In an intriguing case of urban real estate and taxation, the City of San Francisco embarked on a unique strategy to fund a new construction project. It owned two office buildings on Mission Street, which it put up for sale without a listed price but with a condition: the buyer must lease the buildings back to the City for up to five years, initially at below-market rates and then at market rates for two additional years.
290 Division (EAT) LLC stepped forward with a $52 million offer, which the City accepted. Notably, 290 Division's loan appraisal valued the property at the same amount, taking into account the leaseback arrangement. Conversely, the City's appraisal came in higher at $61,850,000, excluding the leaseback.
After finalizing the sale and lease agreement in May 2017, the City assessed the property for tax purposes at $68 million. 290 Division challenged this, arguing that the assessor didn't factor in the leaseback as a restrictive element on the property's value. The City countered, stating that the leaseback wasn't a legally enforceable restriction since it was negotiated in the City's proprietary, not regulatory, capacity. Generally, market rent, not contract rent, is used in property tax calculations when private parties engage in below-market leases.
The legal debate centered on whether such privately set restrictions should influence a property's assessed market value. The parties agreed that if the statute considering enforceable restrictions applied, the property's value would be $52 million; if not, it would be $63.1 million. Thus, 290 Division benefited from an $11 million discount due to the leaseback agreement.
The Assessment Appeals Board sided with the City, valuing the property at $63.1 million. 290 Division took the matter to the Superior Court, which rejected their argument, ruling that the lease wasn't an enforceable restriction as it lacked a governmental or regulatory aspect. The case escalated to the court of appeal.
The appellate court scrutinized the statute's language and intent. In California, property taxation is based on fair market value without encumbrances. The law does allow for exceptions, considering the impact of "enforceable restrictions" on land use. However, these typically encompass governmental constraints aimed at serving public interests, such as zoning or environmental regulations.
290 Division argued that the City's lower rent served public interests, allowing municipal operations to continue while funding new construction. Yet, the court determined that this didn't exemplify the City exercising its regulatory powers, as the benefits primarily accrued to the City rather than the public at large. Consequently, the court upheld the superior court's decision in favor of the City, affirming the higher property value assessment. This case, 290 Division (EAT) LLC v. City and County of San Francisco, became a notable example of the complexities surrounding property taxation, government contracts, and urban redevelopment.
Source: Appraisal Journal, Benjamin A Blair, Michal Mohelsky
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