UPDATE: Kansas Supreme Court Reverses Lower Court Decisions, Previously in Favor of Big-Box Retail and “Dark Store” Approach

UPDATE: The Kansas Supreme Court came to a consensus on the the commercial property valuation issue of big box stores by unanimously overturning lower court decisions and rejecting Johnson County’s evaluation of nine Walmart locations and two Sam’s Club stores in the area. The 2021 decision, made by the Kansas Court of Appeals and previously by the Kansas Board of Tax Appeals, stated that the stores had been overvauled millions of dollars and, rather, should be assessed as if they were vacant as opposed to being assessed with their lucrative lease agreements in consideration. As of Friday, July 1st, this decision has been overturned by the Kansas Supreme Court, is no longer in favor of big-box stores, and subsequently, no longer in favor of the ever-controversial “dark-store” approach.

May 24, 2022– The Kansas Supreme Court will hear arguments on Thursday, May 26th to determine if buildings housing “big box” stores, like Target and Walmart, are worth more than other commercial buildings simply because of those stores which occupy them. The retailers themselves are arguing that they should be valued the same as any other property based on a number of factors, including location, operating costs and market rents in the respective areas. On the other side, municipalities are arguing the “dark store” approach, which states that there is no doubt that Walmart is exceedingly more valuable than an unoccupied K-Mart building down the street.

While both sides have extensive support behind them, our experienced property tax consultants who are well-versed on “dark store” took this hearing as an opportunity to look at the implications of what bringing the controversial approach to the Supreme Court may mean for Kansas and the rest of the United States. Invoke Tax Partners’ Director – West Coast Real Estate, Mike Clark, provided his analysis on the issue:

Mike Clark – “This will be an interesting hearing dealing with a controversial topic that has been around for many years. The original dark store premise dealt with closed dark stores as sales comps for viable big box stores. At the time, the average sales price of occupied big boxes in the U.S. was around $130 per square foot whereas the average sales price per square foot for dark stores was $20. This premise still exists today with higher price points, but use of the dark store approach has evolved beyond its initial use case.

Most dark stores are mostly empty due to their location in secondary or tertiary locations or a failed retail concept such as K-Mart, Sears, or Toys-R-Us. The intended new leases on these dark stores, if reused for retail, will naturally be lower than viable big box concepts.

In my experience, we’ve used a modified version of the approach to save major big box retail clients millions of dollars on property taxes. The variance between dark store comps and viable big boxes was not large due to the high land values in California, but we were able to use a closed Walmart example, where Walmart opened a new, better location three miles from a previous store and closed the old one, to save our home improvement store client $1,000,000 in property taxes in a single year.

One thing I do believe the news out of Kansas misses on is the development of build to suit properties. In a build to suit situation, they have a prospective tenant before they even break ground. The prospective tenant already knows reasonably well what their gross sales will be at that location based on research that highly depends on a well-developed algorithm (or in the old days: multivariant regression analysis). Take big box grocery stores, for example, if the rents for a cost for a build to suit doesn’t exceed a certain level of anticipated gross sales (say 3%), they’ll pay just about anything for the site. Major pharmacies are in the same category. They know they will make so much money on their pharmacy, if they find a 1 ½ acre site and anticipate that the construction and land won’t exceed their hurdle rate of return, it will be built. Additionally, if they build it for $5.0M, they may do a sale-leaseback for $7.0M, and pocket the extra $2.0M. However, it will be assessed at $7.0M when realistically it should be $5.0M, but the assessor says the contract rent supports a $7.0M assessment.

The premise out of Kansas is that Walmart shouldn’t be taxed more than similar big box retailers. This may be true, but you don’t need a dark store for a rent comparable… just similar properties with economic rents in a market comparable to the Walmart. What Kansas assessors are attempting to do is discriminate against successful tenants based on their business model and not on the economic utility of the real property. This approach will eventually turn the property tax system into a de facto income tax system.

I also disagree with the notion of vacancy. Valuing a property’s fee simple interest doesn’t mean that the property must be vacant to assess, it must be valued as if ready to be leased at market rents, or is leased at market rents. With the Kansas Court of Appeals mandating that property must be assessed at its fee simple interest, it arrives where most state property tax systems already are and have been for decades: assessing the fee simple interest in a leased fee world.

I am interested to see how this pans out in Kansas, and if there are any larger themes that stem from this hearing for larger real estate markets in the United States.”

Mike Clark, Director – West Coast Real Estate

To read the full article and any updates published from the Kansas Supreme Court hearing, visit the Legal Newsline website. With any questions on implications of this dark store trial for your commercial real estate portfolio, or to speak with a property tax consultant, contact Invoke Tax Partners today.