Through the Looking-Glass: Debunking the 'Dark Store' Idiom.

Author:Lennhoff, David C.


This article addresses some of the misunderstanding and mischaracterization around fundamental appraisal terms and methodology, such as fee simple, market value, and highest and best use. In the context of big-box assignments, the discussion explains the label "dark store theory," and unravels its many fallacies and misrepresentations. Using proper and long-standing appraisal interpretations of fundamental terms, the article explains how standard methodology, properly applied, correctly answers the appraisal questions in big-box assignments. The intention is not to disparage ideas or methods, but to unveil the reasons for some of the differences abundant in the current-day appraisal arena.


Lewis Carroll's Through the Looking-Glass is a novel that presents an alternate version of reality. To a certain extent, the perceptions of reality in the purported "dark store theory" are equally fantastical and controversial. The controversy over these perceptions involves both appraisers and assessors, and concerns the relationship of property rights to market value. This controversy has overflowed into tax courts around the country, where the confusion centers on the methodology for estimating market value of real estate occupied by a first-generation tenant. One side of the controversy seems to argue that this particular property type is a special condition, and therefore it should be valued differently than all others. The other side argues that no special condition exists, and the valuation of such a property should adhere to conventional appraisal methodology.

The controversy was again brought to the forefront by a 2018 article in The Appraisal Journal, "Highest and Best Use and Property Rights--Does It Make a Difference?," by Fanning, Wright, and Muenks, which addressed both sides of the debate on valuation of first-generation, build-to-suit properties. (1) Based upon the content of that article and other literature on the topic, however, it is clear there is a general misunderstanding of fundamental appraisal concepts--such as market analysis, highest and best use, and market value--as they apply to build-to-suit properties. The present article will address these issues, then distill them to one fundamental question: Are build-to-suit properties with first-generation occupants so unusual as to require a special valuation methodology?

Property Rights Characteristics and the Valuation Challenge

Market value presumes a transfer of ownership. It is generally recognized that market value is the most probable price that a property should bring with consummation of a sale and the passing of title from seller to buyer. (2) The key characteristic in this context is not the "most probable price" but that title would transfer "from seller to buyer." This is important because there can be no determination of market value without the presumption of there being a second party--an independent buyer. The buyer can purchase either the fee simple or leased fee interest in real estate; consequently, the rights associated with the valuation of a build-to-suit property can be either fee simple or leased fee, depending on the purpose of the appraisal. (3) In the case of a build-to-suit property, the appraisal's purpose will depend on the specific scenario, as noted below.

Scenario One. If the purpose of the appraisal assignment is to estimate the market value of the fee simple interest, and the property is occupied by the build-to-suit owner/occupant, the assignment is straightforward. The valuation is only complicated if the highest and best use conclusion is that the most likely purchaser is an investor--in which case any loss of value due to the risk associated with a lease-up period (as well as tenant quality risk) must be taken into consideration.

Scenario Two. If an estimate of the market value of the fee simple interest is the question, and the property is occupied by the build-to-suit tenant with ownership held by a third party (that is, the owner/occupant of the property sold it to an investor while simultaneously leasing the property back from the investor), the property is nonetheless valued as if available to be leased and as if the occupancy can be delivered with title. As with the first scenario, the valuation is only complicated if the highest and best use conclusion is that the most likely purchaser is an investor--in which case the risk of a loss of value due to vacancy must be taken into consideration.

Scenario Three. If the market value of the leased fee is the question, and the property is occupied by the build-to-suit tenant, the assignment is also straightforward: the property is valued based on the existing lease for the occupied space and market rent for any vacant space, recognizing any possible costs or risk associated with getting the vacant space leased. Caution must be taken, however, to recognize that market rent may be well below or above the contract rent, with enhanced or diminished risk involved. (4)

If the above scenarios seem elementary, that is because they are. There is nothing peculiar about the valuation of a build-to-suit property that cannot be handled by traditional appraisal methodology. The confusion arises when the first-generation build-to-suit sales and leases are treated as arm's-length market transactions for determination of the market value of a fee simple interest. Recognizing that these leases and sales do not meet the definitional criteria of either market rent or market value of the fee simple interest dispels much of the confusion. (5) Understanding the prevalent valuation fallacies presented in the literature should resolve the controversy.

Similar to the discussion in the Fanning, Wright, and Muenks article, the discussion here will rely on a build-to-suit big-box retail store to illustrate the valuation controversy. (6) The discussion will begin with an explanation of "dark store theory" and the valuation mischaracterizations that accompany it, then explain the rules associated with application of market analysis and highest and best use that are critical to correctly developing a market value conclusion. The discussion also will clarify the differences between leased fee and fee simple, explain what constitutes a proper highest and best use conclusion, and illustrate how inappropriate incorporation of the business interest of the occupant of the real estate can result in a value in use or investment value conclusion rather than a market value conclusion.

Demystifying Fee Simple Big-Box Valuation: Dark Store Theory Misunderstandings and Mischaracterizations

"Dark store theory" reportedly arose within the past decade among some groups of assessors and appraisers, (7) who have promoted the theory in the media and legislatures without acknowledging that it is contrary to current, generally accepted appraisal practice. In fact, dark store approach proponents have mischaracterized and attempted to discredit accepted valuation methodology, which simply acknowledges that the hypothetical buyer in a fee simple transaction is entitled to occupy the property. In its simplest form, this principle applies to any valuation involving the market value of the fee interest, including a big-box retail store. Traditional appraisal theory recognizes that a second-generation user must be the purchaser of space formerly occupied by a first-generation user. However, a second-generation user does not necessarily indicate a secondary use nor does it necessarily result in a distress transaction. Importantly, the methodology must be evaluated in the context of all property types: office buildings, houses, warehouses, and apartments. In the case of houses in particular, the flaws in the dark store approach are clearly revealed.

Dark store theory starts from a mischaracterization of the proper methodology used to estimate the market value of the fee simple interest in big-box real estate. Well-recognized appraisal methodology in the body of knowledge answers the question, What is the market value of the fee simple interest in the subject real estate? As such, a proper answer to the question is based on the transfer of the property, available to be occupied by the hypothetical buyer or a new tenant. This is conceptually identical to how the market value of the fee interest in a house is developed (of course, there is no such thing as "dark house theory"). In the house analogy, the comparables used are sales of similar real estate to a new occupant, a second-generation user, (8) who is eligible to...

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