEST, Justice
(dissenting).
I respectfully dissent.
In my opinion, the majority has disregarded two basic provisions of settled law in overruling the circuit court, State Board of Equalization, County Board of Equalization, and the County Assessor (Sessions), i.e., (1) giving deference to the circuit court on findings of fact unless clearly erroneous and (2) considering income under a reasonably economic and prudent management rather than actual income.
Before addressing the errors of the majority, I emphasize that Associates has two presumptions to overcome:
First, there is a presumption that tax officials will do their duty in accordance with the law and not act unfairly and arbitrarily regarding the assessment of property. Skinner v. New Mexico State Tax Comm’n, 66 N.M. 221, 345 P.2d 750 (1959). Second, there is a presumption that the county director of equalization’s valuations are correct. Mortenson v. Stanley County, 303 N.W.2d 107[, 110] (S.D.1981).
Hutchinson County v. Fischer, 393 N.W.2d 778, 782 (S.D.1986). Accord, Roseland v. Faulk County Bd. of Equal., 474 N.W.2d 273, 275 (S.D.1991). To overcome the presumption the Director of Equalization’s valuation is correct, an appellant “must produce sufficient evidence to show the assessed valuation was in excess of true and full value, lacked uniformity in the same class or was discriminatory.” Knodel v. Board of County Commissioners, 269 N.W.2d 386, 389 (S.D.1978). Accord Roseland, 474 N.W.2d at 275. “[O]ur scope of review of a trial court’s decision in a trial de novo of a tax assessment is to determine whether the findings are clearly erroneous.” Kindsfater v. Butte County, 458 N.W.2d 347, 348 (S.D.1990). Examining the facts developed below, I do not believe the trial court was clearly erroneous.
Article XI, section 2 of the South Dakota Constitution states “the valuation of property for taxation purposes shall never exceed the actual value thereof.” Accord Roseland, 474 N.W.2d at 275; Kindsfater, 458 N.W.2d at 350; Codington County Bd. of Com’rs. v. Bd. of Equalization, 433 N.W.2d 555, 557 (S.D.1988). Further SDCL 10-6-33 (1989) provides: “All property shall be assessed at its true and full value in money_” 1 Thus, our constitution speaks of “the actual value thereof,” and SDCL ch. 10-6 speaks of “full and true value.” The two phrases were discussed by this court as follows:
The terms “actual value” and “true and full value” mean the “market value” of property to be assessed and market value has been defined as the price which a purchaser willing but not obligated to buy would pay an owner willing but not obligated to sell, taking into consideration all uses to which the property is adapted and might in reason be applied.
Roseland, 474 N.W.2d at 275 (quoting Rau v. Fritz, 81 S.D. 311, 314, 134 N.W.2d 773, *879775 (1965)). In addition to the statutes involved, a director of equalization must follow the rules found in article 64:03 of the Administrative Rules of South Dakota. SDCL 10-1-16.1 (1989). The three approaches to valuing property which a director of equalization is required to consider and document are: the income approach, the market approach, and the cost approach. SDCL 10-6-33. Turning to the appraisals, we will address each individually.

Income Approach:

Using the income approach, Associate’s appraiser (Hansen) used Associates’ actual rental rates in arriving at estimated annual income. Likewise, he used the actual average vacancy rate of fifteen percent. He included land taxes as an operating expense and treated it as a deduction from gross annual income. He also used Associates’ actual maintenance and repairs expense. He used a capitalization rate of 10.3% based upon the “band of investment” technique and research of two comparable apartment complexes in the Brookings community. Based upon the above, Hansen estimated the net operating income to be $112,925. His gross income estimate, based upon actual rental rates, was $309,-000, less $46,345 for vacancies (fifteen percent), for a net operating income before expenses of $262,655. Based on the income approach, Hansen’s opinion as to fair market value was $1,096,500.
Sessions used market rent compiled from questionnaires that she sent to, and received from, other apartment owners in Brookings. Likewise, she used average operating expenses of an amount equal to thirty-five percent of the estimated annual income. This percentage was obtained by averaging the operating expenses of other apartment owners and using the average ratio of expenses to gross income. Sessions did not include taxes in operating expenses, but instead added an effective tax rate to the capitalization rate.2 She used an average vacancy rate of seven percent, again a figure arrived at by averaging the vacancy rates of like properties.. Sessions used a capitalization rate of 13.-55% which was arrived at by obtaining equity and mortgage interest rates from lending institutions (resulting in an overall discount rate of .0825%), adding an effective tax rate (.0277%), and a recapture rate based upon forty years average life of the property (.0253%).3 Using the market rental rate, Sessions found gross income of $322,560, less $22,500 for vacancies (seven percent) for a net operating income before expenses of $299,980 per annum. Based on the income approach, Sessions’ opinion as to fair market value was $1,439,020.
Associates contends the proper method of appraisal using the income approach must use the actual income, vacancy rate, and expenses for the property rather than market rentals and average expenses for like property. Associates asserts a reasonable buyer and seller would rely on actual income and expenses. The trial court disagreed, reasoning that unless averages are used, “the effectiveness of management of the property [is assessed,] which is not an element properly subject to appraisal.” *880The trial court noted if actual figures were used, a poor manager would be rewarded by a lower assessed evaluation.4
In Yadco, Inc. v. Yankton County, 89 S.D. 651, 656, 237 N.W.2d 665, 668 (1975), we held where a taxpayer had burdened his property with a long term uneconomical lease, the capitalization of actual income to determine “true and full” value was inappropriate. Associates argues Yadco does not apply because there is no evidence of poor management practices in this case. In Mortenson v. Stanley County, 303 N.W.2d 107 (S.D.1981), the taxpayer contended the valuation of the property should be reduced where part of it had been rated as cropland but was instead used as range-land. We rejected that assertion noting that a decision whether or not to farm such property is a management decision. “[A] landowner should not be able to determine the valuation of property by using it as rangeland when it could be used as cropland.” Id. at 111. Whether the decision of the landowner was a poor decision or not did not enter into the Mortenson holding.
Further, Associates’ position is incongruous with our statements in Rau: “A prospective purchaser in forming an opinion of the value of property looks to its income potential as distinguished from its actual earnings.” Rau, 81 S.D. at 317, 134 N.W.2d at 777. “The income producing capacity is ordinarily a factor in fixing valuation for taxation purposes.” Id.; 72 Am. Jur.2d State and Local Taxation § 755 (1974). A prospective purchaser does not, in forming an opinion as to value of property, look at actual earnings of the former management. Instead, the buyer looks to the property’s income potential, based in part on what has occurred in the past, what other similar properties have done, and based on management changes the buyer himself plans to implement.
In ascertaining the value of property via the income approach, the value of the property is arrived at by capitalizing the net income at the rate of return prevailing in the same section of the country upon investments of a similar nature. 72 Am.Jur. 2d, supra, § 755. In such cases, the average net income for a number of years should be considered, rather than the earnings of a single year. Yadco, 89 S.D. at 657-58, 237 N.W.2d at 669; 72 Am.Jur.2d, supra, § 755. However, it must be emphasized once again it is the earning capacity of the property that is the proper element for consideration in valuing property. Rau, 81 S.D. at 317, 134 N.W.2d at 777. Thus, the gross receipts considered are such as would be received under a reasonably economic and prudent management, and the expenses to be deducted likewise are not the expenses actually incurred, but such expenses as would be incurred under a reasonably economical and prudent management. 72 Am.Jur.2d, supra, § 755. Management effectiveness is simply not an element properly subject to appraisal.
By taking a survey of what other similarly situated businesses were doing, Sessions was essentially establishing the income and expenses based on reasonably prudent management practices. Sessions’ valuation based on income was supported by valuations using the cost approach and the market or comparable sales approach which I address next. Sessions based her final assessment on the cost approach, because she felt she did not have sufficient information to make a completely accurate valuation based on income or comparable sales.

Market or Sales Approach:

Under the market or sales approach, fair market value of the subject property is estimated by comparing it to similar property which has recently been sold in the area in arm’s length transactions. ARSD 64:03:01:02.02 (1989). Hansen listed four comparable sales which occurred between 1986 and 1988. Hansen concluded one provided the best comparison.5 That property *881was the Costello property which Hansen appraised at $13.35 per square foot. Sessions testified the Costello property was not an appropriate comparison because the consideration given in exchange for the property consisted partly of a trade for land in Minnehaha County. In order to use the Costello property for comparison, Sessions testified it would be necessary to appraise the property in Minnehaha County. See 29 Am.Jur.2d Evidence § 400 (1967) (allowing evidence of value of property traded for subject property amounts to “pyramiding of approximations”). Sessions also noted the Costello property was in worse condition. Hansen’s opinion as to the fair market value of the subject property was $1,086,000.
Sessions used two comparable sales, both of which occurred in December 1986. Sessions valued the first comparable at $21.26 per square foot and the second comparable at $25.81 per square foot. Sessions concluded $20.00 per square foot would accurately reflect the valuation of the subject property. Based on comparable sales, Sessions concluded the subject property had a value of $1,508,660.
Associates specifically asserts Sessions should have utilized the acquisition price of the property indicated by Boeckermann’s dealings with the former owners wherein Boeckermann agreed to assume their debt, indicating a valuation amount of $1,093,-243. The trial court found the sale to Boeckermann was not a valid comparable sale. I agree. In such sales, owners sell to get out of debt. Thus, they may be hard pressed for funds. 29 Am.Jur.2d, supra, § 398. Even Boeckermann agreed it is unusual to have a contract for deed written for 100% of the price of the property. I cannot say the trial court was clearly erroneous in agreeing with Sessions on that point.
Sessions testified that, in determining whether a sale was a valid comparable, she went by date of sale, similarity of construction, and similarity of location. Sessions’ valuation comports with accepted methods of property valuation for tax purposes. 72 Am.Jur.2d, supra, § 781.6 Moreover, she did not rely on this assessment, but instead relied on the costs approach which in turn was supported by her comparable sales valuation.

Cost Approach:

The third method of determining market value is the cost approach where the replacement costs of a new building and land improvements are estimated. A deduction is then made for physical depreciation, functional obsolescence, and economic obsolescence. Rau, 81 S.D. at 313, 134 N.W.2d at 775. Finally, the value of the land is added. “Physical depreciation” is “wear and tear occasioned by use and by the elements.” “Functional obsolescence” is loss of utility and failure to function because of inadequacies and deficiencies of the property. “Economic obsolescence” is loss of value brought about by changing conditions in the neighborhood causing loss of business. Id. In this case, both appraisers used the Marshall and Swift cost estimating service. Hansen consulted the service book, and Sessions used a computer software service supplied by Marshall & Swift. Using the same service, Hansen’s opinion of fair market value was $1,187,000 and Sessions’ was $1,477,465. From a replacement cost of $2,540,040, Hansen subtracted $1,397,040 in physical, functional, and economic depreciation (35%, 10% and 10% respectively). Sessions subtracted $761,324 in physical, functional and “locational depreciation” (25%, 3.3%, and 8% respectively).
Associates takes issue with the depreciation charged off by Sessions labelled “loca*882tional depreciation,” arguing this is not in compliance with Rau’s mandate that “economic obsolescence” be used. Associates argues locational depreciation is more narrowly defined. Sessions testified her locational depreciation took into consideration where the property was located. Associate’s economic depreciation also considered the property’s location. Locational depreciation would seem to include any changes having occurred in a neighborhood, and therefore, the difference is merely one of semantics.

Conclusion:

Associates maintains throughout its brief that Sessions improperly assessed the property because she was not assessing the property for a buy/sell transaction but for tax purposes. Sessions substantially complied with legislative directives in assessing the subject property.7 “Substantial compliance with legislative directives is sufficient in determining assessed valuation.” Kno-del, 269 N.W.2d at 389. It does not appear the property was assessed in excess of its fair market value. Associates has not overcome the assessment’s presumed correctness. Therefore, the trial court was not clearly erroneous in sustaining the assessment. I respectfully dissent.

. There was a difference of opinion between Hansen and Sessions as to whether real estate taxes are a proper deduction from gross annual income. The Director of Equalization must consider taxes by adding an effective tax rate to the capitalization rate instead of deducting real estate taxes as a deduction from annual income. ARSD 64:03:01:02.03 (1989).

. ARSD 64:03:01:02.03 (1989) addresses the income approach to valuation of property:
An assessor using the income approach to valuation of property shall estimate the value of a property by determining the present value of the projected income stream. Income and expense analysis builds upon the following components:
(1) Normal unit rent;
(2) Potential gross rent;
(3) Vacancy and collection loss;
(4) Normal gross rent;
(5) Miscellaneous income;
(6) Normal gross income;
(7) Normal expenses; and
(8) Normal net income.
The capitalization rate selected must reflect the proper relationship between the value of the property and the net income it produces. The capitalization rate is composed of an interest rate, a recapture rate, and an effective tax rate.

. ARSD 64:03:01:05 (1989) implies estimation of value may properly consider actual gross income and operating expenses, but any such estimation must be based on reliable information. The regulation also states comparison with similar properties is acceptable if reliable information cannot be ascertained. That regulation does not require an appraiser to use actual income and expenses, nor would I.

. Hansen stated the other three properties appraised at $31.40, $32.02, and $20.30 per square foot were not the best comparables because they *881were "smaller and required larger amounts of adjustment.”

. ARSD 64:03:01:02.02 (1989) provides:
An assessor using the market approach to valuation of property shall compare property to similar properties that have recently been sold. Adjustments shall be made for the following:
(1) Trades, partial interests, personal property, and incomplete or unbuilt community property;
(2) Physical differences and condition;
(3) Financing and assumed leases; and
(4) Date of sale.

. South Dakota Real Estate Commission rules govern Hansen. SDCL 36-21-1.1, 14 (1986). Those rules differ in methodology for determining valuation. They do not apply to county assessors who are assessing for tax purposes and must follow the rules found in A.R.S.D. article 64:03. SDCL 10-1-16.1. Thus, the Real Estate Commission Rules are irrelevant.