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Hull Junction Holding Corp. v. Princeton Borough

August 8, 1996


The opinion of the court was delivered by: Kuskin


The Property

These local property tax appeals concern a multi-use, multi-building facility located in the Borough of Princeton and designated on the Borough Tax Map as Block 20.04, Lot 1. The tax years under appeal are 1992, 1993 and 1994. For each of the years 1992 and 1993 the total assessment was $13,137,800, and for 1994 the total assessment was $13,226,800.

The property, which comprises office, retail and apartment components, an indoor parking garage and rights to build ninety-seven additional residential units, is located at the northern end of Palmer Square, the central commercial district of the Borough. Palmer Square extends from Nassau Street on the south to Paul Robeson Place on the north, and from Chambers Street on the west to Witherspoon Street on the east. The subject property is bounded by Paul Robeson Place on the north, Hulfish Street on the south and Chambers Street on the west. The eastern boundary is approximately 100 feet west of Witherspoon Street. Hulfish Street is located one long block north of Nassau Street, and is connected to Nassau Street by Palmer Square East and Palmer Square West which bisect Palmer Square. Nassau Street is the focal point of this commercial district. Princeton University is located along, and immediately to the south of, Nassau Street across from Palmer Square.

The Palmer Square area (including Nassau Street) is a separate retail and office submarket within the general Princeton market, which includes the Route 1 corridor. Palmer Square retail stores compete primarily with shopping centers on Route 1 and the Princeton Shopping Center (which is located in adjoining Princeton Township). The Route 1 corridor contains substantial off-ice space which, in general, is not in competition with the office space in Palmer Square because of the nature of the tenant market. Major corporate tenants seeking space in Route 1 office parks are not interested in locating in the Palmer Square area. Tenants of Palmer Square office space are generally service and professional organizations which have a particular relationship with the Borough or the University.

The subject property contains 4.439 acres of land and includes four buildings, designated 5,17, 29 and 47 Hulfish Street, respectively. The office component consists of 70,771 square feet, with approximately 62,000 square feet located in 47 Hulfish Street (also called 100 Palmer Square) and the balance located on the second floor of 17 Hulfish Street. Office tenants also use 4,555 square feet of basement storage area. The retail component consists of 34,775 square feet, with 30,226 square feet located on the ground floors of 5, 17, 29 and 47 Hulfish Street and 4,549 square feet located on the second floor of 29 Hulfish Street. All retail space fronts on Hulfish Street. The seventeen apartment units are located above the office space in 17 Hulfish Street (9 units) and above the retail space in 5 Hulfish Street (4 units) and 29 Hulfish Street (4 units). The parking garage contains 421 spaces and has entrances on Hulfish Street, Chambers Street and Paul Robeson Place. The ninety-seven additional residential units, if built, would be located on the roof of the parking garage and on a landscaped area between the two sections of the garage.

Construction of the subject improvements occurred from 1988 through 1990 and was financed by a construction mortgage loan from The Bank of New York ("BNY"), the parent corporation of plaintiff Hull Junction Holding Corp. ("HJHC"). By August 1991 this loan was in default, and HJHC took possession of the property. On October 16, 1991 HJHC acquired title by Sheriff's Deed after an uncontested foreclosure.

At the time of foreclosure, the condition and operation of the property reflected poor management. Leasehold improvements for existing tenants remained incomplete as did building lobbies, construction of a central plaza area facing Hulfish Street and construction of a portion of the seventeen residential units. Fencing at the rear of the property was damaged, and construction debris had not been removed. Tenants were complaining about the incomplete construction items, lack of cleanliness at the property, upkeep of common areas and inadequacies in the heating, ventilating and air conditioning systems. Some tenants refused to pay full rent or any rent at all. Approximately 35% of the office and retail space was vacant and the apartments were approximately 60% vacant.

By April 1992 most of the foregoing problems were resolved and some leases had been renegotiated. Existing tenants were paying rent, the property was competently managed and a leasing program was in effect. Vacancies, however, remained at approximately 35% for office space, approximately 30% for retail space and approximately 60% for the apartments. Commencing April 30, 1992, a brochure offering the property for sale was distributed to prospective purchasers. In July 1992 a Contract of Sale was signed for a price of $18,400,000, and, pursuant to the Contract, title was conveyed to plaintiff PSN Partners, L.P. ("PSN") on September 30, 1992.


Valuation Methodology

Although the subject property constituted one tax lot on the Tax Map of the Borough for each of the years under appeal, the Borough Assessor allocated the assessment among multiple line items. The office and retail segments of each building were combined and assigned a separate assessment by building. Although the seventeen apartment units were part of three of the buildings containing office and retail space, each apartment was assigned a separate assessment. The parking garage was a separate line item, and the ninety-seven rights to build were combined into another line item.

The appraisers for plaintiffs and defendant valued the property in a manner generally consistent with the assessment line items. *fn1 Plaintiffs' appraiser determined a combined value for the office and retail components, while defendant's appraiser segregated these components. Both appraisers valued separately the parking garage, the seventeen apartment units and the ninety-seven rights to build. Defendant's appraiser aggregated his component values to determine the over-all value of the property as one economic unit. Plaintiffs' appraiser concluded that the value of the property as one economic unit was less than the aggregate of his component values even though, in determining his values for the income-producing components (i.e., all components other than the ninety-seven rights to build), the appraiser selected capitalization rates which reflected the complex multi-use nature of the property.

The major difference between plaintiffs' expert's "one economic unit" value and his aggregate component value was his Conclusion that the ninety-seven rights to build, which he appraised at almost $2,000,000 as a component, contributed no value when the property was viewed as a single economic unit. The expert's "one economic unit" value for the components of the property other than the rights to build was 3.6% lower than his aggregate 1992 value for such components and less than 1% lower than his 1993 and 1994 aggregate values for such components. In context, this difference could be the result of arithmetic rounding, and, in any event, is relatively insignificant.

There is no credible basis for the expert's opinion that the ninety-seven rights to build would contribute a value of nearly $2,000,000 when viewed separately and no value when viewed as an element of a unitary property. An investor would attribute the same value to these rights to build whether the investor analyzed the rights as a discrete component of a multi-use property or as an unsegregated aspect of an integrated economic unit. The highest and best use of the rights to build would be the same whether the rights were viewed separately or as part of the whole. Actual construction of ninety-seven units would be no more speculative under one analysis than the other.

Because of the multi-use, multi-building character of the subject property, and because of the unavailability of multi-use, multi-building comparable properties from which to derive relevant data, the appropriate methodology for valuing the property is on a component-by-component basis, including a value for the ninety-seven rights to build. This methodology applies even though, as discussed (infra) in Section IX, the property constituted one economic unit and one tax lot for assessment purposes. See Newark v. West Milford Tp., 9 N.J. 295,303 (1952). It is, of course, necessary to "make sure that the sum of the separate use values does not exceed the value of the total property." Appraisal Institute, The Appraisal of Real Estate 293 (10th ed. 1992).

In valuing the income producing components of the property, that is, the office area, retail area, parking garage and seventeen apartments, both appraisers used the income approach. Defendant's expert also used the cost approach as a secondary basis and support for his income approach valuation of these components, and used the sales comparison approach as a test of the reasonableness of his value for the office and retail components developed through use of the income and cost approaches. Both experts used only the sales comparison approach to value the rights to build ninety-seven residential units. Although not a basis for their expert's valuation analysis, plaintiffs also relied on the sale of the subject property as demonstrating that the assessments on the property were excessive.

The parties stipulated the following facts:

1. For all years under appeal, the economic rent for the office component was $25 per square foot inclusive of storage area;

2. The value of the seventeen apartment units was $3,317,700 for tax year 1992 and $2,100,000 for tax year 1993;

3. For tax year 1994, the gross potential income of the apartment units was $328,320 and operating expenses were $73,798.

In valuing property for tax assessment purposes, the court should consider a sale of the subject property because such sale "may be indicative of the true value of the property," Glen Wall Assocs. v. Wall Tp., 99 N.J. 265,282 (1985), and should otherwise use that methodology which reflects the actions of the market. Id. at 278-79; New Brunswick v. Division of Tax Appeals, 39 N.J. 537, 551 (1963). With the exception of the ninety-seven rights to build, the property was income producing, and its value in the marketplace was a function of its income stream. This is confirmed by the Investment and Sales Brochure prepared in connection with efforts by plaintiff HJHC to sell the property (see Discussion (infra) in Section III) and by the Confidential Private Placement Memorandum prepared in connection with the formation of plaintiff PSN, the partnership which purchased the property. Both such documents analyzed the property in terms of its income producing potential. The income approach is, therefore, the proper method for determining the value of the office, retail, parking garage and apartment segments. University Plaza Realty Corp. v. Hackensack, 12 N.J. Tax 354, 366 (Tax 1992), aff'd, 264 N.J. Super. 353 (App. Div. 1993), certif. denied, 134 N.J. 481 (1993); Shav Assocs. v. Middletown Tp., 11 N.J. Tax 569, 578-79 (Tax 1991); The Appraisal of Real Estate, supra, at 409. The sales comparison approach reflects how the market would view the ninety-seven rights to build and, therefore, is the proper valuation approach for such rights.

The cost approach of defendant's expert not only does not reflect the realities of the market but also is an unreliable indicator of value. The expert accepted, as an accurate statement of the reproduction cost of the office, retail and parking garage improvements, costs which were included in an appraisal report prepared for BNY by Cushman & Wakefield valuing the property as of August 2, 1990. These "costs" were actually BNY budget amounts contained in what appeared to be attachments to a request or requests submitted to BNY for loan advances under the construction mortgage loan. No proofs were presented as to the methodology or sources used by BNY in establishing its budget, as to the date the budgeted costs were determined or as to trending of the budgeted costs from the budget preparation date to the applicable assessing dates. The budgeted costs included a "Developer's Fee" which may be duplicative of the 10% developer's profit added by the expert. Furthermore, the BNY construction mortgage loan balance, including accrued and unpaid interest, was, at the time of foreclosure, in excess of $48,000,000, an mount approximately double defendant's expert's value for the office, retail and garage segments of the subject property. This alone suggests excessive construction costs. As a result, the BNY budget is highly suspect, and the cost information derived from it and used by the expert is of little assistance to the court. See Beneficial Facilities Corp. v, Peapack & Gladstone Bor. 11 N.J. Tax 359, 375, 381-82 (Tax 1990), aff'd, 13 N.J. Tax 112 (App. Div. 1992), certif. denied, 130 N.J. 397 (1992). The expert's 1994 cost approach for the seventeen apartment units is of no more assistance. This approach was based upon unit reproduction costs derived from Marshall Valuation Service, but the expert provided only minimal information as to the basis for selecting such unit costs and gave no consideration to the effect on costs of the location of these units above retail and (as to one building) office uses. Accordingly, I reject the expert's cost approach as to all components of the property.

I also reject defendant's expert's sales comparison approach as to the retail and office segments. The expert utilized comparable properties varying in age from twenty-six to fifty-eight years, in size from 4252 square feet to 27,326 square feet, in height from one to four stories, in on-site parking facilities from none to sixty-five spaces in an underground garage and in highest and best use from office to office/retail. The actual use of all of the comparables appears to have been solely for office with no retail. The expert's failure to address and adjust for these factors renders his sales comparison approach virtually meaningless. The Appraisal of Real Estate, supra, at 371-74. Even for the limited use "to test the reasonableness" of the expert's combined retail and office value, the approach is unreliable.

Both appraisers, in their income approaches to value, developed capitalization rates using the Band of Investment technique. This technique is a form of "direct capitalization" which is used "to convert a single year's income estimate into a value indication." Id. at 467. The technique includes both a mortgage and an equity component.

The overall [Band of Investment] capitalization rate must satisfy both the mortgage constant [i.e., the annual debt service, expressed as a percentage, necessary to amortize the mortgage over a specified term at a specified interest rate] requirement of the lender and the pre-tax cash flow requirement of the equity investor.

[Id. at 471.]

Plaintiffs' appraiser relied solely on this technique. Defendant's appraiser described the technique as "antiquated" and relied primarily upon the Akerson Format, a version of the Ellwood Approach, for determining his capitalization rates.

Defendant's appraiser also considered capitalization rate data published by Real Estate Research Corporation. This data was national only, with no segregation by property location or size of investment. The data reflected substantial discrepancies between the rates shown for different types of the same category of property. For example, for the third quarter of 1991, in the Retail category, the going-in capitalization rate for regional shopping centers was 7.6% and for community/neighborhood/power shopping centers was 9.4%. The appraiser relied upon the regional shopping center data, but the retail component of the subject property does not fit neatly into this category. Because the Real Estate Research Corporation data is so generalized and because of the significant differences between rates shown for different types of the same category of property, the data, as an independent indicator of capitalization rates, provides little assistance to the court and I will accord it little weight.

The Akerson Format "substitutes an arithmetic format for the algebraic equation in the Ellwood formula." Id. at 518. The Ellwood Approach is a form of "yield capitalization" which is used "to convert future benefits into present value by... applying an overall rate that explicitly reflects the investment's income pattern, change in value, and yield rate." Id. at 508. The Approach includes a mortgage factor (using a mortgage constant as does the Band of Investment technique) and an equity yield factor (as distinguished from the equity dividend factor used in the Band of Investment technique). An equity yield rate is "[a] true annualized rate of return on equity capital including (in addition to the average annual dividend) the full effect of any gain or loss from resale at the termination of the investment...." Charles B. Akerson, Capitalization Theory and Techniques, 139 (Appraisal Institute 1991); see also The Appraisal of Real Estate, supra, at 415. An equity dividend rate "reflects the relationship between a single year's pre-tax cash flow expectancy and the equity investments," The Appraisal of Real Estate, supra, at 415, and is alternatively described as the "cash on cash rate". Akerson, (supra) , at 139.

In order to utilize the Ellwood Approach the appraiser must determine an appropriate holding period for the property, calculate the equity build-up resulting from mortgage amortization over the holding period, and determine a rate of appreciation or depreciation in value over the holding period. A sinking fund factor is used to calculate the annual percentage of equity build-up and appreciation or depreciation over the holding period. This sinking fund factor reflects "the amount per period that will grow to one dollar at a given rate in a given period of time," Akerson, supra, at 147, and is, therefore, a function of the equity yield rate and the holding period. Because a capitalization rate expresses only "the relationship between a single year's net operating income expectancy and the total property price or value," The Appraisal of Real Estate, supra, at 415, the Ellwood Approach requires the subtraction of the annual percentage components relating to equity build-up and appreciation in value (and addition of a percentage reflecting depreciation in value) in order to arrive at a capitalization rate.

In using the Ellwood Approach, as in using the Band of Investment technique, it is incumbent upon the appraiser to support the various components of the capitalization rate analysis by furnishing "reliable market data ... to the court as the basis for the expert's opinion so that the court may evaluate the opinion." Glen Wall Assocs., supra, 99 N.J. at 279-80. For these purposes, the Tax Court has accepted, and the Supreme Court has sanctioned, the use of data collected and published by the American Council of Life Insurance. Id. at 277-81. Relevant data is also collected and published by the Appraisal Institute, Real Estate Research Corporation and Korpacz Real Estate Investor Survey. Excerpts from this data are included in the reports submitted by both appraisers. By analyzing this data in toto, the court can make a reasoned determination as to the accuracy and reliability of the mortgage interest rates, mortgage constants, loan-to-value ratios and equity dividend rates used by the appraisers.

Support for the other elements of the Ellwood Approach, namely the equity yield rate, the holding period and the appreciation or depreciation in value over the holding period, is far more problematic. The only data used by defendant's expert in support of his equity yield rate consisted of ranges of rates throughout the United States by property type, without any breakdown by geographical location or size of investment. The expert provided no data in support of, or as a basis for, his assumptions as to holding period and appreciation in value.

The Ellwood Approach, is a version of discounted cash flow analysis.

Although the Ellwood formula is essentially a way to solve a discounted cash flow problem, Ellwood simplified the discounting procedure by publishing tables of precalculated rates that could be combined into a representative overall capitalization rate.

[The Appraisal of Real Estate, supra, at 423.]

A discounted cash flow analysis was specifically rejected by the Tax Court in University Plaza, supra.

The DCF [Discounted Cash Flow] method is an assumption-laden approach to estimating the present value of future benefits. It presupposes a measure of reliability in the projection of cash flows over a significant span of years. It also assumes the reasonable accuracy of vacancy rates, expenses, the discounted value of the reversion at the end of the projection period, the capitalization rate applied to the reversion in the first instance and finally, the discount rate assigned both to the cash flow projections and the reversion....

As one distinguished commentator has declared: Although DCF analysis has been misunderstood and unfairly criticized, there is nevertheless a tendency to attach undue weight to the results. Perhaps this is because the neatly printed computer printouts give the appearance of accuracy and proof. In reality, the results of DCF analysis can be no more accurate than the appraiser's input. Because countless different combinations of numbers representing rates, time, and cash flow in the equation of value can point to the same final value, it is difficult to imagine that any single combination of numbers could serve as proof of value. DCF analysis as used in the appraisal process should therefore be viewed as simply another means of estimating and explaining value from an investor's point of view, but DCF analysis should not be viewed as a means of refining or proving value.

The DCF method, as applied to tax valuation proceedings, is an amalgam of interdependent, attenuated assumptions of limited probative value. Whatever may be its utility in other contexts, its use in this case can only be described as an exercise in financial haruspication.

[University Plaza, supra, 12 N.J. Tax at 366-68 (citations omitted) (emphasis in original).] *fn2

The reliability of the discounted cash flow analysis, and thus the Ellwood Approach, has also been questioned in the context of hotel valuation.

Even with good data and support, estimating a hotel equity yield rate is a subjective process based largely on judgment. On the other hand, the estimate of a hotel mortgage interest rate can be well documented using...published life insurance industry data. Although an element of subjectivity remains, the value of the mortgage component is largely objective. Thus the capitalization technique produces results that are approximately 75% objective and 25% subjective. In contrast, a ten year forecast using a discount rate produces results that must be considered largely subjective and do not reflect the investment analysis procedures currently used by typical hotel buyers.

[Stephen Rushmore, Hotels and Motels: A Guild to Market Analysis. Investment Analysis and Valuations 234 (Appraisal Institute 1992).]

Defendant's expert's opinion that the Ellwood Approach reflects the thinking of investors in determining market value is without any support in his appraisal or otherwise. This Approach was rejected by the Tax Court in Middlesex Builders. Inc. v. Old Bridge Tp., 1 N.J. Tax 305, 311-313 (Tax 1980) because "the assessor failed to demonstrate that actual investors would use this method to determine value." Id. at 313. The Band of Investment technique, by contrast, has consistently been accepted by the Tax Court as an appropriate and reliable basis for determining market capitalization rates. See, e.g., Glen Pointe Assocs. v. Teaneck Tp., 10 N.J. Tax 506, 520-21 (Tax 1989), aff'd, 12 N.J. Tax 127 (App. Div. 1991). This methodology is not perfect. Indeed, the technique includes implicitly some of the investor assumptions which are explicitly analyzed in the Ellwood Approach. " satisfactory rate of return for the investor and recapture of the capital invested are implicit in the rates or factors applied in direct capitalization because they are derived from similar investment properties." The Appraisal of Real Estate, supra, at 467. Each of the explicit components of the Band of Investment, however, can be analyzed in terms of published market data from several independent reliable sources, and this analysis engenders a reasonable level of confidence in a rate developed by this technique. Such is not the case with respect to the equity yield rate, the holding period and rate of appreciation or depreciation utilized in the Ellwood Approach.

Yield capitalization methods are all based on the assumption that meaningful forecasts of income and value can be made and that an appropriate yield rate can be ascertained. They are obviously hazardous. Although they might be used to estimate market value in the absence of certain market data, they are more applicable in making investment value decisions, where the objectives of a specific investor are being considered, or in estimating the probabilities of obtaining specific yields through the analysis of market capitalization rates.

[Capitalization Methods & Techniques. An Educational Memorandum of the American Institute of Real Estate Appraisers 15-16 (1979)].

Accordingly, I will rely on the Band of Investment technique for determination of the appropriate capitalization rates.

In summary, in valuing the subject property for property tax purposes, I will (i) consider the sale of the property, (ii) utilize the income approach with respect to the office, retail, parking garage and apartment components, developing capitalization rates using the Band of Investment technique, and (iii) utilize the sales comparison approach with respect to the ninety-seven rights to build.


The Sale of the Property

In order to determine the reliability of the sale of the subject property on September 30, 1992 (pursuant to a Contract of Sale dated July 24, 1992) as an indicator of fair market value, the background of the sale must be analyzed.

In August 1991, HJHC, BNY's wholly-owned subsidiary, took possession of the property and immediately engaged SNE Asset Management Co., Inc., an affiliate or subsidiary of The Sammis Company (which later became Gale & Wentworth, Inc.) pursuant to a Property Management Agreement dated August 23, 1991. Under Section 1.2 of this Agreement, SNE Asset Management Co., Inc. had three general areas of responsibility:

A. seeking tenants for the leasable portions of the property;

B. managing the property;

C. marketing the property for sale and preparing appropriate promotional literature and programs.

SNE Management Co., Inc., The Sammis Company and Gale and Wentworth, Inc. are hereafter referred to as "G&W."

BNY never had any intention of retaining the property as an investment. BNY's objectives upon obtaining title were to "stabilize" the property and sell it in an expeditious manner. BNY's primary motivation was to reduce the non-performing assets shown on its balance sheet. BNY's 1991 Annual Report noted "considerable progress in improving the quality of our balance sheet by increasing loan loss reserves, reducing the level of non-performing assets and strengthening our capital base" and described a 31% reduction in commercial real estate non-performing assets "through charge-offs, writedowns and the sale of 25 foreclosed properties." BNY's 1992 Annual Report emphasized that "throughout 1992 the company continued to pursue its objective of driving down non-performing assets" through the sale of properties "plus a combination of write-downs and charge-offs." Consistent with the procedures described in its Annual Reports, in October 1991, BNY wrote down to $28,000,000 the approximately $48,000,000 balance in default under the construction mortgage loan encumbering the subject property. Such write-down was apparently based on an appraisal prepared for BNY by Cushman & Wakefield. As described by the review appraiser for BNY (a vice-president of the Bank and a Member of the Appraisal Institute), this appraisal, which excluded the seventeen apartment units and ninety-seven rights to build,

concluded that the current Market Value of the leased fee interest in the commercial space as of August 2, 1990 is $27,000,000. Furthermore, they estimate the Market Value of the leased fee interest upon stabilization (lease-up) anticipated to be January 1, 1992 is $28,500,000. The Present Market Value of the fee simple interest in the garage as of August 2, 1990 is estimated to be $2,500,000.

The process of stabilizing the property to the satisfaction of BNY and G&W was completed by early Spring 1992. This process included restructuring and renegotiation of existing leases, completion of tenant fit-up work, completion of common areas particularly the central plaza facing Hulfish Street, completion and improvement of interior lobbies and completion of the seventeen residential units. In April 1992 BNY decided to proceed with the sale of the property notwithstanding that the New Jersey commercial real estate market was then severely depressed and the office and retail segments of the subject property had not yet achieved their projected long term occupancy levels of 90-95%. At BNY's instructions, G&W undertook formal efforts to market the property for sale. These efforts took into account (i) marketing difficulties resulting from the perception of the property as a failed project and (ii) the limited number of investors who would consider purchasing property containing office, retail, parking garage facilities and residential components. In light of these factors, the marketing program did not include newspaper or trade journal advertising or listing with real estate brokers. The program initially consisted of contacting those prospects who, before BNY acquired title, communicated to BNY interest in acquisition of the property and contacting 100-150 institutional and local investors and property developers selected by G&W based upon its knowledge of the market and input from BNY and real estate brokers. These efforts produced expressions of interest from thirty-two prospective purchasers.

A second aspect of G&W's marketing program was preparation of a sales brochure for distribution to the thirty-two prospects. By the end of April 1992, a highly professional Investment and Sales Brochure (the "Brochure") was completed. This document included a description of each of the components of the property, financial summaries and projections, and characterized the property as favorably as possible (containing a "creative marketing spin") in terms of both the property's condition and its potential for producing increased income.

The Brochure contained an asking price of $22,000,000, substantially below the Cushman & Wakefield appraisal which BNY had used to justify the loan write-down but which BNY consciously disregarded (as based on incorrect information) in setting the asking price. The asking price reflected the financial analysis, particularly the income projections, contained in the Brochure as well as the Discussion in the Brochure of two "Value Added Opportunities." One such Opportunity was the additional rent which would be realized from leasing vacant space at the property (including approximately 20,000 square feet of office space and 12,000 square feet of retail space). The Brochure assumed that stabilized "full" occupancy of 90-95% of the office and retail space would occur by the end of 1993. The other Opportunity was the right to construct ninety-seven additional residential units above and adjacent to the existing parking garage.

BNY and G&W recognized that the asking price was too large for local investors to consider and too small to interest institutional investors. BNY and G&W also recognized that the real estate market was severely depressed and that deferral of Disposition efforts until stabilized office and retail occupancy levels were attained would permit a higher asking price and might produce a higher sales price. They understood that a purchaser would be likely to pay more if: (i) the property could be acquired without assuming the risk that the property would not attain the projected stabilized occupancy levels, and (ii) the purchaser would not be required to undertake the expenditures required to reach such levels. BNY determined, however, that the investment required to achieve the projected stabilized occupancy levels (approximately $1,000,000 to $1,500,000 for tenant improvement work, brokerage commissions and repair and upgrading of the parking garage) was not warranted by the potential increase in sales price. Furthermore, selling the property was consistent with BNY's "objective of driving down non-performing assets" even though, under applicable banking regulations, BNY was not required to dispose of the property for five years after acquisition. BNY elected, therefore, to sell the property in its condition as of late April-early May 1992.

Commencing April 30, 1992 and continuing until mid-July 1992, G&W transmitted the Brochure to the thirty-two prospects and received approximately eight responses indicating further interest. One such response was from Mr. Oded Aboodi who had been an investor in Hulfish North Limited Partnership, the original developer (and defaulting mortgagor) of the property. Mr. Aboodi's Discussions and negotiations with BNY, which had commenced before BNY acquired title and continued for approximately six months, culminated in a purchase offer of $18,400,000. During the course of the negotiations with Mr. Aboodi, G&W received other offers ranging from $11,000,000 to $16,000,000.

On July 24, 1992, less than three months after the Brochure was transmitted to most of the prospective purchasers (and less than two months as to five prospects) and before several prospective purchasers had completed their review of the Brochure and the property, HJHC entered into a Contract of Sale (the "Contract") with G.A. Properties, Inc., an entity formed by Mr. Aboodi. The Contract contained extraordinary provisions which can be explained as demonstrating either BNY's strong motivation to sell the property or the weakness in the real estate market which required unusual concessions in order to effect a sale. It is impossible to determine which of these explanations is the more accurate one; the likelihood is that the unusual provisions are a reflection of both BNY's motivation and market conditions. The following is a Discussion of these Contract provisions.

A. Article 2 (a)-(c) provided a ninety-day due diligence period for the purchaser, even though Mr. Aboodi was familiar with the property and its financial results except, perhaps, for the period between August 1991 and April 1992. Under paragraph (c), if, after conducting inspections and investigations of the property and its books and records, the purchaser was not satisfied with the results, the purchaser was not bound by the Contract. The purchaser had, in effect, a ninety-day purchase option.

B. Article 3.1 provided for a cash deposit of $368,000 which represented 10% of the cash portion of the price and 2% of the total purchase price. A more customary deposit of 5% to 10% of the total purchase price would have been $920,000 to $1,840,000. Cf. Krupnick v. Guerriero, 247 N.J. Super. 373, 377, 380 (App. Div. 1990).

C. Article 3.2 (b) obligated the seller to grant a non-recourse purchase money mortgage loan in the amount of $14,720,000 with terms differing in four respects from "market" terms. Firstly, the loan represented 80% of the purchase price. Data compiled by the American Council of Life Insurance ("ACLI") indicates that mortgages on commercial properties during the third quarter of 1992 generally did not exceed 70% of value. Plaintiffs' appraiser, in his income approach, utilized a "market" mortgage ratio of 75% and defendant's appraiser used 70%. Secondly, the interest rate was well below going market rates at the time. The Private Placement Memorandum (the "PSN Memorandum"), distributed to prospective investors in connection with the formation by Mr. Aboodi of plaintiff PSN, described the interest rate as of the date of closing of the loan as approximately 4.8%. The ACLI data indicated prevailing interest rates on loans secured by mortgages on commercial properties in the third quarter of 1992 of approximately 8.5% to 9%. The appraisers for the parties used mortgage interest rates ranging from 8.25% to 9.5%. The Contract provided that the mortgage interest rate was subject to periodic adjustment, but, at least during the first half of the loan term, the rate was likely to remain low relative to the market. Thirdly, the loan required no amortization of principal for seventeen months and thereafter only in amounts equal to one half of cash flow unless the lender, whose consent could not be unreasonably withheld, permitted use of such cash flow for capital expenditures. Fourthly, the mortgage note provided that, if the loan was prepaid within ninety days, there would be a $1,400,000 discount in the principal balance so that the loan could be fully satisfied by a payment of $13,320,000.

D. Article 4.1 provided for a closing date of August 20, 1992, but permitted the purchaser to extend that date to September 11, 1992 if, as of August 20, the purchaser had not received approvals required from various state attorneys general in order to offer for sale interests in a partnership which would acquire the property. The Article further provided that, if the approvals were not obtained by the adjourned date of September 11, the purchaser had the fight to terminate. There was no requirement that the purchaser make diligent efforts to obtain the approvals.

E. Article 4.8 provided that, if the purchaser obtained approval to purchase the liquor license for the property, the seller funded the $250,000 purchase price. If the approval was not obtained, the seller paid the purchaser $250,000 as a post-closing adjustment. The seller also was obligated to pay the purchaser the unused portion of a $210,000 tenant improvement allowance for premises then leased to the Canton Grill if this tenant terminated its lease because of failure to obtain the liquor license.

F. Article 9.9 obligated the seller to complete tenant improvement work at a cost of $596,277 and pay $258,680 for brokerage commissions.

Upon closing of title on September 30, 1992, BNY wrote off the approximately $10,000,000 difference between the sales price and the previously written down loan balance of $28,000,000. Simultaneously, the purchase money mortgage loan of $14,720,000 was placed on BNY's books as a performing loan, thus improving the BNY's balance sheet.

The expert witnesses interpreted the foregoing facts in opposite manners. Plaintiffs' appraiser, as well as Mr. Aboodi and Stephen Lapham, a vice president of BNY, testified that the purchase price of $18,400,000 represented fair market value for the property or, perhaps, a price in excess of fair market value because of the favorable financing. Mr. Aboodi testified that he regarded the cash price for the property to be $17,000,000 ($18,400,000 minus the $1,400,000 discount obtainable by payment of the mortgage loan within ninety days).

Defendant's expert concluded that the purchase price was not reflective of fair market value because: (i) BNY was willing to accept a lower than market price in order to replace a non-performing asset on its balance sheet with a performing loan; (ii) the office and retail occupancy levels at the property at the time of the sale were significantly below stabilized levels; (iii) the rental projections in the Brochure were significantly below rents then existing and thereafter realized at the property and significantly below both appraisers' estimates of economic rents, resulting in an asking price which was too low (and which limited the ultimate sales price) and causing concern among potential purchasers even if each purchaser performed an independent financial analysis of the property; and (iv) the property was not exposed to the market for an adequate period of time.

Defendant's expert adjusted the purchase price by determining the additional income which would have been realized from stabilized occupancy levels of 90% for the office space and 95% for the retail space as compared to the actual occupancies (70% of office space and 65% of retail space) at the time the Contract was signed, and from increased garage occupancy resulting from higher building occupancy. He then capitalized this "additional income" producing $10,300,000, which he added to the sales price of $18,400,000 resulting in an adjusted price of $28,700,000.

The expert made a further adjustment for marketing time. This adjustment assumed that the sales price, as already adjusted for additional rental income, represented only the present value of the price which would have been obtained had the property been exposed for sale for the eighteen months which the expert determined to be an adequate marketing period. The expert thus divided $28,700,000 by a present value factor, which produced a fully adjusted sales price of $34,100,000.

The expert also analyzed the difference between the office and retail rents projected in the Brochure and the economic off.lee and retail rents utilized by both appraisers and the difference between such projected rents and actual rents. Capitalizing this difference produced $6,800,000, which, when added to the actual price of $18,400,000, produced an adjusted sales price of $25,200,000. If the expert's marketing time adjustment were applied, the fully adjusted sales price would be $29,917,400.

As rebuttal to the analysis of defendant's expert, plaintiff presented a second appraisal expert ("plaintiffs' sale expert"), whose report and testimony were limited to the reliability of the sale by HJHC to PSN as an indicator of fair market value. This appraiser rejected the adjustments by defendant's appraiser on two grounds: (1) the adjustment for additional rental income erroneously assumed that the purchaser believed stabilization at 90% to 95% occupancy would never occur, and, therefore, the purchase price was uninfluenced by "upside potential," and (2) the marketing period for the property was fully adequate given the nature of the property, the relatively small group of prospective purchasers and general economic conditions at the time. The expert did not analyze or respond to the adjustment by defendant's expert for the difference between the rents projected in the Brochure and actual or economic rents.

Plaintiffs' sale expert determined that BNY was under no regulatory time constraint or financial pressure to sell the property, and concluded that BNY would not knowingly and intentionally have sacrificed a substantial increase in the price which could have been realized by retaining ownership for a short additional period and making a relatively modest investment of capital. In this expert's opinion, the sales price of $18,400,000 bore a reasonable relationship to the income projections in the Brochure and PSN Memorandum and represented fair market value for the property in its condition at the time of sale, given the then depressed condition of the general real estate market. The expert further concluded that the price may have represented more than fair market value because of the influence of the favorable 80% purchase money mortgage financing provided by the seller. The expert did not quantify this increment to the sales price.

As a general principle, the sale of a subject property "is not dispositive on the issue of value." Glen Wall Assocs., supra, 99 N.J. at 282. See also Hackensack Water Co. v. Division of Tax Appeals, 2 N.J. 157, 162-63 (1949). Such a sale is, however, a reliable indictor of fair market value if the following criteria are satisfied:

1) buyer and seller are typically motivated and neither is under duress;

2) buyer and seller are well informed or well advised and are acting prudently, knowledgeably and in their respective self-interests;

3) the property has been reasonably exposed to an open, relevant and competitive market for a reasonable period of time;

4) the purchase price is paid in cash or its equivalent; and

5) the purchase price is unaffected by special or creative financing or by other special factors, agreements or considerations. The Appraisal of Real Estate, supra, at 18-22; Appraisal Institute, The Dictionary of Real Estate Appraisal 222-23 (3rd ed. 1993)

Although the sale satisfied criteria (2) and (4), it did not satisfy criteria (1), (3) and (5). As to criterion (1), the seller was not typically motivated; as to criterion (3), BNY's signing a contract of sale within less than three months after distribution of the Brochure commenced, while several prospects were still reviewing the Brochure and the property, was precipitous given the complex nature of the property and prevailing market conditions (see Discussion (infra)); and, as to criterion (5), the purchase price was affected by special financing as described (supra) in the Discussion of Article 3.2(b) of the Contract, and by special factors, agreements and considerations. These special factors, agreements and considerations were the following:

1. The seller, although not under duress either as the result of applicable banking regulations or financial pressure, was unusually highly motivated to sell the property. See Whippany Park Assocs. v. Hanover Tp., 1 N.J. Tax 325, 330 (Tax 1980). This motivation is evident from the fact that, as soon as BNY acquired title, indeed before it acquired title, it was planning for the Disposition of the property and engaging in Discussions with prospective purchasers. Furthermore, the sale of the property was part of BNY's program of "driving down non-performing assets." This motivation is significant even though the impact on BNY's balance sheet of the removal of this particular nonperforming asset was relatively insignificant in the context of BNY's total assets of over forty billion dollars.

2. The Brochure was unduly conservative in its rental projections. The asking price of $22,000,000 based on these projections was, therefore, unduly conservative and limited the ultimate sales price. Even though prospective purchasers would be likely to perform independent financial analyses and not rely solely on the Brochure's projections, the rent levels contained in the projections inevitably caused concern among prospective purchasers and may have had a depressing effect on purchase offers.

3. That the seller of the property was a foreclosing mortgagee may, in itself, have negatively influenced the amounts of purchase offers because prospective purchasers took into account the strong desire of the mortgagee to dispose of the property. See Ibid.

4. At the time the property was offered for sale and the Contract signed, occupancy levels at the property were significantly below stabilized levels and the real estate market was severely depressed (plaintiffs' sale expert described the market as "dismal" and the president of G&W's commercial group described the market as "terrible" and 1991, 1992 and 1993 as "three of the worst years in the commercial real estate market in New Jersey in quite some time"). The combination of these temporary conditions caused a reduction in the number of investors willing to bid on the property and a reduction in the dollar amounts of the bids made. Tax assessment value should be determined on the basis of stabilized market conditions and stabilized property conditions. In Hackensack Water Co. v. Division of Tax Appeals, supra, 2 N.J. 157, the Supreme Court held: "Value for purposes of taxation has some measure of permanency which renders it secure against general temporary inflation or deflation." Id. at 163. See also In re Appeal of East Orange, 103 N.J. Super. 109, 117 (App. Div. 1968). The Tax Court has adopted and followed this precept. For example, in Inwood at Great Notch v. Little Falls Tp., 6 N.J. Tax 316 (Tax 1984), the court noted the "strong public interest in assessment stability and its corollary, stable, predictable municipal revenues...." Id. at 332. In Berkley Arms Apartment Corp. v. Hackensak, 6 N.J. Tax 260 (Tax 1983), the court summarized the proper approach: "In view of the need for stability in taxation, our cases uniformly hold that true value of realty must be 'fairly constant and must be gauged by conditions, not temporary and extraordinary, but by those which over time will be regarded as measurably stable.'" Id. at 286.

If BNY had deferred its sale efforts until stabilized occupancy occurred, and invested the capital necessary to produce such occupancy, or simply waited a few months for occupancy increases anticipated by G&W in April 1992 to take effect (by the date of closing with PSN, office occupancy had increased from 70% to 85% and retail occupancy had increased from 65% to 83%), the asking price, even in a depressed market, would have been higher and, in all likelihood, the sales price would have been higher. BNY explained its reluctance to invest such capital as resulting from its concern that the investment would not produce a concomitant increase in the sales price. This was the short term view of an impatient owner which had already decided to dispose of the property and, consequently, was unwilling to wait for an investment to bear fruit.

The adjustments to the sales price made by defendant's expert do not provide an acceptable basis for disregarding the impact of the foregoing special factors, agreements and considerations. The expert's adjustment for increased rents generated at stabilized occupancy levels is unacceptable because it erroneously assumes that the purchase price was unaffected by the potential for increased revenues at the property. The potential for increased income resulting from leasing of vacant space was an important element of the sales marketing program. The Brochure contained projections of increased rental income as an inducement to prospective purchasers, and the PSN Memorandum contained similar projections as an inducement to investors in PSN. Both the Brochure and PSN Memorandum projected 90% to 95% occupancy of the retail and office space by the end of 1993. The extensive cautionary language in the PSN Memorandum is typical of such documents and does not detract from the significance of the revenue potential to investors.

The expert's adjustment for increased rents is unacceptable because it assumes that increased revenue would be achieved without cost to the landlord. In capitalizing "gross" projected revenue increases, the expert improperly disregarded additional costs which would be incurred by the landlord to generate the increases. Costs for improvements to tenant space would be required and increased operating costs might result from higher occupancy levels. These costs would reduce, to some extent, the increase in revenue. The amount of this reduction cannot be calculated from the record, but it also cannot be ignored.

Defendant's expert's adjustment for marketing time is unacceptable because it assumes, without factual support, that eighteen months was the appropriate marketing period and further assumes, without factual support, that having the property available for purchase for such a marketing period would, in itself, have produced a higher sales price. Expert opinion unsupported by adequate facts has consistently been rejected by the Tax Court. Willow/Leonia Assocs. v. Leonia Bor., 12 N.J. Tax 338, 344 (Tax 1992); Biunno, Current N.J. Rules of Evidence, comment on R. 703 (1995). Furthermore, the expert failed to consider all factors relevant to marketing time and time of exposure to the market. See The Appraisal Foundation, Uniform Standards of Professional Appraisal Practice 83, Advisory Opinion G-7 (1993 ed.) ("The reasonable marketing time is a function of price, time, use, and anticipated market conditions such as changes in the cost and availability of funds; not an isolated estimate of time alone."). See also id. at 64, Statement on Appraisal Standards No. 6 ("The reasonable exposure period is a function of price, time and use, not an isolated estimate of time alone.").

Finally, defendant's expert's adjustment based on excessively low rental projections in the Brochure is unacceptable because it assumes that an investor would consider all retail and office rents at the property to be at the levels projected in the Brochure. The expert ignored the probability that a prospective investor would rely upon the existing actual rents which, in most cases, exceeded the projections.

In summary, whether the $18,400,000 sales price for the subject property reflected fair market value for tax assessment purposes as of the relevant assessment dates of October 1, 1991, October 1, 1992 and October 1, 1993 is, at best, uncertain. The sale is, therefore, an unreliable indicator of such value. The adjustments made by defendant's expert are equally unreliable. Accordingly, in determining the fair market value of the subject property, I will attach little weight to the sale.


Office Valuation

In applying the income approach to the 70,771 square feet office component, the first step is to determine economic rent as of the relevant assessing dates. The parties have stipulated this economic rent to be $25 per square foot for each of the tax years under appeal which amount includes the 4,555 square feet of storage area used by office tenants. Such rent is a gross rent with the landlord responsible for payment of real estate taxes out of rental income.

The next step is to determine the appropriate vacancy and collection loss factor. Plaintiffs' appraiser used a factor of 15%, and defendant's appraiser used 10%. The office portion of the subject property had an actual vacancy of 15% as of October 1992, 10% as of October 1993 and 9% as of December 1994. The general vacancy rate for office space in the Palmer Square area averaged 18.6% for 1992, 11.7% for 1993 and 9.2% for 1994. Defendant's appraiser determined that the available office space in the Borough of Princeton reflected an average vacancy rate of 9.22%. General studies of vacancies in the Mercer County area and in the Princeton area as of 1992 showed average vacancy percentages of in excess of 18%. The Brochure projected office vacancy as stabilizing by the end of 1993 at 5% per annum. A similar projection appears in the PSN Memorandum.

Giving primary emphasis to the experience of the subject property itself, I find that the appropriate vacancy and collection loss factor, on a stabilized basis, is 10%. See University Plaza, supra, 12 N.J. Tax at 369. This is twice the vacancy percentage projected by G&W in the Brochure and twice that projected in the PSN Memorandum.

The third step in an income approach is a determination of the appropriate expense deductions. The following analysis of these deductions uses the categories selected by the appraisers.

1. Management - Plaintiffs' appraiser used 5% of effective gross income as a management fee and defendant's expert used 4%. In light of the complex nature of the subject property, the location of the office space in two separate buildings and the differences in character and quality of the office space (the 47 Hulfish Street space being superior to that in 17 Hulfish Street), I find that 5% of effective gross income is the appropriate management fee.

2. Utilities - Plaintiffs' expert deducted a utilities expense of $159,235 for each year while defendant's expert deducted $106,058 for each of 1992 and 1993 and $94,074 for 1994, including water and sewer. Plaintiffs' expert noted that tenants reimbursed the landlord for office electricity at the rate of $1.25 per square foot leaving a net utilities expense to the landlord of $70,771. I find that the appropriate utilities expense is $100,000 per year.

3. Leasing Commissions - Plaintiffs' expert utilized 5% of effective gross income for leasing commissions. Defendant's expert assumed that only 30% of the office space would be leased to new tenants in each year and, therefore, that commissions would be payable only with respect to this portion of the space because commissions are customarily not paid in connection with renewals of office leases. Although I accept the expert's opinion that payment of renewal commissions is not customary, I find it unreasonable to assume that 70% of existing office leases will be renewed annually and no commission will be payable as to any of these renewals. The normal leasing commission is 5% ...

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