Assessment Review Board

Commission de révision de l’évaluation foncière

ISSUE DATE: October 24, 2016

FILE NO.: WR 143092

Assessed Person(s): See Schedule “A”

Appellant(s): See Schedule “A”

Respondent(s): See Schedule “A”

Respondent(s): Municipal Property Assessment Corporation (“MPAC”) Region 15

Property Location(s): See Schedule “A”

Municipality(ies): See Schedule “A”

Roll Number(s): See Schedule “A”

Appeal Number(s): See Schedule “A”

Taxation Year(s): See Schedule “A”

Hearing Event No.: 634265

Legislative Authority: Section 40 of the Assessment Act, R.S.O. 1990, c. A.31, as amended

Heard: August 10, 2016 in Toronto, Ontario

Parties	Counsel+/Representative
See Schedule “A”	Peter Milligan, James Walker
MPAC	Frank Shea

DECISION OF THE BOARD DELIVERED BY JOSEPH M. WYGER

INTRODUCTION

1Industrial malls in Halton and Peel Regions are assessed using the income approach to value. The net income of the property is calculated and then divided by a factor that is called a capitalization rate (“cap rate”) to arrive at an estimated value. The cap rate is derived from a study of the actual sale prices of sold industrial malls. The sale price of each sold property is divided by its net income to arrive at a range of cap rates. A median or average cap rate is then selected to apply to the net income of unsold industrial malls to estimate their assessed values. The formula is Value = Net Operating Income (“NOI”) /Cap Rate.

2For the 2012 valuation year, applicable to the 2013 through to 2016 taxation cycle, MPAC employed a 7% cap rate to estimate the values of all industrial malls in Halton and Peel Regions which are given MPAC’s property code 580 (“580s”). Subsequently, for properties whose 2013 through 2016 assessments were appealed, MPAC changed the cap rate to 6.6%, based on a new cap rate study. The Appellants of these properties challenged the 6.6% cap rate as being incorrect, but mostly inequitable because the properties which were not appealed remained at a 7% cap rate, which normally results in lower assessed values. Three “test cases” were presented at this hearing for the trial of an issue: What is the appropriate cap rate to use for industrial malls in Halton and Peel Regions for the 2013 to 2016 taxation years?

DECISION

3I conclude that the appropriate cap rate to employ for industrial mall assessments under appeal in Halton and Peel Regions for any of the 2013 to 2016 taxation years is 6.6%.

REASONS FOR DECISION

MPAC’s Position

4Frank Shea, counsel for MPAC, made the case that the change in the cap rate to 6.6% was necessary to arrive at correct current values. This was largely due to the fact that most appeals of 580s were grounded on the complaints by numerous Appellants that MPAC was employing fair market rents (“FMR”) that were too high. Upon investigation, MPAC’s expert witness, Raymond Wang found that while MPAC’s FMRs were generally too high, the resulting current values were not. The current values when matched against actual sale values resulted in an assessment to sale ratio (“ASR”) very close to 1.00, which demonstrated that the method was generating assessed values that reflected the market well. Mr. Wang determined that if incorrect FMRs were resulting in correct current values, then the third factor in the equation, the 7% cap rate may also be wrong. Mr. Wang advised his superiors that if FMRs were going to be corrected to a lower level, then the cap rate may also need to be adjusted to maintain a correct level of assessment for industrial malls. Mr. Wang performed a cap rate study that demonstrated a rate of 6.6% to be appropriate.

5The three properties put forward as leading cases had their FMRs reduced by MPAC, a 6.6% cap rate applied, and the result was current values that were lower than the returned values for the three properties. Mr. Shea contended that there was no prejudice to the Appellants and no inequity relative to properties not under appeal that remain at a 7% cap rate. He argued that equity does not apply to component parts of the income approach, such as the cap rate, but only to overall assessed values and those reflected both correct and equitable current values.

6Mr. Shea emphasized that Mr. Wang’s cap rate study was the only one in evidence. The Appellants did not perform an alternate study or produce the 7% cap rate study that they were defending. He urged the Board to find that the preponderance of the evidence favoured the position of the assessing authority.

Appellants’ Position

7Peter Milligan acted as counsel for the Appellants, and he advanced the position that the 6.6% cap rate was both incorrect and inequitable. He presented two expert witnesses whose opinions were that the 7% cap rate was more appropriate and equitable, and that the 6.6% cap rate was grounded on a flawed analysis which was based on actual or contract rents rather than the preferred use of market or typical rents.

8Mr. Milligan framed the issue in terms of whether MPAC should be taking the unprecedented step of altering such a key component as the cap rate, mid-cycle and in such a scattered way. He asserted that the result is not fair or equitable because hundreds of appealed properties are affected, while hundreds of other properties not appealed continue to be assessed differently at the 7% cap rate.

9One of the three properties selected by the Appellants abutted extremely similar units in the same complex that were not under appeal, and were assessed using the 7% cap rate. The valuation witnesses testified, and Mr. Milligan argued that to apply a 6.6% cap rate to the subject unit was the very definition of inequity. They submitted that since the 5% vacancy and the 3% expense were uniformly applied to gross rents yielding the net income for capitalization, so should the 7% cap rate be applied uniformly to these very similar properties to achieve an equitable result.

Legislation

10Section 19.(1) of the Assessment Act (“Act”) states:

19.(1) Assessment based on current value. – The assessment of land shall be based on its current value.

11Section 44.1(3) of the Act states:

44.(1) Assessment may be open upon appeal. – Upon an appeal on any ground against an assessment, the Assessment Review Board or court, as the case may be, may reopen the whole question of the assessment so that omissions from, or errors in the assessment roll may be corrected, and the amount for which the assessment should be made, and the person or persons who should be assessed therefore may be placed upon the roll, and if necessary the assessment roll, even if returned as finally revised, may be opened so as to make it correct in accordance with the findings made on appeal.

(3) Same, 2009 and subsequent years. – For 2009 and subsequent taxation years, in determining the value at which any land shall be assessed, the Board shall,

(a) determine the current value of the land; and

(b) have reference to the value at which similar lands in the vicinity are assessed and adjust the assessment of the land to

make it equitable with that of similar lands in the vicinity if such an adjustment would result in a reduction of the assessment of the land

The Evidence

Raymond Wang

12Raymond Wang was qualified as an expert to give his opinion on the cap rate issue. Some 460 of the approximately 800 industrial malls in Halton/Peel filed appeals that were largely grounded in complaints about the FMRs employed by MPAC being too high. Mr. Wang was engaged to develop statistical studies to analyze actual rental data trends. His analysis revealed that the rental market for industrial malls had decreased from 2008 to 2012 by about 5%. MPAC had returned assessed values for the 2012 valuation year on the basis that rents had not changed from 2008. Mr. Wang confirmed that the FMRs MPAC used for the returned assessments were too high, just as the agents for the industrial malls were alleging.

13Mr. Wang undertook two assessment to sale ratio (“ASR”) studies for sales from 2010 through 2013, which both produced a median ASR of 1.00. This suggested to Mr. Wang that MPAC was achieving correct current values, even while using incorrect FMRs. The clear implication of this was the probability of an incorrect cap rate, causing MPAC to commission a new cap rate study for 580s in Halton/Peel.

14Mr. Wang reviewed the original 7% cap rate study and found it deficient in two ways: The sales were not time-adjusted to the January, 2012 valuation day and most sales were from 2009 or 2010 with only one sale in the base year of 2012.

15Mr. Wang implemented a “fresh review” of 86 sales between 2010 and 2013, identifying 61 valid transactions. He conducted a market trend analysis of the 61 sales, using a sale to assessment ratio approach to calculate time-adjustment factors. He undertook an exhaustive review of all the income and expense amounts in MPAC’s possession from source documents for incorporation into a new cap rate study. Of the 61 properties, 44 industrial malls provided at least one year of financial information, from which Mr. Wang sought to calculate NOIs. Those NOIs were divided into each property’s time-adjusted sale price to result in a cap rate for each. The range of cap rates produced were from 1.1% to 32.1% with a median of 6.1%. Outliers beyond the IAAO sanctioned coefficient of dispersion (“COD”) of 15 were removed. The COD is a measure of how far from the median value, any given cap rate is. Removing the sales that had a COD higher than 15, left 24 sales with cap rates ranging from 5% to 9% and a COD no greater than 15. The median cap rate of these 24 was 6.57% which was rounded to 6.6%.

Laine Fernandes

16Laine Fernandes is an MPAC Property Valuation Specialist. Ms. Fernandes prepared valuation reports on all three properties. She employed the 6.6% cap rate and conceded that she had simply accepted Mr. Wang’s cap rate without any further analysis as to whether it was appropriate. Her results are summarized below:

6150-6200 Dixie Road

Returned Value: Gross Market Income $1,437,080 Net Operating Income $1,324,057 Cap Rate 7% Value $18,915,000

MPAC Recommendation: Gross Market Income $1,003,460 Net Operating Income $ 923,801 Cap Rate 6.6% Value $13,997,000 TAS Sale Price $13,981,578

1575 South Gateway Road

Returned Value (2014, 2015): Gross Market Income $ 944,049 Net Operating Income $ 869,941 Cap Rate 7% Value $12,428,000

Returned Value (2016): Gross Market Income $ 808,400 Net Operating Income $ 744,940 Cap Rate 6.6% Value $11,286,000

170 Wilkinson Road

Returned Value: Gross Market Income $ 259,375 Net Operating Income $ 239,014 Cap Rate 7% Value $ 3,414,000

MPAC Recommendation: Gross Market Income $ 243,975 Net Operating Income $ 224,823 Cap Rate 6.6% Value $ 3,406,000

17Ms. Fernandes’ report repeated how approximately 60% of the 580s in Region 15 were appealed, and the main ground of appeal was that the FMRs were too high. The three calculations using the 6.6% cap rate were accompanied by reductions in some of the net rents per square foot leading to lower NOI figures. The net result of adjusting both the FMRs and the cap rate was an equivalent or reduced current value for the three properties before me, a result that Mr. Wang confirmed was the case with all appeals settled at the 6.6% cap rate. As demonstrated by the above summary, this resulted in values for the appealed properties that were at roughly the same level of assessment as before.

Evan Hovius

18Evan Hovius was qualified as an expert to give his opinion on the cap rate issue. Mr. Hovius focused on the valuation of 6150-6200 Dixie Road, in defense of the 7% cap rate, as there was a sale of the property to corroborate that rate. Mr. Hovius’ report details its purpose is “to assist the Assessment Review Board in the determination of a fair and equitable capitalization rate to be applied to industrial malls in Region 15”. His report did not claim to assist in determining the appropriate capitalization rate that leads to a correct current value.

19Mr. Hovius analysed the FMRs of the Dixie Road property, and calculated the net operating income NOI to be $967,579. He tested three different cap rates to see which one came closest to the valid time-adjusted sale price (“TAS”) of $13,981,578. The 6.6% and the 7.4% cap rates applied to the NOI resulted in values much higher and much lower respectively than the TAS price. The 7% cap rate resulted in an indicated value $13,883,000. This appears to be a minor typographical error as a 7% cap rate applied to the NOI is actually $13,823,000. In either case, it is a value that is reasonably close to the TAS value. On this evidence, Mr. Hovius concluded that 7% was the rate that best reflected the market.

20Ms. Fernandes reduced the FMRs for this property such that her NOI of $923,801 was less than Mr. Hovius’ NOI of $967,579. Applying the 6.6% cap rate to her NOI results in practically the same figure as applying the 7% cap rate to his NOI, thus demonstrating that the income calculation is just as connected to the value estimate as is the cap rate.

21On cross-examination, Mr. Shea asked what “fair and equitable” had to do with the accuracy of the cap rate. In response to a question about his assertion that a 6.6% cap rate produced inequitable assessments, Mr. Hovius stated that where income-producing capacity is the same, then it is inequitable to use different cap rates. He overlooked the fact that the estimated income-producing capacity of the 580s that were not appealed is not the same as the corrected NOIs of the 580s that are under appeal. I find that it is not inequitable that the similar lands with higher FMRs remain at an incorrect cap rate of 7%, while the 580s with lower FMRs are applied a different cap rate. It is the overall values remaining at the same level of assessment reflecting the level of sales that achieves equity.

22Mr. Shea’s main concern with Mr. Hovius’ analysis was that it was based on this single property. I agree that the fact that a 7% cap rate applied to one estimate of the NOI comes close to the sale price is not sufficient evidence to demonstrate that 7% is the cap rate that will result in most 580’s being assessed close to their market values. If instead you selected one of the four properties in Mr. Wang’s study with a sale at a 5.1% or 5.2% cap rate for example, that by itself would not corroborate a 5.1% cap rate. If it were included in the mix with the 7% cap rate, this would result in an average and median cap rate of approximately 6%. This result from two properties is just as statistically meaningless as it is from one property. That is why a meaningful cap rate study is done with multiple sales. The 7% cap rate that works for 6200 Dixie is only evidence that it works for 6200 Dixie, and only if one accepts the NOI as correct. Mr. Hovius’s analysis provides insufficient evidence to support a 7% cap rate.

Robert Ford-King

23Robert Ford-King was qualified as an expert to give opinion evidence on the cap rate issue, and he focused on the property at 170 Wilkinson Road. This property was built the same year and by the same builder as neighbouring industrial malls at 160, 180 and 188 Wilkinson Road, which were described as “cookie-cutter” comparables. Mr. Ford-King’s report stated that its purpose was to address the proposed alteration of the cap rate and “to review the equity of such a change for the current value…” It further cites: “It is the Appellant’s position that this proposed capitalization rate change is inappropriate and contrary to the principal (sic) of equity of similar properties...” He did not address the question of whether the alteration resulted in a correct current value for 170 Wilkinson Road.

24Mr. Ford-King provided a chart to show that from 2013 through 2016 all four of the “cookie-cutter” industrial malls in this complex were returned using a 7% cap rate. His analysis of these rows of sevens on the chart was that the change to 6.6% was “inequitable and contrary to s. 44(3) of the Act.” He did not calculate how this change actually affected how the new value compared to the “…assessed values of similar lands in the vicinity…” that the Board is directed to have reference to. Mr. Shea took Mr. Ford-King through an exercise of calculating the per square foot (“psf”) assessed value of the subject property 170 Wilkinson Road at the 6.6% cap rate, and comparing it to the psf assessed values of the three most similar properties which remained at a 7% cap rate. The subject property at 170 Wilkinson was $81.60 psf, while 160, 180 and 188 Wilkinson came in at $82.02 psf, $82.29 psf, and $82.28 psf respectively.

25The seeming equity in those numbers results from the fact that the effect of the lower cap rate 6.6% was offset by the reduction in the NOI of 170 Wilkinson Road from $239,006 to $224,823. Mr. Ford-King requested not only that the cap rate remain at 7%, but that “the final current value be determined by applying any adjustment MPAC will propose with regard to the determination of fair market rents.” In other words, Mr. Ford-King wanted both the lower cap rate and the lower NOI. Applying the 6.6% cap rate to the lower NOI of $224,823 results in an assessed value of $3,211,757 or $76.74 psf. Compared to the assessed values of similar lands, this would put the subject assessed value almost $200,000 less than the nearly identical industrial mall next door at 160 Wilkinson Road, and at a lower level of assessment than the most directly comparable properties each of which is assessed at just over $82 psf. Mr. Ford-King’s prescription invites me to create an inequity, rather than providing any evidence that MPAC’s values are inequitable.

26Mr. Milligan asked his witness to perform a different exercise, by calculating the dollars of total value as a function of dollars of net income. The MPAC value based on a 6.6% cap rate was $3,406,000 on an NOI of $224,823. This is $15.15 of value for every dollar of net income. The returned value based on a 7% cap rate was $3,414,373 on an NOI of $239,000. This is $14.28 of value for every dollar of net income. The three very similar properties on Wilkinson Road similarly show $14.28 of value for each dollar of income. Mr. Milligan exclaimed that the higher $15.15 of value per dollar of net income for 170 Wilkinson Road proves inequity.

27I know the only thing that it proves is that when a cap rate is lower, an owner must invest more money to earn the same dollar of income. A property’s value is higher for any given income amount because a larger investment is required to earn the same income return, than it would with a higher cap rate. However, the equation changes when the income variable changes as it does here. For example, at a 6.6% cap rate, in order to earn the original NOI of $239,000, the property’s value would have to be $3,621,212 instead of $3,414,372. This is also $15.15 of value for every dollar of net income, but it is not equitable because the resulting overall value is $200,000 higher. To earn the lower NOI of $224,823 at the same 6.6% return, the investment or value need only be $3,406,000 which is still $15.15 for every dollar of income, but now it is equitable because the overall value is at the same level as similar properties.

28Counsel’s proposal for equity is placing the subject at the lower $14.28 of value for every dollar of net income, which results in the $3,211,000 value that is $200,000 less than the near identical property next door that I already found to be inequitable. The $15.15 and $14.28 are simply the inverse multipliers of the cap rates 6.6% and 7.0% respectively. Cap rates represent the dollars of income expected for every dollar of value, which is simply the ratio that is the inverse of dollars of value per dollar of income. Neither ratio illustrates anything about what is equitable. What these examples clearly illuminate is the fallacy of altering valuation variables in the name of equity.

Principles of Equity

29The witnesses for the Appellants displayed a misunderstanding of what equity in assessment is, and how it is achieved. Equity is a judicial concept employed by judges to provide a remedy from the unjust or unfair result of the strict application of legal principles. Section 44.(3)(b) of the Act gives the Assessment Review Board (“ARB”) the authority to remedy the strict application of the law leading to the correct current value if that value is unfair or unjust or not equitable. This first requires a finding that the correct current value is inequitable after having reference to the assessed values of similar lands.

30Mr. Ford-King’s report cites s. 44.(3) and underlined is a part of s. 44(3)(b): “…if such an adjustment would result in a reduction of the assessment of the land.” This provision is a simple prohibition on increasing an assessment on account of equity. I would underline a more important part and indeed the operative part of the entire provision: “…make it equitable.” This phrase provides the rationale and prerequisite to any adjustment to a correct current value. That value needs to be shown to be inequitable, before you can make it equitable. For 170 Wilkinson Road, the current value using 6.6% is clearly at the same level of assessment as the very similar and directly comparable properties nearby, and with all the other industrial malls based on the ASR near one. A finding of inequity is not supportable.

31Section 44.(3)(b) directs the Board to have reference to the assessed values of other properties. It does not direct us to have reference to the component parts of the valuation analysis leading to those assessed values. Making a finding of inequity in a correct current value does not require either an examination or an equalization of component parts across all similar properties. Mr. Ford-King repeated the common misperception that equity means similar treatment of similar properties. It is not the treatment or method or components of value that must be similar or equal, it is the product of those things that must lead to a level of assessment for the subject property that is at the same level of assessment of similar lands.

32If the FMRs were not adjusted down, a 6.6% cap rate could have created an inequity, because the result would have been assessed values with ASRs above one, or a higher level of assessment than the 580s remaining at the 7% cap rate. That is the opposite result from retaining the 7% cap rate and applying it to the lower FMRs as the Appellants suggest. That would result in an ASR below one or a lower level of assessment for the appealed 580s before me, while the un-appealed 580s remain at their correct level of assessment. The middle route of applying the 6.6% cap rate to the lower FMRs produces correct current values that are also equitable. It is the result or product of all the current value calculations that must be equitable, not necessarily each component part.

33Components of valuation such as cap rates, gross income multipliers, and fair market rents among others, are values derived from the market and applied in accordance with appraisal theory to arrive at market or current values. If equity required the equalization of these amounts across the board, there would be no need to do the current value determination in the first place. The use of a cap rate is as a valuation tool, not an equity tool. Re-calculating current values using different valuation components under the guise of achieving equity is not what s. 44(3)(b) was intended for.

Capitalization Rate

34I have reviewed Mr. Wang’s cap rate study, and considered the deficiencies pointed out by the Appellants’ witnesses and counsel and determine that it provides the best evidence for the appropriate cap rate to be applied to arrive at correct current values for industrial malls in Halton and Peel Regions.

Actual/Contract Rents v. Market/Typical Rents

35Mr. Milligan and his witnesses challenged the cap rate study as being flawed because the cap rate is grounded in what is referred to as “the lease fee” rather than “the fee simple”. The submission was that Mr. Wang’s analysis was based on actual rental data rather than typical or market rents. Appraisal theory confirms that a leased fee cap rate based on actual or contract rent ought not to be applied against market FMRs and NOIs: Altus Centre v Calgary (City), [2008] AWLD 4246. I have reviewed the data that Mr. Wang based his study on and I am persuaded by Mr. Wang’s testimony that he measured, checked and adjusted his income and expense figures against market benchmarks, so that his numbers accurately reflect real market rental activity during the period of his study. I also accept Mr. Wang’s testimony, and Mr. Hovius’s concession on cross-examination, on the entirely reasonable proposition that actual rents can also be market rents.

Stabilized Net Income

36Concern was raised by the Appellants over the dearth of income and expense information on which Mr. Wang’s stabilized income was calculated. Many of the properties in the study did not have a full three years of income and expenses. Some of the figures showed substantial year over year differences that questioned their ability to be stabilized. Mr. Wang extrapolated to some extent, but his figures appear to be reasonable estimates which he tested against typical market standards.

37I conclude that Mr. Wang’s approach demonstrates a 7% cap rate is unsupportable. When I reviewed the seven properties for which there was two full years of reasonably consistent income and expenses, the cap rates range from 4.2% to 8.4% with both an average and median cap rate of 5.9%. When I reviewed the four properties for which there was three full years requiring no extrapolations, the cap rates range from 4.9% to 7.7% with an average of 5.8% and median of 5.1%. The higher cap rates in the study that are closer to 7% are almost all derived from properties where there is only a single year of income and expenses, or two years of data with widely divergent, inconsistent amounts, with Mr. Wang using the highest figure for the stabilized NOI. The best evidence based on two or three years of reasonably consistent income and expense data supports a cap rate closer to 6.6% than it does to 7%.

38Aside from critiquing Mr. Wang’s analysis, the Appellant’s valuators did not attempt their own analysis of these figures in any effort to a support a 7% cap rate. I accept Mr. Wang’s expert statistical analysis and conclusion that a 6.6% cap rate is the correct product of his analysis. I accept Mr. Wang’s evidence that his new study is based on more complete and contemporaneous data than was MPAC’s original 7% cap rate study.

Authority to Correct

39MPAC’s new cap rate study is the only one in evidence, as the Appellants’ witnesses and counsel focused almost exclusively on the inequity and novelty of MPAC altering the cap rate near the end the four year cycle. It may have been “unprecedented” but is within the authority of the assessment corporation to do so. MPAC has the statutory authority to correct assessments during the four year cycle, as each annual roll return is a new, separate and independent assessment. Mr. Shea reminded me that this Board “has no inquisitorial, supervisory or regulatory powers” to weigh in on such decisions however ill-timed they may seem. (“Subotich et al. v MPAC et al. November 2012, Ont ARB unreported).

40When assessments are appealed however, s. 44.(1) grants the Board the discretion to “reopen the whole question of the assessment” to allow the correction of errors and omissions in the assessment roll. The assessment roll may be “opened so as to make it correct in accordance with the findings made on appeal”. The finding made on these appeals is that both FMRs and the cap rate were in error and I exercise my discretion under s. 44.(1) to correct the cap rate to 6.6%, applicable to all 580s in Halton and Peel that are under appeal before me. I expect that the assessment corporation will continue to correct the FMRs on a case by case basis in order that “…the amount for which the assessment should be made … may be placed upon the roll …” .

CONCLUSION

41The best evidence that a 6.6% cap rate leads to correct current values when applied to accurate FMRs and NOIs for industrial malls in Halton and Peel is provided by Mr. Wang’s expert analysis and testimony. These values are corroborated by the ratios comparing assessed values to actual sale prices because the values produced reflect the market well. The same ratios showing that all Halton/Peel industrial malls are assessed at their correct current values also demonstrates that equity is achieved. The cap rate to be applied to the NOIs of 6150-6200 Dixie Road, 170 Wilkinson Road and 1575 South Gateway Road is 6.6%.

42A continuation of this hearing is already scheduled for November 10, 2016 to deal with the scheduling or other disposition of the hundreds of other 580s on this docket. The agents and owners of the other industrial malls awaiting this decision should consider themselves bound to a cap rate of 6.6%, unless there is an appeal by any of the Appellants of the three properties that were put forward to determine this issue. Any appeals where FMRs and other items are in issue should be subject to resolution discussions in short order. Any that cannot be settled can be scheduled to hearings or mediations early in the new year. I request that counsel come with a joint plan along those lines to expedite these outstanding current cycle matters in anticipation of the new four year assessment cycle looming just around the corner.