IN THE MATTER OF AN APPEAL PURSUANT TO S. 50 OF THE ASSESSMENT ACT

CONCERNING:

Sears Canada Inc.

APPELLANT

AND

Assessor Of Area #10 - North Fraser Region

RESPONDENT

INTRODUCTION

[1] The Appellant, Sears Canada Inc. (“Sears”) leases retail space in the Coquitlam Shopping Centre at 2929 Barnet Highway, Coquitlam BC (the “Property”) as an anchor tenant.  Coquitlam Centre is a super-regional shopping centre located in Coquitlam, B.C. with a total of 915,000 square feet of gross leasable area.  For the 2009 assessment roll, the entire property is valued by the income approach to determine its value, where an economic or market rent is applied, along with economic vacancy and expense rates to achieve a net operating income, which is then capitalized by a capitalization rate. 

[2] Sears says that the Assessor has over estimated the contributory value of their rented space (the “Sears space”) to the value of the Property, and in particular, disagrees with the economic rental rate of $5.00 per square foot attributed to the Sears space by the Assessor.  Sears says that the appropriate market rent to be applied is $3.50 per square foot.

FACTS

[3] The Sears store is located at the eastern end of the shopping centre and consists of 151,455 square feet over two floors or 16.5% of the total gross leasable area (GLA) of the centre.  Exterior access is available to the Sears store from the upper levels at the east or north entrances.  Main floor access is available from the south entrance.  Upper and lower floors are accessible directly from both mall levels.  Customers can access both floors from within the store via a central escalator or by elevators.  The Sears space is currently leased for $4.90 per square foot as the “face” rent set out in the lease.

[4] In addition to Sears, there are two other major anchors, The Bay and Zellers.  Only The Bay and Sears are characterized in the retail industry as full line department stores, namely stores that provide a diverse produce line of both hard and soft goods, as well as a variety of customer services.  

[5] The Bay is 120,527 square feet and forms 13.2% of the GLA.  The Bay was constructed in 1979 and, like the subject, is over two floors and has similar interior and exterior accesses to it.  It was built in 1979 and is of comparable design, layout and quality.

[6] Zellers is located at the north end of the mall and was constructed in 2000.  At 111,668 square feet, it occupies 12.2% of the shopping centre’s GLA.  Zellers differs in design from Sears and The Bay in that it’s totally located on one floor.  Zellers is not considered a full line department store by the retail industry.

[7] Other large tenants include Future Shop, London Drugs, T&T Supermarket, H&M, SportsCheck, Golf Town, Old Navy, The Gap, Sephora and Coast Mountain Equipment.  Coquitlam Centre also has approximately 190 Commercial Rental Unit (CRU) tenants.  Smaller malls built near Coquitlam Centre to take advantage of the retail traffic include Henderson Place, Pinetree Village, Sunwood Square and Westwood Mall Shopping Centre.

ISSUE

[8] The only issue in the appeal is the appropriate economic or market rent of the Sears space as of the date of valuation for the 2009 assessment roll.  “Market rent” is defined in the Appraisal of Real Estate as the rental income that a property would probably command in the open market, indicated by current rents that are either paid or asked for comparable space as of the date of the valuation.

[9] For the 2009 assessment roll, the property is to be valued as of either July 1, 2008 or July 1, 2007, whichever produces the lower value.  Although the parties’ experts used different valuation dates, at the hearing, both agreed there was no difference in value between the two dates. 

[10] The key question in the determination of the appropriate economic rent is whether to adjust the face rents of comparable leases for cash allowances or tenant inducements.  Sears says that an analysis of comparable face rents should deduct for cash allowances or inducements while the Assessor says that there should be no deduction as those monies are spent on fixtures or leasehold improvements which form part of the real estate.  The parties also disagree on which leases are comparable in the rental analysis and in the competitive market set.  Sears uses leases of full line department stores across the country from 2001 onwards, while the Assessor says that only B.C., and specifically, leases in the Lower Mainland, should be used from 2000 onwards.

EVIDENCE AND ANALYSIS

What is the Competitive Market Set?

[11] To determine market rent, we must consider the rent being paid by Sears under the existing lease, as well as rents currently prevailing in the same market competitive set of comparable properties as the subject.  The parties disagree on the comparables that should be used for analysis based on location (i.e. whether the comparables should be in the Lower Mainland, as the subject, or across Canada), and on whether or not leases before 2001 should be used. 

[12] Sears and The Bay are the only full line department stores in Canada and make up the competitive market set.  This is largely because of increased competition from the big box retail sector and the downfall of Woodward’s in the early nineties, then Eaton’s in the late nineties.  The demise of Eaton’s created a glut of space within shopping centres across the nation, as well as opportunities for the remaining department store operators to expand into those locations.  Sears views this period in the late nineties as being non typical and, therefore, any leases negotiated during this time should not be included in a rental analysis.  The Assessor disagrees, and says leases negotiated during this period should be analyzed because of the limited number of comparable leases available.

[13] Sears produced an appraisal report by David Nishi-Beckingham, a real estate appraiser.  Mr. Nishi-Beckingham reviewed 20 leases from across Canada from 2001 to date.  He did not review leases of stores prior to 2001 because he concluded that there was a decline in department store rental rates being achieved by landlords since the demise of Eaton’s and a resulting increase in the amount of inducements being offered to attract the remaining two prospective tenants.  He stated the leases with the largest concessions and lowest rates fell nearer the valuation date.

[14] Mr. Nishi-Beckingham’s lease analysis is based on the start date of the lease and not the negotiation date.  Good appraisal theory would suggest the negotiation date is preferable when trying to establish a time line for adjustment purposes because the negotiation date sets the market conditions surrounding the participants to the lease transaction at the time of the negotiation, which conditions may differ at the start date.  If the two dates are fairly close, the date used may not be critical, but several of the leases relied upon by Mr. Nishi-Beckingham have periods of up to two years or more between the date of negotiation and the start date.  For example, Cambridge Centre was negotiated in July 2000 but the lease start date is August 2002, Les Galeries Joliett was negotiated in April 2001 but has a start date of October 2003, Festival Market Place was negotiated in March 2003 but has a May 2004 start date, and Bower Place was negotiated March 2003 but has a December 2008 start date.  Eight leases were submitted without documentation and evidence of their date of negotiation and only the start dates of these lease terms are known.  These leases cannot, therefore, be properly time adjusted.

[15] Mr. Nishi-Beckingham also says location of the comparables is not important for full line department stores because these stores are only interested in actual or projected sales per square foot of a community, regional or super-regional shopping centre and specific population / income statistics within a desired driving distance of the centre.  He analyzed population statistics from Financial Post FPmarkets, titled Canadian Demographics 2009 and compared them to his rental calculation in two groupings:  department store rents by population and department store rents by number of shopping centre stores per 1,000 people.  He explained this data is important in the retail industry when determining locations for department stores.  He included copies of the Canadian Directory of Shopping Centres and explained how annual sales per square feet relate to a shopping centre’s annual sales performance, with a super-regional centre achieving higher sales per square foot.

[16] In regional centres, there is usually only one full line department store represented but in the super-regional centres, usually both Sears and The Bay will be present.  The subject is a super-regional centre.  Sears says that adjustments for location are not necessary because there are different motivations for full line department stores that may not apply to other retail facilities.  Mr. Nishi-Beckingham produced charts comparing his net effective rental rates against store size, population, age and density to show rates have decreased over his start date period and as support for his conclusion that the rate does not appear to be affected by the location of the store.  However, the net effective rental rates used reflect the start dates of the leases, rather than the negotiation date, therefore, the analysis is not entirely reliable.  Also, although he produced demographic charts, he failed to relate that information to the conclusion that location does not affect the rental rates.  For example, in his report, he produced charts of department store rents by store density showing lower rents for higher density stores, but he did not provide an explanation as to how this information supported his conclusion that a store in Ontario is comparable to a store in B.C.

[17] Mr. Nishi-Beckingham also relied on extracts of evidence given by Brian Whibbs, from Sears, in a hearing of Sears Canada Inc. v. Assessor of Area #09 (2005 PAABBC 20040345), where he stated there is national market for full line department stores, as well as comments made by Mr. Zinner of the Bay who made a similar comment at a roundtable discussion that occurred this year.  As Mr. Whibbs and Mr. Zinner did not attend the hearing and were not available for questioning, and as only parts of the transcript was provided, we do not find this evidence to be reliable and give it little weight.

[18] The Assessor relied upon the appraisal report of David Kingston, appraiser.  He reviewed leases of 24 full line department stores in B.C., i.e. Sears or The Bay stores, and relied on eight of them to determine a market rental rate for the subject.  He analyzed the Lower Mainland stores and compared them to the non-Lower Mainland stores and determined that non-Lower Mainland stores had lower rents on average and by median than Lower Mainland stores.  Because some of the leases were dated and were renewals of leases that were dated, there was some question on whether these rents were truly reflective of the market as of the valuation date.  Despite this, Mr. Kingston provided support for his analysis which was based on a review of the terms of the actual leases, and we find that Mr. Kingston was more knowledgeable about the lease comparables compared to Mr. Nishi-Beckingham.  Although there were some discrepancies, overall, we accept Mr. Kingston’s analysis on the issue of whether location of comparables is a factor compared to the evidence of Mr. Nishi-Beckingham, who provided insufficient evidence in support of his analysis.

[19] Mr. Kingston relied largely on three leases from the Lower Mainland to determine a rental rate for the subject and two of three of these leases occurred prior to 2001.  The Bay Lougheed was re-negotiated in February, 2009, shortly after the valuation date.  Although he was cross-examined on the source of this information and there was some question as to whether the renewal was a predetermined rental rate, there was insufficient evidence provided to contradict Mr. Kingston’s evidence and reliance upon this comparable.  The other two comparables used by Mr. Kingston are Sears Guildford, negotiated in October 1999, and Sears Brentwood, negotiated in September 1999, although this lease was part of a multi-property transaction involving another store and a land swap.  The Sears Brentwood lease should not be precluded entirely from the analysis as suggested by Sears because it was part of a larger transaction, but given lesser weight.  If the rental rate negotiated as part of that transaction was shown not to be economic or a market rate, then the lease could be precluded from the analysis, but that evidence was not provided.

[20] As Sears and The Bay are the only full-line department stores in the retail industry, the competitive market set include only those stores that have comparable space.  There are not a lot of lease transactions of comparable space.  As we accept Mr. Kingston’s analysis that there is a locational difference between rents achieved by Lower Mainland stores compared to non-Lower Mainland stores and we do not accept Mr. Nishi-Beckingham’s largely unsupported analysis that there is no locational difference, the competitive market set would include Sears and The Bay stores in B.C. and specifically the Lower Mainland.

[21] Both appraisers also disagreed on whether the leases negotiated directly following the demise of Eaton’s, and that involving takeovers by Sears and The Bay, should be included in an analysis.  Mr. Nishi-Beckingham concluded this was a highly unusual time and leases negotiated prior to 2001 should not be included in any analysis, while Mr. Kingston disagreed and did include those leases in his analysis.  If we are to discard those leases from analysis, we would need evidence to support the contention that they do not represent market transactions or the market during that time was distorted.  That evidence was not provided by Mr. Nishi-Beckingham.  Comparable leases of Sears or The Bay stores in the Lower Mainland occurred in 2000.  As there is insufficient evidence to support the opinion that leases negotiated prior to 2001 should be excluded, we include those leases as comparables in determining market rent.

Should there be a deduction to Face Rents for Cash Allowances?

[22] The parties also disagree in their analyses on whether to make adjustments to the rental rates on the face of the comparable leases (i.e. face rents) for the impact and treatment of tenant inducements or cash allowances.

[23] Sears submitted that cash inducements provided by the landlord to the tenant at the commencement of a lease arrangement are used for non-realty expense items that are not assessable, such as inventory or chattels the store requires to operate.  Therefore, Mr. Nishi-Beckingham adjusted the rents of his comparables for these inducements and arrived at an effective rental rate.  The Assessor treated the inducements as going towards realty items that are assessable and Mr. Kingston did not adjust contract rents for these inducements because he was unable to find evidence to prove that the cash inducements were spent on non-assessable items.

[24] Sears says that the landlord’s obligation is to provide a store to Sears that has a Construction Standard L972 level of finishing which stands for “finished, ready for Sears to move in and set up business”.  The Construction Standard is a document provided to landlords that sets out Sears’ base construction requirements for their store. 

[25] Sears submitted that their landlords offer a completely finished store for Sears to occupy and Sears does not provide tenant improvements.  In addition, landlords offer Sears cash incentives up to an amount where, in some instances, Sears does not have to spend their own money to get the store set up and operating, and these monies are used for the purchase of display shelving and inventory.  However, Sears did not provide documents or other evidence to support this, nor did Sears provide specific examples or leases. 

[26] Because of the limited number of full-line department store operators in the market set, Mr. Nishi-Beckingham stated that tenant improvements are specific to the stores’ brand and therefore, of no use to any other potential tenant.  Therefore, in his opinion, department store tenant improvements have little value in the marketplace and only represent value to the owner, and consequently, the subject must be valued as though vacant and ready for occupancy as of the date of the valuation.

[27] We have difficulty with this concept as out of the 28 leases submitted by the parties, only five were identified as examples of the landlord providing the L972 construction package and a tenant inducement.  Of these, three were takeovers from a previous occupier (North Gate Square, Cambridge Centre and Avalon Mall) and two were for brand new stores (Les Galeries Joliette and Place St Eustache).  There were two examples where Sears did not receive the L972 package but did receive a tenant inducement.  Both were takeovers from previous tenants (Lambton Centre and Festival Market Place).  There were two other examples of takeovers with Sears receiving a tenant inducement, expansion rights at Sears’ expense but no L972 construction package (Eastgate and Guildford).  1000 Island Malls is an example of a new store to be built by Sears at their expense without receiving an inducement at all.  But, Bower Place is an example of Sears building a new store at their expense but with specific tenant inducements.  In terms of renewals, there were four renewals without any tenant inducements at the newly negotiated renewal date, although the tenant had received inducements to enter into the original lease (Rutherford Mall, Pine Centre, Lougheed and Bay Centre).  Lastly, seven examples were submitted without any documentation at all and do little to assist us (Edmonton Centre, Victoria Eaton Centre, Polo Park, Hillside, Conestoga Mall, Woodgrove and Aberdeen).

[28] Not all of the leases presented reflect cash inducements.  There were eleven out of the twenty leases submitted by Mr. Nishi-Beckingham (excluding Hillside).  For his conclusion that leases should be adjusted for the inducements, he relied on the testimony of Mr. Whibbs from Sears, supra. in the form of excerpts from the transcript of hearing.  Mr. Whibbs is responsible for negotiating lease transactions on behalf of Sears and he commented in the transcript on their negotiating process from Sears’ perspective.  As indicated earlier, we were not present to hear this testimony, the cross examination or to ask questions of this witness, nor did we receive the entire transcript, therefore, we find this evidence unreliable and give it little weight.

[29] Mr. Nishi-Beckingham referred to Mr. Whibbs’ testimony in the previous Sears hearing again during discussion of Hamilton’s Eastgate Shopping Centre lease, an example of a former The Bay store being taken over by Sears.  It has a February, 2008 start date and a negotiation date of at least April, 2007.  He indicated he spoke to Mr. Whibbs to get a breakdown of the cash inducements and how they were apportioned by Sears.  The inducement quoted by Mr. Whibbs was significantly different than what is stated in the lease document.  The lease indicated the inducement would be $5,000,000 and Sears would be allowed to build a 20,000 square feet expansion with the shopping centre only providing the land and pad for Sears to build out the store.  The lease documents indicate Sears took the space “as is” with the landlord only responsible for doing specific minor changes such as, interior alterations, exterior façade upgrades, clear out movable tenant improvements’ from the past tenant, replace the HVAC, repair the roof and convert a public entrance to a Sears merchandise pick up area.  After speaking to Mr. Whibbs, Mr. Nishi-Beckingham said the inducement was different than what was quoted in the lease and was apportioned as follows, $5,000,000 for Sears to move, $5,000,000 for tenant improvements and $60 per square foot to build out the store expansion.  That is $6,200,000 more than what is set out in the lease agreement.  Mr. Nishi-Beckingham was unable to explain the discrepancy and why the lease stated something different.  Again, Mr. Whibbs did not attend the hearing to speak to any discrepancies.

[30] Mr. Nishi-Beckingham did not have a thorough knowledge of the twenty lease comparables he submitted and could not say what the non specified tenant inducements were spent on, in any of his examples.  He indicated this is confidential information to Sears and they will not expand on it or provide specifics.  He could only say inducements were used for non realty items that were not assessable, unless the lease specified the item or work involved.

[31] Sears published a press release on February 16, 2005 indicating they were treating these cash incentives as allowances on their balance sheet as a deferred credit and amortized as a reduction of rent expense over the term of the related lease.  This announcement was made to clarify Sears’ accounting practices and does not prove that tenant inducements should be adjusted for.  Rather, declarations relating to actual lease examples on whether the inducement was spent on realty items or non-realty items, or direct evidence from Sears on how specific cash allowances were spent would have been more helpful. 

[32] We have little reliable or supporting evidence to support Mr. Nishi-Beckingham’s statement that cash allowances or tenant inducements are used by Sears to purchase non-realty items, such as inventory.

[33] Mr. Kingston did not adjust for tenant inducements as the lease documents stated these represent the tenant’s contribution to get the store completed to a Sears’ quality of finish.  He says tenant improvements can influence contract rents or they may be built into asking rents as a tenant improvement allowance.  He gave the example that when capital expenditures are not accounted for in the asking rent and are made by the lessor (owner), reimbursement may be accomplished through a marginally higher rent that amortizes those expenditures over all or part of the lease period.  If the lessee (tenant) makes capital expenditures, the lessor may reduce the lessee’s rent for all or part of the lease term as compensation for those tenant expenditures.  In many retail environments, rents vary directly with the level of build-out provided to the tenant. 

[34] As these expenditures form part of the capital improvements made to the real estate, the Assessor says that value is being added and should be considered the tenant’s contribution, above that of the landlord, to finish the store when arriving at a market rental rate for the property.

[35] Sears submitted a cursory analysis during cross-examination of Mr. Kingston based on leases selected by Mr. Kingston where those with cash allowances had face rents averaging $4.87 while those without allowances averaged $3.11 as support for the proposition that cash is used for non-real estate purposes.  However, this analysis is not based on the specific lease terms nor is there evidence to support what the cash allowances were specifically used for in each instance.  There is no consideration given in this analysis on other factors that might impact the rental rate, such as term of the lease or location. 

[36] As stated by the B.C. Supreme Court in London Life Insurance Co. v. Assessor of Area #09 (S.C.389), an allowance for tenant inducements in the calculation of economic rent can be made when the evidence supports such an allowance.  Unfortunately, Sears has not provided that evidence.  Although Mr. Nishi-Beckingham concluded such a deduction should be made based on what he says the tenant allowances are used by Sears (i.e. for non-realty items), he provided no supporting evidence for this conclusion.  Sears did not provide any evidence, documentary or otherwise, to show specifically what they used the tenant allowances for in each of their leased stores.  Little or no reliable evidence was provided from Sears directly as to how they negotiate their leases and how they factor in tenant allowances in negotiating rents with a landlord.

[37] Rather, a review of the lease documents themselves show that at least some of the cash allowances were paid for installing real estate fixtures or leasehold improvements.  In some situations, like Deerfoot in Calgary, the inducement was for specific purposes and used for realty items such as signs or access doors.  In response, Mr. Nishi-Beckingham submitted these hold little or no value in the marketplace to a competitor and represents only value to the owner, while the Assessor says these items are part of the going concern aspect of running a department store.  Neither party provided any evidence to support what depreciation if any should be applied to the leasehold improvements. 

[38] As stated by the B.C. Supreme Court in Discovery Parks Inc. v. Assessor of Area #10 (2006 S.C. 504), the difference in value between turn-key rental space (fully improved) and shell rental space represents the tenants’ interest in the lease space, but both the tenant’s and owner’s interest must be valued.  Here the evidence is that the majority of the comparables contained some sort of cash allowances for tenant improvements.  There are several examples of takeovers from previous tenants given where some if not all of the old tenant improvements were not discarded and replaced but utilized in the scheme of the new store (Sears Aberdeen, Sears Pine Centre, Sears Timmins, Sears Festival Market Place, Sears Eastgate and The Bay Lougheed).  Therefore, there is insufficient evidence to support the conclusion that tenant improvements have no value to anyone else but Sears.

Adjustment for Common Area Maintenance Cost (CAM)

[39] CAM costs are an expense to the tenant over and above the base, face or contract rent payable to the landlord.  It is the tenant’s contribution towards the repair and maintenance of the common area within the shopping centre.  The CAM amount can vary and to deal with this situation both experts agree an adjustment would be appropriate to equate a CAM that is above or below what is standard in the marketplace.  Both parties agree to an adjustment for CAM charges.  The CAM adjustment was found by Mr. Nishi-Beckingham to be $1.00 SF and by Mr. Kingston to be $1.05.  This is quite a close range, however, the amount determined by the Assessor was based on a Lower Mainland analysis and we give it more weight than the evidence provided by Sears.

SUMMARY

[40] Overall, and despite difficulties with both parties’ evidence, we prefer the evidence of Mr. Kingston over Mr. Nishi-Beckingham.  We accept the best lease comparables are those analyzed in the Lower Mainland.  Mr. Kingston concluded The Bay Lougheed lease at $5.34 per square foot is the best comparable to the subject in terms of location, store size, design and layout but the interior finish of The Bay is slightly superior.  Sears Brentwood is at $4.48 per square foot and Sears Guildford is $6.02 square foot.  The median of the three is $5.28 per square foot.  This rate supports the rental rate of $5.00 per square foot applied in the assessment.

CONCLUSION

[41] We find the market rental rate for the 2009 assessment of the Sears space is $5.00 per square feet.  As this is the only issue in the appeal, the Board confirms the 2009 assessment as follows:

Roll No. 10-43-305-32599-000: