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The business value of super-regional shopping centers and malls.

Standard Rule 1-2(e) of the Uniform Standards of Professional Appraisal Practice (USPAP) requires appraisers to "identify and consider any personal property, fixtures or intangible items that are not real property but are included in the appraisal."(1) Similarly, according to The Appraisal of Real Estate, ninth edition,

Going-concern value is the value created by a proven property operation; it is considered a separate entity to be valued with an established business. This value is distinct from the value of the real estate only. Going-concern value includes an intangible enhancement of the value of an operating business enterprise which is associated with the process of assembling the land, building, labor, equipment, and marketing operation. This process leads to an economically viable business that is expected to continue.(2)

An appraiser's obligation is clear. To the extent that business or going-concern value exists, it should be recognized as a value separate and distinct from the value of the real property with which it is associated. The obligation of an assessor is set by law. Many property tax jurisdictions exclude intangible value, business value, and fixtures from property tax assessment. It is therefore paramount that valuers of shopping centers and malls differentiate real property value from all other sources of value.


The position of shopping center business value advocates is also clear. They feel that too often appraised and assessed values have failed to differentiate between real property value and going-concern (i.e., business) value. Similarly, recent articles have explored the issue, providing a broad range of arguments to support the contention that shopping centers and malls are overvalued and overassessed.(3)

Arguments to support the presence of business values in malls and shopping centers have taken a variety of forms and have included the following points.

* Hotels and motels have been recognized in appraisal literature as having business or going-concern value.

* When the returns to land, labor, and capital are considered, the residual factor of production is not land but management or entrepreneurship.

* Mall tenants pay rent for more than real estate--rent includes a component for association with the business and trade name of the mall or center.

* Higher base and percentage rents upon lease renewal indicate business value.

* Lease premiums that result in rental payments above the market rental are a source of business value.

Jeffrey Fisher and William Kinnard note in "The Business Enterprise Value Component of Operating Properties" that lease premiums (i.e., payments above the market rent due to overage or lease renewals at an above market rate) are excess rentals that represent evidence of business value resulting from management expertise, arguing that "Proper management and marketing of the mall (center) results in a successful tenant mix and tenants with a successful business. The mall owner participates in the success of the tenants through overages from percentage rents and higher than market rents on lease renewals."(4) Presented as sources of business value to tenants that

show up in the market "rental" of nonanchor stores and in lease premiums are

* Management expertise

* A balanced tenant mix

* A well-functioning owners' association

* Advertising and promotion by the mall owner and department stores

* Image of mall

* The trade name associated with the department stores

* The trade names associated with national chains in the mall

* Operating agreements with department stores

* Contractual agreements with mall tenants

* Income from license agreements (e.g., push carts)

* Profit from provision of utilities to tenants

* Catalog sales by stores located in the mall(5)

To explore the hypothesis of renewal lease premiums, Fisher and George Lentz(6) systematically examine the difference between initial and renewal lease rates in "Business Value in Shopping Malls: An Empirical Test." The authors conclude that because lease renewals are for greater amounts than initial lease rates, lease renewals include a lease premium by which the mall owner captures some of the going-concern value created by the tenants' business, noting that "This results in an aggregate business value for the mall."(7)

The fact that there are differences between initial and renewal lease rates does not support the position that lease renewals represent premiums that indicate business value. It is just as likely that renewed leases for successful businesses represent the market rate and initial leases are offered at a discount to encourage new enterprises to locate in a particular mall. Regardless, two schools of thought are sharply divided on the issue of business value as part of the total value of a super-regional mall. Advocates of business value imply that any value over that indicated by the cost approach is attributable to entrepreneurship and business enterprise. According to the opposing school of thought, however, property rights and value are transferred through leases, easements, and operating agreements from space occupied by anchor tenants to space occupied by mall tenants.


Much of the confusion about the value of a super-regional shopping center arises when only a part of the total entity is valued without consideration of the complete project. A super-regional center must be viewed in its entirety to achieve an accurate valuation. This is because some parts of the property support or subsidize other parts to make the whole economically feasible. Therefore, both the mall and anchor areas must be evaluated even though they may be owned by different individuals, partnerships, or corporations.

It is generally agreed that a mall area has to subsidize the cost of anchor space, or the entire center becomes a financial impossibility for its developer.(8) The subsidy of the anchor tenant is necessary to ensure the success of all other tenants. As an example of this phenomenon, assume a new super-regional center is proposed by a developer, with the following key data:

* Anchor areas

1. 2/3 of total net rentable area

2. Total costs including improvements and land at $80 per square foot

3. Projected average retail sales at $120 per square foot

* Mall area

1. 1/3 of total net rentable area

2. Total costs including improvements and land at $150 per square foot

3. Projected average retail sales at $250 per square foot

The day that the anchor space opens for business it is worth about $50 per square foot based on comparable sales and capitalized net rents. On the other hand, it has cost the developer $80 per square foot to create this space. The remaining $30 per square foot has apparently disappeared. Obviously, the developer is not going to enter into such a proposition unless there is a way to recover this apparent loss elsewhere in the project. That other place has to be the mall space.

To justify the real estate investment in the anchor space, the mall space must therefore generate the following values.
Cost of mall space $150 per
Shortfall in anchor
space value, $30.00/
square foot x 2 (2/3
of total space) $ 60 per
Value of mall space, if
project is to be
feasible $210 per

Stated in another way, the mall area must generate sales and net rents that produce a minimum value of $210 per square foot to justify the investment and development of anchor space.

This transfer of value from the anchor space to the mall is generally held to be in the form of real property such as leases, easements, and operating agreements.(9) For example, an anchor occupant typically agrees to long-term operation and specific hours of operation regardless of future profitability, much to the benefit of the mall tenants.

Proponents of the business enterprise theory would argue that the $210-per-square-foot value does indeed exist for the mall area, but would also claim that real estate value could not exceed the actual costs of $150 per square foot. The difference of $60 per square foot is said to be business enterprise value. Business enterprise advocates would have you believe that the $60 per square foot that transfers to the mall from the anchors becomes business value in the process of this transfer. This claim is made in spite of the fact that the $60 per square foot originated in the anchor area in the form of bricks, mortar, and land. The business enterprise proponents are thus performing a kind of alchemy; instead of changing water into gold they are changing real estate assets into business enterprise value.


Just as the mall area must subsidize the anchor space, certain spaces within the mall will have to help subsidize other spaces within the same mall. This subsidy within the mall is necessary so that the proper tenant mix may be achieved. The classic illustration of this phenomenon is comparison of a barber shop with a cookie store that both occupy similar-sized spaces, with the former generating $12-per-square-foot net rent while the latter generates $40-per-square-foot net rent. As much as the mall owner would like to have all $40-per-square-foot net tenants, the owner realizes that a mixture of lower rent tenants is necessary to achieve a maximum benefit for all tenants. Therefore, it cannot be hypothesized that the $12-per-square-foot net rent represents market rent and a return to real estate only, while $40 per square foot less $12 per square foot, or $28 per square foot, represents a return to business enterprise in the form of a rental premium.

When two freestanding buildings have similar retail businesses, have identical base and percentage rents, and occupy space of similar construction and size with the same locational benefits, each is likely to have different gross sales per square foot. If it is assumed that the first store has gross sales of $175 per square foot and the second has sales of only $100 per square foot, each store will pay a different percentage rent and total rent. The value of the interest, benefits, and rights of ownership for each building will be different. The value for each parcel of real property will be different because the income to be received for each is different. This will be true regardless of common ownership or management.

Whether store buildings are separate freestanding units or are located in a shopping mall, all other things being equal when the combined benefits to be received, now or in the future, are identical, the value of the real property is identical. This is because the value of the real property is fundamentally a function of the present value of future base and percentage rents to be received over the term of the lease plus the value of the residual at lease termination.

The approach to individual or aggregate value for 100 independently owned, freestanding buildings is identical for a 100-store mall. The presence or absence of common development, ownership, or management does not change the fundamental requirements of valuation. Buildings or malls that house more successful tenants who pay higher total rents have higher real property values than those with less successful tenants and lower total rent.


Shopping mall business value enthusiasts argue that while assessed values are typically less than appraised values, both exceed the correct market value of the real property. The overvaluation results from the inclusion of business value as part of the value of the real property. The business value is theoretically created by the entrepreneurship of the mall developer and management.

An extension of the business value argument is to consider the effects of dismanagement or disentrepreneurship. If successful management adds business value, which is a return for entrepreneurship and should be excluded from the assessed or appraised value of the real property, then poor management that causes high vacancy and below-market rent should not reduce the assessed or appraised value of the real property.

To be consistent with business value theory, appraisers and assessors should ignore the effects of high vacancy and below-market rent to arrive at a correct market value. In other words, low levels of profitability for unsuccessful malls and shopping centers (or other real estate) would result in an addition to the assessed or appraised value to determine the correct fair market value.(10) The addition would be for dismanagement and disentrepreneurship. These concepts are illustrated in Figure 1.

To derive assessed or appraised values for unsuccessful malls that are different from the fair market values (i.e., probable sale prices) is absurd. Differences in income attributable to real property that arise from good or bad management cause differences in the value of the real property. If, however, the business value argument is valid, it is equally valid to recognize that disentrepreneurship creates a negative business value to be added to the traditional assessed or appraised value.


Income approach to value

Careful analysis of a shopping center's or mall's statement of income and expense is a prerequisite for successful valuation. Appraisers and assessors must properly recognize the full cost of management, exclude profit contributed by retail operations, and assign service profits to the proper entity. As the court states in State of Wisconsin, Ex Rel. N/S Associates, by JMB Group Trust IV v. Board of Review of the Village of Greendale et al, "The key is whether the (income) value is appended to the property, and is thus transferable with the property, or whether it is, in effect, independent of the property so that the (income) value either stays with the seller or dissipates upon sale."(11) (Emphasis added.)

Management profit

Some contend that it is management expertise that creates business value. There is no doubt that good management is essential for a shopping center or mall to succeed. The value of management, however, is not so unique that one fee management company cannot be substituted for another or that rental income should be allocated to other than the real property.

Typically, the cost of self-management (e.g., salaries, advertising, promotion) is lower than the management fee for an outside management company. The proper charge against rental income is the amount normally paid for outside, independent management services. The cost of all services provided through self-management should be eliminated and the normal cost of independent fee management services substituted. The failure to recognize the full cost of management as represented by outside, independent management fees will result in overstatement of net operating income (NOI). When NOI is overstated and capitalized, the resultant value is also overstated and includes the business value of management services.

Retail operations

Any part of a mall's total income that is derived from sources other than those attributable to the real property must also be determined. For example, mall owners in many instances are operators of retail outlets, food centers, or service centers. Income and expenses related to merchant or retail activities not normally associated with the ownership of real property should be segregated from statements of income and expense. The failure to do so causes the value of retail business to be included in the value of the real property.

Services profit

Revenue, expense, and therefore the profit derived from providing utility services, concessions, common area maintenance, or other services may or may not be part of the property gross income or revenue. If these profits normally accrue to the fee management company, they should be excluded when the NOI of a shopping center or mall is valued. In turn, if these profits are earned by a fee owner and the right to receive the profit is transferred with the title to the real estate, they are properly part of the gross income or revenue attributable to the real property, and hence contribute to its value.

As a matter of public policy regulators set electric rates. These rates are established to permit electric utilities to provide electricity to bulk purchasers (e.g., large office buildings, apartment complexes, malls, factories) at a cost lower than that charged to typical small business and residential users of electricity. The justification for lower electric rates is provided by lower distribution costs. In other words, bulk purchasers provide their own distribution (i.e., wiring) system for tenants as a mall or other facility is constructed. The utility thus does not have to incur the cost of obtaining easements for distribution lines or for the building and maintenance of poles, wires, and transformers necessary for the distribution of electricity to typical residential and business users.

In a paper presented at a meeting of the International Association of Assessing Officers, Kerry Vandell clearly states that "If the landlord essentially provides no conversion or distribution services for the utility (i.e., simply profits from the differential price without adding any economic value), then the 'profit' is properly assignable as a return on real estate. This is effectively a supplemental rent charged to tenants in a different form."(12) A mall's electrical distribution system is an integral part of the real estate. Mall owners provide no "value-added" service when they provide electrical service for tenants. There is no transformation of the product or service (e.g., electricity) that makes it possible to consider that electrical profits accrue to any business enterprise activity other than the rental of real property.

Cost approach to value

Two common errors are often associated with the cost approach to the value of a shopping center or mall. One is the issue of development profit, and the other is the cost of land.

Development profit

Whether the appraisal is for property tax assessment or lending purposes, an appropriate component of cost is developer's profit. Kinnard argues in "Valuing the Real Estate of Regional Shopping Centers Independently of Business Value Components: A Review of Recent Research" that "Entrepreneurial profit is properly a charge against anticipated future revenues, since it will be earned only if they materialize."(13) Distinctions between development profit and entrepreneurial (operator's) profit are spurious. Kenney explains in "Does Shopping Mall Development Create Business Value?" that "Shopping malls would never be developed without finalized and signed operating agreements with the anchors."(14)

The expectation and realization of development profit are necessary to attract capital and encourage the risks required to bring about initial construction or replacement. Without inclusion of development profit in the cost model, the resulting value represents wholesale cost. Business generally and shopping mall construction in particular are not undertaken with the expectation of recovering only cost. As is pointed out in The Appraisal of Real Estate, ninth edition, "If the cost approach is to provide a reliable indication of value, the appraiser must add to the direct and indirect costs a figure that represents the entrepreneurial or developer's profit that is reflected in the market."(15)


Similarly, the appropriate cost of land is not the original cost--nor is it necessarily the cost of nearby retail sites or other undeveloped sites with similar locational characteristics. Rather, the cost sought by appraisers is for the highest and best use of the site as if vacant with full knowledge of the uses to which it may be put. Full knowledge of locational benefits cannot be obtained until after a shopping center or mall is fully operational. Only with knowledge of the performance of tenants and total rents received can all the locational benefits be known.

Land for a shopping center or mall is initially acquired after extensive feasibility analysis. A feasibility study, however, cannot precisely forecast traffic patterns and locational advantages to reveal the full potential and ultimate value of a site. Land acquisition is completed when a site is priced at a discount to its full potential and forecasted retail value as indicated by the feasibility study. It should be remembered that the land would not be purchased if the price were greater than the potential value indicated in the feasibility study. Further, potential value is discounted for risk, uncertainty, and development profit to indicate acquisition value.

If the developer is correct, the original cost is less than the current value of the land with full knowledge of the location's potential. When a feasibility study overstates locational advantages, the original cost may be greater than the current fair market value. Although comparable sales may be used to indicate the value of land as if vacant, these purchases also represent a discounted wholesale value. When valuing land as if vacant for a developed and operational mall or center, the land residual technique(16) may be the best indication of current fair market value of the specific location with full knowledge of its uses and benefits.

Sales comparison approach to value

The sales of shopping centers and malls often include intangibles in addition to real property. Analysis and adjustment of the selling price must include elimination of intangibles, fixtures, and business value. A sale price will be overstated unless an appraiser carefully considers what has been paid for the fixtures that revert at the end of a lease, the value of the management team acquired, if any, and anything paid for retail operations independent of the business of renting space. These specific intangible items may be regarded as business value, but in aggregate they represent only a small portion of a shopping center's total value.

Selection of comparables

When valuing unique, super-regional shopping centers or malls it is important to recognize that comparable sales are unlikely to be found within the local metropolitan area. The number of regional centers and malls is limited and transactions are infrequent. Further, the market for the buying and selling of such properties is national in scope.

The sale prices of rental homes, duplexes, 12-unit apartments, and 1,000-unit apartment complexes are not directly comparable. Similarly, freestanding retail stores, local strip centers, or neighborhood shopping centers are not appropriate sources of sale comparables for regional centers and malls. When the market for property is national in scope sale comparables must be obtained from the national market in which such properties are bought and sold. The physical, locational, and income characteristics of sale comparables must, in fact, be comparable to a subject.


Leases often provide that fixtures will revert to an owner upon termination of the lease. Each lease and business must be examined to determine

* Length of the lease and any renewals

* Type and value of the fixtures

* Likely continuation of the tenant's business for the full term of the lease

With this information the present value of fixtures to revert to the fee owner may be calculated and deducted from the purchase price. As a practical matter, however, the value of fixtures is rarely considered by the marketplace.


Purchase of management-intensive shopping centers and malls may include the current management team. If so, a value must be assigned to the management company. The profit of management is the cost of normal outside management less operating expenses.

The resulting management profit may then be capitalized to indicate the value of management purchased as well as the amount to be deducted from the gross sale price. If, however, the acquisition included a contract for independent management services for a fee, no value should be allocated for purchase of a "mall management business."

Retail operations

The sale prices of some shopping centers and malls as well as including payment for the management team include the transfer of retail operations. A sale agreement must be reviewed to determine whether retail businesses were included in the purchase price. The value of any retail business must be deducted from the purchase price.


The standards of real estate appraisal require that identification and consideration of personal property, fixtures, intangibles, and business value be included in the appraisal. The complexity of shopping centers and malls thus necessitates careful analysis of the income, cost, and market approaches to value to ensure that business value is not inadvertently included as part of the value of real property. Common valuation errors and inclusion of business value may occur if the value of management and retail operations are not excluded when using the income or sales comparison approaches to value. The cost approach to value may result in value understatement if consideration is not given to development profit. Further, the land residual method is recommended to estimate the value of the land as if vacant with full knowledge of its locational advantages and disadvantages. Regardless of the values indicated by the use of the cost and sales comparison approaches, the final arbiter of value is income. On a scale between replacement cost and salvage value, fair market value is set by the value of both current and expected future income.

With regard to business value generally, systematic theoretical or research evidence is not available to support the concept. While argument abounds, whatever benefits arise from operating agreements, cross-easements, management expertise, and other alleged sources of business value are transferable with, and add to, the value of the real property.

George R. Karvel holds the Minnesota Chair in Real Estate at St. Cloud State University. He received DBA, MS, and BS degrees in accounting and finance from the University of Colorado. He has written articles for several real estate journals and has co-authored a book on real estate principles and practices.

Peter J. Patchin, MAI, is president of Peter J. Patchin and Associates, Inc., in Burnsville, Minnesota. Mr. Patchin is a graduate of Kansas State University and is affiliated with several professional associations. He has published articles in The Appraisal Journal as well as in other real estate-related journals.

1. The Appraisal Foundation, Uniform Standards of Professional Appraisal Practice (Washington, D.C.: The Appraisal Foundation, 1990), B-10.

2. American Inst. of Real Estate Appraisers, The Appraisal of Real Estate, 9th ed. (Chicago: American Inst. of Real Estate Appraisers, 1987), 22.

3. See, for example, Jeffrey D. Fisher and William N. Kinnard, "The Business Enterprise Value Component of Operating Properties," Journal of Property Tax Management, v. 2, no. 1 (1990); Jeffrey D. Fisher and George Lentz, "Business Value in Shopping Malls: An Empirical Test," Journal of Real Estate Research (Spring 1990): 167; and Howard Gelbtuch, "Shopping Centers are a Business Too," The Appraisal Journal (January 1989): 57-64.

4. Jeffrey D. Fisher and William N. Kinnard, "The Enterprise Value Component of Operating Properties: The Example of Shopping Malls," Proceedings of the International Association of Assessing Officers, Fort Worth, Texas, September 20, 1989, 225, 230-231.

5. Ibid., 225-226.

6. Fisher and Lentz, 167.

7. Ibid., 173.

8. Mark McElveen and Barry Diskin, "Valuation of Anchor Department Stores," Assessment Digest (September/October 1990): 16.

9. Mark T. Kenney, "Does Shopping Mall Development Create Business Value?", The Appraisal Journal (July 1991): 307, 311, 313.

10. See American Inst. of Real Estate Appraisers, The Dictionary of Real Estate Appraisal, 2d ed. (Chicago: American Inst. of Real Estate Appraisers, 1989), 192.

11. State of Wisconsin, Ex Rel. N/S Associates, by JMB Group Trust IV v. Board of Review of the Village of Greendale et al, Wisconsin Court of Appeals, District 1, July 23, 1991 (No. 90-2546), 17.

12. Kerry D. Vandell, "Business versus Real Estate Value in Shopping Mall Evaluation: A Critical Examination," Proceedings of the International Association of Assessing Officers, Phoenix, Arizona, October 20, 1991.

13. William N. Kinnard, "Valuing the Real Estate of Regional Shopping Centers Independently of Business Value Components: A Review of Recent Research," paper presented at American Institute of Real Estate Appraisers Annual Meeting, Chicago, Illinois, May 3, 1990, 16-17.

14. Kenney, 308.

15. The Appraisal of Real Estate, 9th ed., 359, 352-353, 358-360, 373.

16. Ibid., 69, 270, 291, 293, 306-307, 309, 479-480, and 486.
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Author:Karvel, George R.; Patchin, Peter J.
Publication:Appraisal Journal
Date:Oct 1, 1992
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