Buying patterns for retail goods have changed and continue to evolve within the Amazon world. The growth of eCommerce has made retail business risky, which has made retail properties risky. The central issue is how to predict which retail properties will go dark. This is at the heart of whether appraisers pursue a dark store theory in reviewing property.

The answer, though complex, contains just two words: market analysis.

Thorough market analysis is necessary for an understanding of retail, whether owner-occupied or leased. The market analysis is relatively easy for owner-occupied properties, assuming the appraisers are able to obtain the store’s historical revenues at minimum, and ideally they should receive the store’s detailed financial statements.

Appraisers Franz Ross and Sergio Lo Presti recently wrote an article in The Appraisal Journal which notes that “in appraising hotels, nursing homes, convenience stores, and other property types, revenues are the primary measure of captured demand, and going concern appraisals are the accepted practice.”

The co-authors note that consistency in using the financial information of a going concern will improve the reliability of the highest and best use analysis and the forecast of durability of the current use. In their article, they discuss the “durability of the current use” as it relates to the likelihood of vacancy under the current highest and best use of the real estate, not the brand name occupying the space, with vacancy caused by deficiencies in location, functional aspects, or demand.

We spoke with Ross and Lo Presti for additional insight as to what appraisers should do when reviewing these types of properties.

“If we’re appraising a hotel, we know the revenue per available room (known as RevPAR) to the penny,” Ross told Valuation Review. “We’ll know that figure even by the room type for that hotel for the last three or four years.

“But if I’m appraising a liquor store, I won’t know within $10 what the annual sales are per square foot (which is the equivalent measure of demand to RevPAR),” Ross added. “I can guess, but it may be off by $10 to $15 per square foot.”

Ross said asking for the sales information while doing a real estate appraisal generally goes nowhere, because the owner claims the appraiser is not doing a business valuation. But that information is important.

 “Knowing the captured demand is just as important for a retail store as for a hotel, and the information is equally sensitive, yet appraisers always get the information for hotels and other traditional ‘going concern’ property types,” Ross said.

Ross cited a January New York Times article which states that many national brand retailers are seeking cuts in their stores’ assessed values, and therefore cuts on their tax bills based upon the assumption that if the retailer leaves, the store will remain dark for a prolonged period and eventually will sell for a fraction of its former value. When such retailers succeed in reducing their tax bill, the town bears the financial consequences.

Lo Presti was involved in a similar case where a retailer tried to get their assessment reduced based on the assumption that their store would remain dark if they moved out, and eventually sell at a great discount to its presumed earlier value.

“Retailers are arguing in assessment courts that the valuation should be based on a second generation use; as a vacant box store with a next use yet to be determined, and should sell for significantly less than what it might be worth today if it were in place as an operating property,” Lo Presti said. “The judge in the case I was involved with did not buy the argument the building would sell as a defunct, vacant store. Consequently, the taxes went up significantly because the assessments were more than doubled. The judge ruled in favor of the appraisal, premised on valuation assuming on-going occupancy.”

Some appraisers, Ross said, have suggested that the appraisal must assume a sale to a new user for owner-occupied properties. He disagrees.

“It comes back to market analysis. If the current user paid to have built-to-suit improvements put in, usually done with a newer building, and they’ve chosen the location, unless they were dramatically wrong in their analysis they are not going to leave,” he said. “The only exception would be if the business is failing. The property can still sell, but the highest and best use analysis will conclude that the likely buyer is an investor in a sale-leaseback or a buyer of the business and the real estate as a package. That’s why you need financial statements to determine the store’s success or failure.”

Lo Presti said the pair were encouraging appraisers to look at the financial health of the retailer or operator, and use that information to determine whether to pursue a dark store theory.

“We’re not advocating for higher values or lower values, because in some cases, dark store theory is the right answer,” Ross said. “You might have a top-notch retailer in a location doing reasonably well but the improvements are older, and the retailer knows he can do better in another store or location. Even if they are doing okay, there is still a good chance they will leave.

“The dark store theory can be applicable, but each appraisal is unique. You have to look at the highest and best use of that property, the best place for that business, and is the business successful in that store.”

Ross and Lo Presti suggest that eCommerce is driving retail, and Amazon is driving eCommerce. Seismic changes are occurring in how money is spent, and eCommerce now is having substantial negative impact on retail stores for certain goods, with the GAFO group – general, apparel, furniture and other – being hit especially hard.

Appraisers, therefore, should perform thorough market analysis to forecast the future demand for all retail properties, Ross and Lo Presti state.

An analysis of the degree of favorability of the land and improvements to the current occupant, combined with an analysis of the financial success of that occupant, should be done early in the appraisal process.

“For leased properties you’re probably not going to get the financial statements,” Ross said. “Ideally, if you receive them, you would know if the stores are successful or not. Usually the only option is to make multiple visits when appraising a leased retail property, in order to see how busy the store is at different times of day and on different days of the week.

“When people leave, how many bags are they carrying out? How full is the parking lot? If you’re out of your market, and you make just one visit, that’s not very reliable.”

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