"Stray Thoughts from the Library"

By James S. "Jim" Bone

A random group of Jim Bone's position statements on property, business enterprises, and some of the unique problems that ad valorem ("based on value") tax appraisers face in California.

Businesses and individuals can own property. Property cannot own a business or hire a person. (Therefore, income from personal services cannot be property income. It must be business income.)

Assessment district bonds are liabilities, period. It doesn't matter what the money was used for. If there are roads, schools, or sewers that benefit a property, then buyers will pay more for the property, including the assumption of bonds. However, only the measurable fair market value of the bonds, if any, is to be added to the nominal purchase price of a property.

A property purchaser only buys the property itself. Externalities such as infrastructure affect the price, but are not a component of property purchased, and no portion of the purchase price can be allocated to them.

Mello-Roos are general obligation bonds. 1900 series are specific obligations. That difference must be considered in all California property tax appraisals.

Property is inanimate. Property is incapable of action.

Property has the capacity to be used.

Property includes the right of the owner to use it. Property does not have the right to be used.

There is no such thing as negative business value.

Entrepreneurs attract capital, hire employees, hire or acquire real property, tangible personal property, and intangible personal property, and form business enterprise units. (Intangible business enterprise assets are not taxable in California.)

Property cannot attract capital, hire employees, or sell goods or services. Those activites are entrepreneurial business activities.

Property provides property services in the form of utility, shelter, space, security, access to public utility services, and environmental control. Business enterprises sell goods and services.

The income from property is only rent, royalty or profit a prendre, and issue. (Property income is a measure of property value.) Income from the sale of goods and services is not income from property. (Business income is a measure of business value.)

One measure of the value of a property is the price someone will pay for the right to use it via purchase or lease.

The going concern value of a business is the profit it will make in the future from property, labor, and capital after acquisition of the rights to use the factors of production.

The value of a going concern is the total value of the business and its property.

At stabilized business operation or commercial occupancy, the appraiser assumes that the projected user business is generating sufficient income to pay the projected rent to the property owner and retain sufficient income to the tenant business operator/entrepreneur to realize a normal profit on the business after payment of rent and all other costs. (At stabilized income, a business must exist and its value cannot be included in the taxable value of the property.)

At stabilized business operation, the maximum rent that the landlord can receive is equal to the tenant's NOI before rent and profit, less the minimum profit necessary to keep the business operator in business.

At stabilized business operation, the minimum rent is equal to the maximum rent the next lower potential lessee or use type will pay.

The value of the right to use property is not the same as the value of the profit from the use of that property. (The right to use is rent or purchase price; the income from the use is business income.)

In property law, profits refer to profits a prendre, or the right to sever minerals or growing crops. In property law, profits does not refer to business profits after acquisition.

If the income is rent, royalty, or profit a prendre, then the source is property and the value indicator is the value of the property.

If the income is from sales of goods or services, then the source is business enterprise and the value indicator is the value of the business.

If the income is from sales of goods or services, or net business income before rent, and the income is used to estimate the rent-paying capacity of the business operation, then the property income to be capitalized is the indicated rent and the resulting value indicator is the value of the property being rented.

Hospitality businesses, mines, refineries, hospitals, and property management companies all sell goods and services; their income is enterprise income, and any sales of those entities are sales of business enterprises.

Shopping center owners own both properties and business enterprises. The value of the business enterprise is the value of the net income from the provision of goods, services, and the markup over triple-net rent that is obtained by marketing the in-line stores to tenants. The property value is the value of the rental stream a hypothetical lessor would pay for the right to lease the non-anchor stores as a unit from the shopping center owner, plus the value of the owned perimeter and anchor stores.

Customers of business entities do not ‘rent' space while they occupy theater or restaurant seats, ski down slopes, occupy hotel rooms, or enjoy entertainment at an amusement park.

Property can be valued as an input to production, an output of production, or a factor of production.

Management fees paid to employees, management companies, or owners, for services are expenses classified as labor. The payments do not represent any part of the value of the property or the business that uses it.

Franchise fees such as hotel operating agreements, and contract management agreements with companies that manage property for a fee, are business costs for either labor or the right to use intangible assets or rights. They do not represent ownership interests in the business that uses property.

The entity or individual that would file bankruptcy in the event of a business failure is the entity that places real property into economic use.

The entity or individual that advertises for customers and hires employees to serve the customers is the entity that places real property into economic use.

Entities or individuals that, as a result of a business failure, would only lose rent, business revenue, employment, or rights to receive money that arose from those relationships, are suppliers of production factors to the business enterprise. They have no ownership interest in the business itself and payment to them does not represent the value of the business itself.

Income-producing property, for property tax purposes, must be limited to properties that produce property income in the form of rent, royalty, or profits a prendre. Any other type of ‘income-producing property' is actually an enterprise that owns real property and utilizes that property and other assets to generate goods and/or services for sale. While the income generated from the sales of goods and/or services may be an indicator of the business's ability to pay rent, the income itself is not a direct indicator of the value of the real property.

Property has three components; physical property, property rights, and ownership of the physical property and rights. A proper appraisal must analyze and value all of the property components that were present on the date of valuation.