January 16, 2002
Appeal of
MEIYAN ENTERPRISES, INC.
LEASE AGREEMENT
PSBCA No. 4566
APPEARANCE FOR APPELLANT:
Karen Y. Uchiyama, Esq.
APPEARANCE FOR RESPONDENT:
Robert E. O'Connell, Esq.
OPINION OF THE BOARD
Appellant, Meiyan Enterprises, Inc., leased the Los Altos, California Post Office to Respondent, United States Postal Service.[1] An option to extend the term of the lease called for the rent to be increased based on the then-prevailing fair market rent. Respondent exercised the option, but the parties disagreed about the appropriate rent for the option period. The contracting officer denied the rental rate claimed by Appellant, and Appellant appealed. A hearing was held, and the parties have submitted briefs in support of their positions.
Entitlement and quantum are at issue (Transcript of Hearing, Page (“Tr.”) 9).
1. On March 7, 1990, Appellant leased to Respondent premises located at 100 First Street, Los Altos, California for use by Respondent as the Los Altos Post Office (Appeal File, Tab (“AF”) 1; Appellant’s Exhibit (“AX”) 1; Stipulation of Facts (“Stip.”) 1).
2. The term of the lease was from February 1, 1990, through January 31, 2000, at an annual rent of $288,984. The lease provided Respondent an option to renew for an additional ten years commencing February 1, 2000. The rent for the renewal period was to be determined according to the following lease provision:
“At the end of the tenth (10th) lease year, when the United States Postal Service (“Postal Service”) is to exercise the [ ] option to renew the Lease, the base monthly minimum rent will be increased to either the then-prevailing fair market value or one hundred twenty-five percent (125%) of the most recent base minimum rent charged for the last lease year, whichever is higher.
Added Notation: Fair market rent/value shall be based upon the existing use, not highest-and-best use, and shall not take into account any tenant improvements or tenant fixtures.” (AF 1 (p. 14 of 18); Stip. 2, 3).
3. The post office is a one-story, concrete block building consisting of approximately 12,041 square feet of net interior space. About 10% of the interior space is office, 75% is an open workroom area for mail processing and 15% is customer and box lobby. Two-thirds of the length of the north end of the building is taken up with a 74-foot long, covered loading platform of over 1,300 square feet with direct access to the mail-processing workroom. A paved parking and maneuvering area is located at the north end of the building, and a paved, customer parking lot is at the south end of the building. The rear of the building abuts but does not have access to an expressway. The building has a windowed, storefront entrance facing First Street, but no windows on the sides or back. (Tr. 173; AF 1, 2 (pp. 19-20), 6 (pp. 5-6)).
4. Los Altos is an upscale community of high value residences—median home values of $800,000 to $900,000—in the Silicon Valley area of the San Francisco peninsula. The city is about 85% residential and 15% small office buildings and small retail store complexes and boutiques. The post office is in the downtown area of Los Altos, which is an area of smaller buildings, small shops, boutiques, service businesses, offices and some financial institutions. Parking is at a premium in downtown Los Altos, and the parking available at the post office far exceeds that available at any of the other buildings in the downtown area. (Tr. 30-33, 139, 172-173, 225; AF 2, 6).
5. In 1998, Respondent decided that it would exercise the renewal option, and it engaged an appraiser, Neil Bardsley, to determine the fair market rental of the post office. Mr. Bardsley chose to estimate the rental value of the post office by a market approach in which he evaluated rentals of similar buildings in the area (“comparables”) as a means to determine the fair market rent of the post office. (AF 2; Stip. 4).
6. In addition to its use as a post office, the building would have been reasonably suitable for a retail user requiring a freestanding, larger building with ample parking for customers, generally referred to as a “retail box” type of store. Such uses require square footage in the range of 5,000 or 6,000 to 15,000 or 20,000 square feet. (Tr. 167, 245, 251, 273, 298-299). It would also have been suitable for a research and development tenant or a manufacturing/assembly use with its minimal office space, large open workroom area and loading platform. (Tr. 66, 111, 167-168; AF 6 (p. 4, 7)). The building is not suitable for office use, having few windows and a concrete block construction that would make adding windows infeasible (Tr. 273-278).
7. As there were no rental buildings in Los Altos comparable in size and use to the post office (Tr. 139, 153, 252; AF 2 (p. 20), 6 (p. 7)), Mr. Bardsley looked beyond the limits of Los Altos to find his comparables.[2] (Tr. 70; AF 2 (p. 20); AX 11). He selected the following as comparable leases:
|
Comparable |
1 |
2 |
3 |
4 |
5 |
|
|
Tenant |
Pier One Imports |
Hollywood Video |
Blockbuster Video |
Gymboree |
Sleep Train |
|
|
Square Footage |
9,000 |
11,956 |
6,435 |
5,600 |
6,000 |
|
|
Date of Lease |
1991 |
1995 |
1995 |
1998 |
1991 |
|
The Gymboree facility was a large space in a retail mall, but the other four comparables were ten-year leases of large, freestanding buildings surrounded by ample parking. (Tr. 167, 174, 211, 214, 226-228; AF 2). All five were reasonably similar to the post office in size and potential use (Tr. 251-252).
8. In arriving at his estimate of the fair market rental value of the post office, Mr. Bardsley made percentage adjustments to the rents of the comparable properties before using them to establish a fair market rent for the post office (Tr. 171). These adjustments were made to reflect differences in certain characteristics between the post office and the comparables. For example, to reach the rent figure he used for the Pier One Imports building, he adjusted the Pier One rent upward because he judged the post office to be in a better location (a 5% upward adjustment of the Pier One rent) and to have better parking (10%). In other words, he estimated that if the Pier One location and parking were as good as the post office’s, the Pier One rent would have been 15% higher. He adjusted the Pier One rent down (-5%) because the building was smaller than the post office, and he considered its rent per square foot would have been lower had it been as large as the post office because smaller buildings generally rent for more per square foot than larger buildings. (Tr. 44, 91-92, 128, 167). He adjusted the Pier One rent down another 5% because it had a better exposure to the street than the post office (Tr. 171-172). Similar adjustments, based on Mr. Bardsley’s experience and expertise, were made to all of the comparables and reflected his judgment as to the value of the differences between the comparables and the post office (Tr. 94, 172-173). He then added/subtracted the adjustments for each building to reach a total adjustment for each of the comparables (5% upward in the case of the Pier One Imports rental) and applied the total adjustment to that comparable’s rent to determine the adjusted rent. He then weighted the comparables, giving greater weight in his calculations to the Pier One and Sleep Train comparables because he judged them to be more like the post office than the others (Tr. 78-79, 174). Mr. Bardsley determined that the fair market rental value of the post office as of September 25, 1998, was $25.68 per square foot or $310,005 annually.[3] (Tr. 171; AF 2 (p. 37); Stip. 4).
9. In his evaluation, Mr. Bardsley considered the Pier One, Hollywood Video and Sleep Train comparables to be inferior locations to the post office and adjusted their rents up by 5% for use in estimating the fair market rent of the post office. However, each of those comparables was on a street with higher traffic volume than the street in front of the post office and was better suited for the retail box type business than was the post office location in Los Altos. As testified by Kurt L. Reitman, an appraiser called by Respondent as an expert witness at the hearing, the rents for each of those buildings should have been adjusted downward by 10% to account for this difference. (Tr. 121, 253-256).
10. The market for commercial real estate rentals was flat or had declined in Los Altos and vicinity during the first years of the 1990s. However in about 1996 rents for commercial properties in the area of the post office’s Silicon Valley location began rising (Tr. 99, 116-119, 154-155, 244, 271), increasing 6% in 1997, 10% in 1998, 10% in 1999, and 12% in 2000. (Tr. 38, 66-67, 243, 245, 272; AF 6 (p.8); AX 8 (p. 2); Respondent’s Exhibit (“RX”) 3). Mr. Bardsley made no adjustment to the comparable rental rates to take into account the fact that rental rates had begun to increase in 1997, well after the leases on four of his comparables had been entered into (Tr. 169-170). Adjustments for the age of the comparable rentals are commonly done to account for changes in market conditions over time (Tr. 36, 61-64, 114-115, 118-119, 121, 243, 252).
11. Mr. Bardsley was not asked to project rental rates forward to the effective date of the renewal, February 1, 2000, and he was not asked to update his appraisal at a later date. To adjust his rentals forward based on the rising rental market of 1997 through 2000, Mr. Reitman adjusted Mr. Bardsley’s figures for those leases entered into before 1996, Pier One, Hollywood Video, Blockbuster Video and Sleep Train, upward by 27% to account for market rental increases (market conditions) over the period 1997 through February 1, 2000.[4] He adjusted the Gymboree lease upward by 15.17% from the lease date in September 1998 to February 1, 2000, to account for market conditions. (Tr. 61, 66, 243-244; RX 3).
12. With the adjustments corrected as above (Findings 9, 10 and 11), Mr. Bardsley’s rental evaluation would be as set forth below:
|
Rentals |
(1) Pier One Imports |
(2) Hollywood Video |
(3) Blockbuster Video |
(4) Gymboree |
(5) Sleep Train |
|
Base Rent |
$24.00 |
$21.95[5] |
$21.69 |
$25.54 |
$25.20 |
|
Market Conditions |
27.00% |
27.00% |
27.00% |
15.17% |
27.00% |
|
Location |
-10.00% |
-10.00% |
0.00% |
0.00% |
-10.00% |
|
Exposure |
-5.00% |
10.00% |
10.00% |
0.00% |
0.00% |
|
Size |
-5.00% |
0.00% |
-5.00% |
-5.00% |
-5.00% |
|
Freestanding |
0.00% |
0.00% |
0.00% |
15.00% |
0.00% |
|
Parking |
10.00% |
0.00% |
15.00% |
0.00% |
0.00% |
|
Total Adj. |
17.00% |
27.00% |
47.00% |
25.17% |
12.00% |
|
Rent |
$28.08 |
$27.88 |
$31.88 |
$31.97 |
$28.22 |
|
Weight |
30.00% |
15.00% |
15.00% |
15.00% |
25.00% |
|
Value |
$8.42 |
$4.18 |
$4.78 |
$4.80 |
$7.06 |
The total weighted rental value, therefore, applying Mr. Bardsley’s weighting factors, is $29.24 per square foot annually or an annual rent of $352,078.84.[6]
13. Respondent exercised the renewal option on October 16, 1998. The contracting officer established the annual rent for the option period at $361,230 ($30 per square foot annually), which was 125% of the last year’s rent of $288,984, because Mr. Bardsley’s appraisal established a market rental below that figure (Finding 8). (AF 3, 5; Stip. 5).
14. Appellant disagreed with the rent established by the contracting officer and hired its own appraiser (AF 4; Stip. 6). Appellant’s appraiser, Hulberg & Associates, Inc., also determined a market rental for the post office by considering the rentals for other buildings in the area (Tr. 33). Hulberg & Associates chose as comparables eight buildings in Los Altos or nearby that had been recently leased or listed for lease. After making adjustments using a process similar to that used by Mr. Bardsley, but based on Hulberg & Associates’ experience, analysis and judgment (Tr. 36, 40-42, 62, 94, 121; AF 13; AX 11), Appellant’s appraiser estimated the annual rental for the post office as of January 17, 2000, to be $505,722 ($42 per square foot). (Tr. 55; AF 6; Stip. 8).
15. Hulberg & Associates comparable 1 was a freestanding, one-story office building with parking, leased to Charles Schwab Company (Tr. 41-42; RX 3). Comparables 2-4 had no onsite parking, and comparables 3 (a Mail Boxes, Etc. store) and 4 were space in larger retail buildings having other tenants. Comparable 5 was space in a multi-tenanted, two-story, 11,000 square foot office building across the street from the post office (Tr. 95, 262). Comparable 6 was a two-story office building, formerly leased to an American Savings branch (Tr. 265; AF 6 (p. 8)). Comparable 7 was a Postal Service non-retail, carrier annex in an industrial area some distance from the post office (Tr. 125-126; AF 6 (p. 8)), but the other comparables were very near the post office. Comparable 8 was a freestanding, Comfort Technologies Ergonomic Furniture store, and, although smaller than the post office, was the only comparable in the Hulberg & Associates appraisal that was sufficiently similar in size and character to the post office that it would be of interest to a potential tenant of the post office building (Tr. 177, 217, 263-264).[7] Comparable 3 was for a ten-year term; the remainder of the comparables had terms of five years or less. The size of each space and lease date follow:
|
Comp. |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
|
Square Feet |
3,125 |
4,350 |
1,700 |
900 |
3,000 |
12,646 |
14,891 |
5,978 |
|
Date of Lease |
12/99 |
Listing |
1/99 |
Listing |
5/99 |
12/99 |
11/97 |
1/98 |
(Tr. 70, 71, 98, 177-179, 262-266; AF 13; AX 11; RX 3).
16. The parties met and exchanged information about their positions, but by final decision dated May 18, 2000, the contracting officer denied Appellant’s claim that rent be paid at the rate of $505,722 per year and confirmed that rent for the ten-year option period would be at the rate of $361,230 per year, 125% of the most recent base minimum rent under the lease. (AF 7, 8, 9, 11, 12, 13, 15; Stip. 9).
17. Appellant filed a timely appeal (AF 16; Stip. 10).
18. The most important factors in comparing commercial properties in an appraisal are their physical characteristics, and the most important characteristic is the size of the building (Tr. 285-290). The rent that a smaller space commands is generally higher on a square foot basis than for a larger space (Tr. 44, 91-92, 128, 167, 216, 218, 258-260, 269). Therefore, the rent for a significantly smaller space is of little use in determining the rental value of the post office because the adjustments necessary to attempt to equate the buildings become too dramatic and subjective to be reliable (Tr. 167-8, 180, 212-213, 269, 298-300). Additionally, tenants interested in space comparable to the post office would not also be looking at much smaller spaces in retail strip malls (Tr. 217, 251). Nor would tenants interested in the post office consider renting office space, which typically rents for more per square foot than retail and which is not comparable in use to the post office building (Tr. 153, 263, 273). Other significant physical characteristics include parking, freestanding building and age of building (Tr. 30-33, 111, 290).
19. The physical proximity of a building to be compared with the subject for purposes of establishing value is also very important, but adjustments to account for different locations can be made when buildings with similar characteristics are not found near the subject (Tr. 30, 111, 252). The age of the lease transaction being compared to value the subject’s rental value is also important, but adjustments recognizing trends in market conditions can be applied to account for the age of the leases being compared to the subject (Tr. 38, 41, 63, 168, 288).
All of the appraisers addressing the rental value of the post office (Messrs. Bardsley and Reitman for Respondent and the two appraisers from Hulberg & Associates who testified) relied on rentals of other properties, “comparables,” to form the basis for their opinions about the rental value of the post office. The most significant factors in determining the comparability of properties for appraisal purposes are the physical characteristics of the properties (especially size), their geographic proximity to one another, and the age of the lease transaction (market conditions) (Findings 18, 19). See United States v. 320.0 Acres of Land, 605 F.2d 762, 798 (5th Cir. 1979). Both Appellant’s and Respondent’s appraisal reports fail to consider properly one or more of these variables.
While Hulberg & Associates’ comparable transactions are close in time and geographic proximity to the post office, the characteristics of the properties Hulberg & Associates chose as comparables fail in significant respects to match those of the post office. First, except for Hulberg & Associates’ comparables 6, 7 and 8, the spaces chosen for comparison are so much smaller than the post office as to have little relevance in estimating the value of the post office (Finding 18), and comparables 2, 3 and 4 have no parking on site, another significant difference between them and the post office. Comparable 6, though a freestanding building somewhat larger than the post office, is a two-story office building, as is comparable 5. Neither is suitable for a Postal Service or retail box type use or other non-office use. Comparable 7 is a Postal Service carrier annex in an industrial area that is not a comparable building. While Hulberg & Associates picked recent rentals and listings of buildings near the post office, addressing two of the variables mentioned above, the buildings were so dissimilar that their rentals are entitled to little or no weight in determining the market rental of the post office. None but comparable 8 could be considered a reasonable alternative for a prospective tenant of the post office, and thus Hulberg & Associates’ comparables have little bearing on the rental value of the post office (Finding 18). See United States v. 320.0 Acres of Land, 605 F.2d 762, 798 (5th Cir. 1979).
Hulberg & Associates made adjustments to the rents of its comparables, but Appellant did not show that the adjustments were adequate to account for the significantly smaller size and dissimilar potential uses of its comparables. In any event, the adjustments necessary to equate fairly the rent of these dissimilar buildings to the post office would likely be so significant and subjective as to render them little more than speculation (Finding 18). See Knollman v. United States, 214 F.2d 106, 109 (6th Cir. 1954). Although subjective application of the appraiser’s experience and knowledge is expected in calculating a fair market rent, see United States v. 1,378.65 Acres of Land, 794 F.2d 1313, 1318 (8th Cir. 1986) (“Appraising real estate is more an art than a science”), the selection of rentals of dissimilar buildings leaves the Hulberg & Associates appraisal of little help in determining the market rental of the post office as of February 1, 2000.[8]
However, that is not to say that the Board has accepted the value established by Mr. Bardsley’s appraisal. In making his estimation of rental value, Mr. Bardsley properly addressed the first variable of comparability—characteristics of the properties—by using buildings of a size and potential use similar to the post office. A type of tenant that would be interested in the post office is a retail box user, like the users of the comparables Mr. Bardsley picked. (Findings 6, 7). However, Appellant argues that the Bardsley appraisal fails to address properly the other two variables: geographical proximity and the age of the leases used for comparison.
Mr. Bardsley’s comparables were located beyond the boundaries of Los Altos and were leases entered into substantially before the date of valuation of the subject post office (Finding 7). However, the properties he chose were in the same general geographic area and were in locations suitable for a retail box operation. While proximity to the post office would have been desirable, as there were no similar buildings in Los Altos, Mr. Bardsley’s comparables are acceptable inasmuch as they were similar to the post office in their most important characteristics: size and character of use. See City of Ontario v. Kelber, 24 Cal. App. 3d 959, 972, 101 Cal. Rptr. 428, 437 (1972). Additionally, using Mr. Bardsley’s appraisal as a starting point and making adjustments, including rental escalation due to market conditions (Finding 11) and the proper adjustments for location (Finding 9), as supported by the record, including testimony at the hearing (Findings 8, 9, 10, 11, 12), allows the Board to establish a reasonable market rental as of February 1, 2000, of $352,078.84 per year (Finding 12).
Appellant used other broad adjustments in the Hulberg & Associates appraisal that we reject in our calculations. Appellant argues that it was the common practice in Los Altos in 2000 for lessors to require that the rents for a ten-year lease increase 3-4% per year. As the post office renewal was a flat rate for the ten-year term, Appellant argues a substantial upward adjustment to each of Mr. Bardsley’s comparables would be in order. Some of the leases Mr. Bardsley used had escalation provisions, although none so dramatic as urged by Appellants, and those were taken into account in the Board’s calculation of the fair market rental rate. (Finding 12, note 5). Furthermore, Appellant has not demonstrated that such provisions are common in retail box leases. Thus, there has been no showing that any further adjustment for the post office renewal being a ten-year, flat rate is appropriate.
Appellant also argues that single-tenant buildings are generally leased on a gross square footage basis and that therefore a 3% premium should be applied to the comparables to account for the post office lease being on the basis of net interior space. However, no evidence was presented as to what the measurement method (interior v. exterior) was for the comparables used by Mr. Bardsley, so there is no basis for making such adjustment. Furthermore, the post office lease is on an annual rent basis. It contains no reference to a per-square-foot rental rate.
Finally, Appellant urges that an adjustment to the comparables should be made because in them the tenant pays real estate taxes and insurance whereas in the post office lease, Appellant pays these costs. This argument is based on a misunderstanding of the post office lease by Hulberg & Associates, because under the lease, Respondent reimburses Appellant for real estate taxes paid. There is insufficient information about Mr. Bardsley’s comparable leases to make any adjustment for real estate taxes and insurance.
Accordingly, we conclude that the fair market rental value of the post office as of February 1, 2000, was $352,078.84 (Finding 12). Although this rate exceeds that calculated by Respondent relying on the Bardsley appraisal, this rate is less than 125% of the rent for the last year of the lease, which Respondent has agreed to pay (Finding 16). Accordingly, Appellant is not entitled to rent greater than that agreed to by Respondent in the contracting officer’s final decision.
The appeal is denied.
Administrative Judge
[1] When docketed, this appeal was captioned as Baymark Properties Inc. However, it was subsequently clarified that Baymark is the property manager for the owner of the post office and true appellant, Meiyan Enterprises, Inc. The caption has been changed to reflect this. (See Order and Memorandum of Telephone Conference dated May 30, 2001).
[2] The only freestanding building in Los Altos near the size of the post office and with as much parking was a Safeway store, and information regarding the terms of the Safeway lease was not available to Mr. Bardsley (Tr. 166, 229).
[3] Notwithstanding the lease’s statement of the building’s interior square footage as 12,041, Mr. Bardsley used the figure 12,072, based on his own measurements of the building (Tr. 164-165). The 12,041 figure used in the lease was based on a September 1988 measurement and drawing of the post office by a civil engineer (AF 6). We use the official square footage as listed in the lease in addressing the fair market rent.
[4] Although there was some evidence addressing movement of market rents before 1997, there was insufficient evidence of particular changes during that period to warrant making adjustments for the period prior to 1997 on the older, Pier One Imports and Sleep Train leases.
[5] The Hollywood Video, Blockbuster Video and Gymboree leases (comparables 2, 3 and 4 in Mr. Bardsley’s appraisal) had rents that escalated during their ten-year terms. This condition warranted an upward adjustment in the rent used for comparison, yet Mr. Bardsley did not make that adjustment. Respondent’s expert, Mr. Reitman, provided this upward adjustment to reflect the rent escalations, a condition superior to the flat, ten-year term of the post office lease renewal, and we have used Mr. Reitman’s adjusted figure in lieu of Mr. Bardsley’s unadjusted figure. (Tr. 249-250; RX 3).
[6] Mr. Reitman, using Mr. Bardsley’s comparables and his (Reitman’s) own adjustments, estimated the rental value to be lower than Mr. Bardsley’s original rent estimate. He believed the retail use could not support rent beyond $25 per square foot annually. (Tr. 258-259). However, Respondent has relied on the Bardsley appraisal, and Mr. Reitman did not choose his own comparables as he would have if he were doing an appraisal of his own. Accordingly, we do not consider his adjustments and his ultimate fair market rental estimate, except as noted above regarding location (Finding 9), rental escalation over the term of the comparables’ leases (Finding 12 (n. 5)) and market conditions (Findings 10, 11).
[7] Applying appropriate adjustments to the Comfort Technologies (comparable 8) lease results in a rent for comparability purposes of $24.99 per square foot per year (RX 3).
[8] The adjusted fair market rental for the Hulberg & Associates’ comparable 8, the Comfort Technologies store (Finding 15, n. 8), is less than the fair market rental figure reached in this decision (Finding 13), so incorporating the one usable comparable into the Bardsley Report comparables would not result in any higher rental value determination.