Article

Beyond the dark store: Exploring valuation challenges and methods for big-box retail

July 2, 2024 · Authored by Zachary Whittacre

The valuation of big-box retail properties for taxation purposes has emerged as a contentious area in commercial real estate appraisal, epitomized by the debate surrounding the dark store theory. This theory posits that active retail stores should be appraised as if they were vacant — or “dark” — for the purposes of property tax assessment. This valuation approach has sparked significant debate among appraisers, tax assessors, property owners, and policymakers due to its implications for taxation and market valuation.

Background and evolution of big box retail

Big box retail, characterized by large, free-standing megastores located predominantly in suburban areas, has been a significant player in the retail landscape since its inception in the early 1960s. These stores were designed to serve the expansive suburban families who valued convenience and affordability, which catalyzed their expansion. However, the rise of e-commerce has significantly altered consumer expectations and shopping behaviors, prompting big box retailers to adapt by integrating online shopping with physical store experiences. Recently, there has been a notable shift towards curbside pickup and delivery services, reflecting an operational adaptation to the growing demand for convenience and immediate gratification. This evolution is starting to render traditional big box models somewhat obsolete, as the physical need for large retail spaces diminishes, challenging appraisers to reassess the highest and best use of these properties in light of changing retail dynamics.

Fundamental misunderstandings in valuation

A fundamental misunderstanding in the valuation of big-box properties lies in distinguishing between ‘value in use’ and ‘market value’. Value in use refers to the value of a property specific to a particular user, often resulting in a higher assessment due to the property’s custom features designed for the original tenant’s operations. Conversely, market value represents the price at which the property would transact in a competitive market setting, irrespective of the specific needs of any particular buyer. The dark store theory challenges this by advocating for the assessment of operational stores as if they were vacant, potentially undervaluing properties and affecting municipal tax revenues.

The dark store theory explained

The dark store theory argues that operational big-box stores should be valued as if they were empty, basing property tax assessments on the characteristics of vacant and possibly obsolete properties. This approach has led to significantly lower tax assessments for operational stores, impacting municipal budgets and redistributing tax burdens. The theory’s application often involves the sales comparison approach, where the chosen comparable properties are vacant, potentially skewing the market value assessments of fully operational stores.

Legal perspectives and case studies

This theory has seen various legal challenges across states, with courts often divided on its application. Some jurisdictions have endorsed the theory under the principle that property assessments should be equitable and reflective of true market conditions without influence from current occupancy or business operations. In contrast, others argue that such a valuation method undermines the economic reality of operational properties. Legislative responses have also emerged, aiming to refine assessment practices to ensure they accurately reflect the property’s current use and condition.

More appropriate valuation methods

The debate over the dark store theory not only highlights divergent views on how big-box retail properties should be assessed but also underscores the importance of employing accurate and robust valuation methods. To navigate the complexities introduced by this theory, a clear understanding of standard valuation approaches is crucial. These methodologies must be meticulously applied to ensure that they reflect true market conditions and provide a fair basis for property assessments. The following section delves into the primary valuation methods used in real estate — cost approach, sales comparison approach, and income approach — each offering distinct insights that can help mitigate the challenges posed by the dark store theory and lead to more equitable tax assessments for big-box retail properties.

Cost approach

The cost approach is particularly effective for big-box retail properties as it considers the cost to replace the property with one of similar utility. This method starts by estimating the reproduction or replacement cost of the property’s improvements as new, and then deducts forms of depreciation such as physical wear and tear, functional obsolescence, and economic obsolescence. Critical to this approach is the market extraction method, which extracts depreciation factors from comparable market data. This technique adjusts the estimated new construction costs by reflecting how similar properties have depreciated in the actual market, taking into account their age, condition, and any relevant market trends​. This adjustment ensures that the valuation aligns closely with current market conditions and perceptions, providing a realistic view of the property’s value.

Sales comparison approach

The sales comparison approach is central to property valuation, particularly for properties like big-box stores that may have unique characteristics. This approach compares the subject property to similar properties that have recently been sold, adjusting for differences in factors such as size, location, quality, and the timing of the sales. Adjustments must be carefully justified; for big-box retail properties, this includes considerations of their specialized designs, sizes, and typical suburban or outlying urban locations. Additionally, the ‘dark store’ theory necessitates adjustments for operational status, as a functioning big-box store usually differs in value from one that is vacant. This method requires a deep understanding of both the specific features of the property and broader market dynamics to ensure a fair and accurate assessment.

Income approach

The income approach is particularly relevant for leased big-box retail properties. This method translates anticipated future cash flows into present market value by estimating potential income generation, subtracting operating expenses, and applying a capitalization rate to the net operating income. For big-box stores, which often have long-term leases at or near market rents, this approach provides a clear picture of the property’s income-generating potential. It is crucial to use market-supported capitalization rates and to adjust for specific lease characteristics that might impact income stability and property profitability. The accurate forecasting of cash flows and modeling of economic conditions that could affect tenant stability are essential components of this approach.

The valuation of big-box retail properties requires a nuanced understanding of appraisal principles, market dynamics, and legal contexts. As retail landscapes continue to evolve and new challenges like e-commerce reshape market dynamics, appraisers must remain vigilant in applying these methodologies to ensure fair and equitable property valuations. The ongoing debate over the dark store theory underscores the need for clarity in appraisal practices and highlights the importance of maintaining rigorous standards in property valuation to support equitable tax assessment practices.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.