C-Store Valuations
Litigation Issues

 

TRPs: Intangible Assets as a Compensable Damage

 

Trade-Related Property is a classification of commercial, income-producing real estate that is different from other types of income property.  The real estate of Trade-Related Property (TRP) is designed to generate income and profit from a single, business-related use. We have all seen examples, such as convenience stores, gas stations, car washes, movie theaters, and bowling alleys.  TRPs are distinct from other income-producing property where their profit is part of the rental income from the real estate. Non-TRPs include apartments, shopping centers and office buildings.  With these, no business-related profit is generated for the property owner.

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Nichols summarizes that the spirit of condemnation law is to “make the property owner whole”.  After all, the property owner is being obliged to sell, often against his desire.  Our condemnation laws do not distinguish between TRPs and non-TRPs.  Yet, they should.  The fairness of the compensation to the TRP property owner is significantly different.

 

For all TRPs, the motivation and reason for owning the real estate is the profit, or business income that is earned over and above the economic requirements of the real estate.  In other words, all operating TRPs earn more than the real estate is worth.  If they didn’t, no one would own them.  Using a convenience store as an illustration, the average pre-tax profit today is about $47,000 per year.  This is the reason the convenience store operator purchases or builds the real estate: to earn this $47,000 per year of business profit that is over and above the investment requirement in the real estate.  The real estate is simply a means to this end.  A trained workforce, negotiated supplier contracts, in-place management, and assumption of risk are some of the elements that produce this profit.

 

Courts across the nation have ruled that business profit is not compensable, reasoning that the property owner has the ability to transfer the business to another location and continue to receive profits. So, the courts limit damages exclusively to the real estate.  For TRPs, important elements are missing from this line of reasoning.

 

In a condemnation taking, the TRP owner has one of two relocation alternatives.  He can purchase an existing property or build.  Continuing with a convenience store as an example, in the first instance all sellers of operating stores demand something for their on-going business, over and above the price of the real estate.  After all, they have an in-place, operating business that required effort to create.  They are not going to give up the business portion without adequate compensation.  In acquiring a substitute store, the convenience store condemnee could theoretically use the damage award for the condemned real estate to buy an exact duplicate store. But, to do this he must also pay the required additional price for the on-going business relinquished by the seller. 

 

The existence of this additional price premium can be proven by simply interviewing buyers and sellers, or by looking at public data bases.  BizComps® is one of the nation’s largest publishers of business sale transactions.  Of over 200 convenience store sales, the average value of the intangible asset component is $270,600, or about 5.7 times the pre-tax profit noted above.  This is the reported part of the sale price that was over and above the real estate and equipment when an existing store passed from seller to buyer.

 

If the condemnee is not awarded for lost intangible assets, then this price premium becomes an out-of-pocket cost to relocate to an existing store.

 

In the second instance of acquiring a substitute property, building a new convenience store requires from 12 to 24 months and during this construction period no business profit can be earned.

 

So, when a convenience store or any other TRP is condemned and the damage award is limited to the market value of the real estate, the property owner has not been made whole.  The TRP owner will either pay a price premium for an existing substitute store or do without business profit during the construction interim of a new store.

 

For TRPs, lost business profit should be considered a legitimate element of relocation expenses and awarded as compensable damages.

 

For condemnation attorneys wishing to pursue lost business income as a compensable damage for your client, please contact us.

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Texas Supreme Court Ruling in the Clear Channel Case

 

In the Spring, 2015, the Texas Supreme Court ruled on the earnings-based income approach in the Clear Channel billboard case.  Significantly, the Court held that “…[while] business income should be reflected in the valuation of the land at its highest and best use, the loss of the business is not compensable.”

 

From a valuation standpoint, in presenting the earnings-based income approach, Clear Channel’s appraiser made several mistakes:

 

(a) Business profit was never separated and excluded from the analysis.  So, the capitalized value conclusion included the intangible portion of Clear Channel’s business.

 

(b)  Market rent and market operating expenses were not developed.  Therefore, the fee simple market value was not appraised.

 

(c)  The development of the capitalization rate was based on sale data that may have included non-real estate items.  This was not clarified in the appraisal report and the Court addressed this issue on Page 15 of their ruling.

 

First, as an eminent domain attorney you should be aware that this decision by the Texas Supreme Court did not reject or prohibit the earnings-based income approach as evidence of market value.  Rather, the Court held the view consistent with previous rulings that business income where profit is included cannot be capitalized to reflect just compensation.

 

Second, the Court expressed the opinion that a relationship exists between good locations and higher business income, stating that “…[higher] business income should be reflected in the value of the land…”.  For eminent domain attorneys, this is an important conceptual breakthrough because for the first time this statement articulates the truth that good locations inherently generate higher business earnings. 

You can download a copy of the Texas Supreme Court decision by clicking the link below.

 

Click Here to Download File