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Casinos, Ground Leases, and Valuation for Real Property Tax Assessment Purposes

Every three years in Maryland, tax assessment authorities assess real property to determine its value for property tax purposes.  Property is assessed at its full cash value – its market value.  An assessor can consider three methods for valuing property: (1) replacement cost value, (2) sales of comparable property, and (3) capitalization of income derived from the property.  For income producing properties, such as office buildings and other facilities that have a rental income stream, capitalization of income is the most commonly used method of valuation. 

In PPE Casino Resorts Maryland LLC v. Supervisor of Assessments of Anne Arundel County, Case Nos. 14-RP-AA-0503 (1-2) and 14-RP-AA-1276 (Dec. 26, 2017), the Maryland Tax Court addressed the issue of the proper method for determining the assessed value of a casino that was constructed on a parcel that was ground leased.  The casino was Maryland Live! Casino, located at the Arundel Mills Mall in Anne Arundel County.  The ground lease for the casino provided for a fixed minimum rent, plus a percentage rent equal to 1% of the gross revenues generated by the casino. 

The assessor asserted that the value of the casino parcel should be based upon capitalization of income from the ground lease, a customary methodology for income producing property.  The taxpayer, however, argued that the capitalization of income from the ground lease would be inappropriate in its circumstance because the majority of the rental payment (property income) arose from percentage rent of the casino business operations – business income, not property income.  The taxpayer urged that the comparable sales and replacement cost valuation methods were more appropriate than the capitalization of income method.  The difference in assessed value resulting from the two competing methodologies was substantial – land value was approximately $15 million under a “comparable sales” valuation method and approximately $70 million under a “capitalization of income” valuation method – a roughly $55 million differential.

The Maryland Tax Court adopted the position of the taxpayer – that capitalization of income was not the appropriate valuation methodology in this circumstance.  The Tax Court acknowledged that Maryland case law required consideration of contract rent under a long term lease for valuation purposes; however, those cases did not mandate that capitalization of such rent be the sole basis for determining value. 

The Tax Court rejected using the rental income as a basis for valuing the property for two significant reasons.  First, using rent as the basis for valuation in this circumstance would be erroneous because “percentage rent is ‘speculative,’ where a business has not yet opened.”  At the time the casino lease was signed, the casino had not opened and neither party could have known how much revenue the casino would generate in percentage rent.  If the amount of rent is “speculative,” then it cannot be a viable basis for assessing value.  Second, including the percentage rent in the capitalization of income methodology would improperly amount to including business income of the tenant as opposed to a valuation of the property as the income producer.  In the words of the Tax Court:

The parties to the lease did not know how much the gross revenue of the casino would eventually total and how certain factors outside their control might affect the gross revenue…. The percentage rent factor in this case was purely speculative and unknown due to the Casino being a new enterprise…

The lease in the present case is a percentage lease and derives approximately two-thirds of the ground rent from business oriented percentage rent. Hence, the problem inherent with using the lease is that it leads to a valuation of the operating business….

A lease agreed to by two parties which includes non-cognizable percentage rent amount indicates that the parties, as well as the market, could not determine the value of the land by capitalizing the rent payment.  Additionally, a lease whose majority of rent payments is clearly the product of a business enterprise should not be used in assessing a property's value.

Accordingly, the Tax Court refused to use the capitalization of income approach to value the property and instead used a comparable sales analysis combined with a cost approach for assessing value.  The net result was an assessment to the taxpayer of approximately $55 million less than that sought by the assessor.

PRACTICE NOTE:  The PPE Casino case may provide a basis for commercial property owners to insist that assessors use comparable sales or replacement cost valuation methodologies for valuing a property, instead of capitalizing rental income where percentage rent is a significant component of income, even if the property is not a casino. Assessors automatically use capitalization of income methodology for commercially leased properties.  This may be incorrect and lead to inflated values where percentage rent is involved.  Retail leases commonly contain percentage rent clauses as a component of rent to be paid.  Accordingly, commercial property owners who have percentage rent leases may want to examine replacement cost values and comparable sales values of their properties to determine whether their properties are being overvalued by an assessor who merely capitalizes the income derived from leases at the property.

For questions, please contact Bill Shaughnessy (410) 576-4092.


April 27, 2018




Real Estate