Plaintiff Missouri Baptist Children’s Home (MBCH) owns commercial property in St. Louis County that has been leased as a K-Mart store since 1967. In 1989 the county assessor informed MBCH that the property’s assessed valuation for that year would be $990,430.00, an increase of more than 100% over the previоus assessed value. An initial appeal to the St. Louis County Board of Equalization was denied. § 138.180, RSMo Supp.1992. Review was sought before the State Tax Commission of Missouri (Commission), which ordered the assessment increased to $1,000,000.00. § 138.430.1, RSMo. Supp.1992. 1 Review was then sought in the circuit court. Following denial of relief in the circuit court and an appeal to the Court of Appeals, Eastern District, this Court granted transfer.
Commercial property must be assessed at 32% of its “true value in money.” § 137.115.-5(1,), (⅞). 2 The preliminary issue is whether a below-market lease may be taken into consideratiоn in determining the “true value in money” of the subject property. A second issue in this case is whether the Commission’s analysis of the effect of the lease on the property’s value is “supported by competent and substantial evidence on the whole record.” Mo. Const, art. V, § 18.
FACTS
The MBCH property was leased to S.S. Kresge Company in 1967 and has been occupied as a K-Mart store since that time. The lease contains three five-year options following the initial twenty years. The lease was typical of those entered into in the late 1960’s. At the time the tax was assessed in 1989, K-Mart was in the middle of the first option period.
MBCH receives rentals of $166,500.00 annually, plus 1% of the gross sales exceeding $6,720,000.00. As landlord, MBCH is responsible for upkeep of the building, parking lot, maintenance and insurance, and payment of utilities and taxes, including real estate taxes.
The only evidence as to value was the testimony of MBCH’s expert, appraiser Tom McReynolds. Relying on three standard methods of valuing real property, 3 he estimated that the property’s fee value, unencumbered by the lease, was $3,125,000.00. His income capitalization analysis ascribed rental value to the property of approximately $3.50 per square foot, based on current market rentals. However, the actual rent under the lease nets only about $1.00 per square foot. Using that rental to calculate the capitalized rental income, McReynolds concluded that the value of the property to MBCH was $1,092,000.00. He calculated this value by adding capitalized actual rental income to MBCH’s reversionary interest in the property at the end of the lease period. His valuation assumed that the options would be renewed even though K-Mart was considering moving elsewhere. He testified that under present market conditions, the lease is highly favorable to K-Mart.
*512 Gary Collins, the manager for MBCH, testified that while MBCH was not actively marketing the property, it had received two offers to purchase the property. One was made on the assumption that the buyer would assume the lease and was for $2,050,-000.00. The other offer, for $2,200,000.00, was made on the assumption that the lease would be terminated. There was no evidence that MBCH made a counteroffer or entered into further negotiations with either potential purchaser. Collins also testified that there had been rumors that K-Mart might leave, but K-Mart had indicated no interest in terminating the lease. Subject to certain exceptions, the lease permits K-Mart to assign its lease or sublet the property to others without MBCH’s permission.
I.
The position of the Commission on appeal is different from that reflected in the order of the hearing officer, which the Commission adopted as its own. 4 It is the Commission’s contention now that the actual rental may not be considered a factor in determining value when relying on the income capitalization method of valuation. The hearing officer whose findings were adopted by the Commission relied in part on the incоme capitalization method to determine value. She concluded the K-Mart lease was a relevant factor to consider. The Commission now argues that such conclusion was mistaken.
True value in money is the price which the property would bring from a willing buyer when offered for sale by a willing seller. Thus, the true value is the fair market value of the property on the valuation date.
St. Joe Mineral Corp.
v.
State Tax Comm’n,
Although no Missouri case has specifically held what effect a below-market lease should have on an assessment, the subject property in
Stephen & Stephen Properties, Inc. v. State Tax Comm’n,
Although courts in other jurisdictions generally еquate fair market value on the date of assessment with the true value, the cases are not in accord as to whether a long-term sub-market lease may be factored into a determination of value under the income capitalization method. Those courts rejecting the actual rental as a factor in the income capitalization method of valuation base their decisions on two propositions. The first is that the potential income, not actual income, determines the highest and best use of the prоperty.
Swan Lake Moulding Co. v. Dept. of Revenue,
Other courts, while paying lip service to those propositions, have stopped short of saying that a below-market long-term lease may not be considered. For example, the Ohio Supreme Court held that the tax assessment board, faced with widely varying appraisals, could give more weight to the “economic rent” over “contract rent” in determining the true value in money of rental рroperty subject to a below-market long-term lease.
Wynwood Apts., Inc. v. Board of Revision of Cuyahoga County,
The more recent and better-reasoned approach is to authorize the assessing authority to utilize actual as well as potential income in determining true value.
Denver v. Board of Assessment Appeals,
By contrast, consideration of potential rent hypothesizes an unrealistic market. It assumes that properties now subject to long-term below-market leases are suddenly available to rent. That highly improbable situation would result in some marginally рrofitable tenants who benefit from such leases going out of business which, in turn, increases the number of commercial properties available for rent. Fundamental economic theory suggests that the greater the supply of rental property available and the lower the demand, rent necessarily will be lower than the current market rent. Wholly excluding below-market long-term leases from the equation assumes facts that do not and are unlikely ever to exist.
At the same time, projected actual income may be adjusted to rеflect current market conditions where actual rent substantially distorts the property’s true value. In fact, circumstances may exist where the income capitalization method is too vague or speculative to be a reliable measure of value.
C.A.F. Investment Co.,
Placing a value on real property is not an exact science. When relying on the income capitalization method to determine value, the factfinder necessarily has some discretion to decide what weight will bе given to actual rent, as opposed to potential market rent, in reaching its decision. Where the lease was prudent when entered into, the Commission is quite correct to consider actual rent as a factor in determining the value of the property under the income capitalization method.
The Commission argues that the uniformity clause of the Missouri Constitution prohibits an assessment based on a valuation which considers the effect of a below-market lease on the property.
Mo. Const, art. X, § 3.
In support of its argument the Commission cites
State ex rel. Cassilly v. Riney,
II.
We now turn to the Commission’s finding that the lease had no diminishing effect on the value of the property to determine whether that finding was supported by substantial and competent evidence.
The Commission accepted $3,125,000.00 as the value of the unencumbered fee, as testi- *514 fled to by McReynolds. The Commission also accepted that the rent paid under the lease was considerably below what the market would bring if the property was available for lease today. However, the Commission concluded that thе below-market lease had no diminishing effect on this value. The basis for this conclusion was that “there is no evidence [other than McReynolds’ opinion] that the lease will be renewed past a present option which has only a few years to run,” and, “there is no reasоn that the present lease cannot be terminated upon the sale of the property.” The Commission found fault with McReynolds’ assumption that K-Mart will continue to lease the property until all options expire.
McReynolds testified that the fair market rental value of the building was $3.50 per square foot and “prudent management would demand that [K-Mart] continue to renew this lease.” This was true whether K-Mart continued to do business at the site or not. Under this lease the tenant has the right to assign or sublet the premises. Thus, even if K-Mart would move its business to another location, it could legally sublet the property for as much as the market would bear, pay rentals of only $1.00 per square foot and pocket a profit. The real problem with the conclusion of the Commission is that it assumes that a business enterprise will freely surrender substantial economic benefits to which it is legally entitled. That conclusion is contrary to all logic. Thus, the Commission’s finding that the property’s value encumbered by the lease is the same as being unencumbered by the lease is not supported by substantial and competent evidence.
The judgment of the circuit court is reversed and the cause is remanded with directions that the circuit court remand the case to the Commission for a determination of the effect of the lease on the true value of the subject property based оn the realistic economic assumption that the lessee will not give up its valuable economic interest in exercising the option to renew the lease.
Notes
.This statute authorizes taxpayer appeals to the Commission. Correction of assessments is authorizеd if the value is “unlawful, unfair, improper, arbitrary or capricious.” Here there was no specific finding that the assessment fell into any of those categories. Nevertheless, the Commission increased the assessment.
. All references to statutes are to RSMo 1986 unless otherwise noted.
. The three methods are the cost method, income capitalization method and sales comparison method.
. It is debatable whether the Commission may attack the validity of its own conclusions of law on judicial appeal. That issue was not argued and is not decided.