Recent Court Decisions on Real Estate and Valuation: Valuation of possessory interest with intangible concession rights.

Author:Blair, Benjamin A.

In the 1990s, San Francisco International Airport (Airport) constructed a new international terminal. In connection with that project, it sought bids for the concession to sell duty-free and other retail merchandise at the new terminal. Details were included in a proposed master agreement, which described the "permitted use" as the display and retail sale of merchandise. Merchandise other than duty-free items would be sold on a nonexclusive basis, but the winning bidder's right to sell duty-free merchandise at the Airport would be exclusive.

DFS Group (DFS), which engaged in the business of duty-free sales at other airports, was the only qualifying bidder. It bid above asking rent, offering a minimum annual guarantee (MAG) of $26,100,000. The Airport and DFS executed a lease agreement, under which DFS would lease 29 retail facilities totaling 58,000 square feet, of which 25,000 square feet would provide duty-free merchandise. DFS agreed to pay monetary consideration structured as a MAG or, if higher, a percentage of its gross revenues.

The lease agreement was set to expire in 2010, but the parties extended the agreement. That extension triggered the County Assessor's reassessment of DFS's property interest at the airport. The Assessor valued DFS's possessory interest in the leased property using the income approach with the full amount of the MAG as the income stream in that analysis.

California statutes provide that intangible assets and rights are exempt from taxation, and the value of intangibles "shall not enhance or be reflected in the value of taxable property." However, taxable property may be valued by assuming the presence of intangibles necessary to put the taxable property to productive use. The California Supreme Court has instructed that these provisions are not mutually exclusive; even if an intangible asset is necessary to put taxable property to a productive use, that intangible asset nonetheless may not be directly taxed.

DFS challenged the assessment on the theory that the MAG compensated the Airport not only for DFS's use of the space, but also for its exclusive right to operate duty-free concessions there. DFS alleged that, by failing to deduct the fair market value of the exclusive right from its valuation, the Assessor's valuation violated California law.

At the county appeals board, DFS presented testimony from three witnesses: a DFS employee who explained that many airports have nonexclusive duty-free concessions; an...

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