The "economic realities of commercial real estate transactions" in Pennsylvania

Update as of June 26, 2009: Joseph C. Bright, the dean of Pennsylvania state tax lawyers, has now weighed in the Tech One Associates case here.

On June 1, 2009, the Pennsylvania Commonwealth Court handed down an intriguing decision about the property tax implications of ground lease deals in Tech One Associates v. Board of Property Assessment, Appeals and Review of Allegheny County, West Mifflin Borough and West Mifflin Area School District.

What intrigues me is the current state of Pennsylvania law, at least according to the landowner who brought the assessment appeal in Tech One Associates. The landowner is the fee owner of 47.5 acres developed with 415,613 sf of buildings under a ground lease where the landowner gets $655,000/yr in ground rent. The landowner's appraiser:

placed no value on the buildings because the economic reality of the long-term land lease held by Landowner, the party being assessed, was that it received no economic benefit from the buildings constructed on the land.

The landowner's argument, which was accepted by the trial court (the Court of
Common Pleas of Allegheny County), was that Pennsylvania law, per the Pennsylvania Supreme Court's holding in In re Appeal of Marple Springfield Center, Inc., 530 Pa. 122, 607 A.2d 708 (1992)("Marple Springfield Center"), currently permits, in the context of real estate that is subject to a "below market" ground lease, the erection of buildings and improvements on real estate without taking the value of those buildings into account in the assessed value of the property.

To me, that's a pretty astounding result.

In Tech One Associates, which overrules the trial court, the Commonwealth Court labors strenuously to distinguish this case from Marple Springfield Center, in which the Supreme Court overruled the Commonwealth Court (that case, too, involved a shopping center that was subject to a below market ground lease). In Marple Springfield Center, the Supreme Court upheld a reduction of assessed value from $19.5M to $8.5M because, among other thigns, to do otherwise would be "to ignore the economic realities of commercial real estate transactions."

It seems to me that the Commonwealth Court, in Tech One Associates, isn't doing a very convincing job of distinguishing the two: for example, the Commonwealth Court states, "The economic difference between this appeal and Marple Springfield I is that Marple Springfield I made no mention that the lessee was responsible for all real estate taxes." I can't imagine that the ground lease in Marple Springfield required anyone but the lessee to pay real estate taxes, so that seems to me to be a very slender reed upon which to distinguish Tech One Associates from Marple Springfield Center.

The "economic realities of commercial real estate transctions" that both courts talk about in these two decisions are pretty far removed from the "economic realities" of ground lease transactions with which I am familiar. I can't understand why I'm not seeing an analysis that looks something like this (which, IMHO, is closer to the "economic realities of commercial real estate transctions" that the parties actually expect):
 

• the assessed land value ought to reflect the actual stream of income from ground lease payments received by the ground lessor, divided by an appropriate cap rate. So, if the ground lessor  made a "good deal" (i.e., lessor receives above market ground lease revenues) or a "bad deal" (the opposite), then, since that factor would, indeed, affect "the rates and prices for which the same would separately bona fide sell" (72 P.S. 5020-402), that factor can certainly also appropriately be taken into account in coming up with the appropriate assessed value of the land.

• but the assessed building value ought to have nothing to do with the revenues payable to the ground lessor under the ground lease. The buildings ought to be assessed via all three methods (depreciated historical cost, capitalized income, market), which, theoretically anyway, ought to reach the same result, and the resulting building value ought also to be included in the assessed value of the real estate, because, after all, the ground lessee can sell its leasehold interest in the land and buildings, and  the statute directs us to take into account  "the rates and prices for which the same would separately bona fide sell" (72 P.S. 5020-402),

Pennsylvania is sometimes a funny place. It will be interesting to see what the Supreme Court does with this decision.

Thanks to Skip Bertine for bringing this case to my attention.