By James P. Regan

As Published in Real Estate Chicago, April 2001

A look at the real estate assessment process used to value regional and super-regional malls reveals that they are significantly overtaxed. These shopping centers are distinct retail facilities with a revenue structure based on that distinctiveness. In levying real estate taxes, local governments have often failed to acknowledge the idiosyncratic features of shopping malls and, as a result, real estate taxes have become an additional tax on sales, and not a tax on real estate.

The entire rent structure of a regional shopping center is based on the retailers’ ability to generate sales. Unlike any other commercial property, a mall’s rental income isn’t derived from the going rate for real estate space but from the retailers’ ability to sell merchandise. The focus is on sales volume.

A cursory examination of any regional mall rent roll would reveal large disparities in rental rates between tenants occupying spaces of similar size, stemming primarily from differences in the merchandise offerings between tenants. For example, jewelry stores typically pay much higher rents than other tenants. Their higher rents are directly proportional to the higher sales productivity of jewelers versus other mall tenants.

On the other hand, card stores typically pay proportionately lower rents and this too is based on their sales productivity. The retail lease negotiation process doesn’t hinge on achieving the average rent psf required to justify construction of the mall. Rather, rental rates are negotiated between landlord and tenant on the basis of type of merchandise, profit margin and anticipated sales volume.

No other property types set rental rates in this fashion. An office tower doesn’t develop rents based on the projected fees generated by, say, its law firm or advertising firm tenants. Banks don’t negotiate their rent based on the volume of transactions they handle, and the assessment of a Ford plant isn’t based on the income derived from the sales of automobiles.

Part of the problem is that we’re influenced by the terminology we use. “Lease” implies that fees are paid for the possession of a particular portion of real estate for a stated term. But the manner of calculating fees in regional shopping centers is unique and the services received are unique. They go well beyond the implied meanings of “rent for the possession of space.”

In regional shopping centers, so-called leases should more properly be labeled “occupancy agreements” to distinguish them from traditional leases with standard terms. Once it has been established that a significant difference between a lease for space in a regional shopping center and a lease in an office building, we can begin to see how a regional shopping center is overvalued. The methods of valuation of regional shopping centers have to be revised to take into account the unique rental structure of these entities.

Until the last decade, the Cost Approach was used to value malls and the problem of valuing a center’s proper revenue stream wasn’t an issue. By definition, the Cost Approach produces an estimate of a property’s fee simple value. The Cost Approach is able to avoid the inclusion of value based on sales productivity.

More recently, assessors typically have used the Income Approach to establish mall assessments, because regional malls are income-producing properties. That’s where the problems begin. To determine the fee simple value of a mall using the Income Approach, the rental rates for the real estate must be determined. The sales volume of general jewelry stores, card shops, clothing stores and restaurants aren’t tied to the value of the land and its improvements. Empirical research has confirmed that factors apart from real estate account for over half of store sales productivity.

As long as assessing authorities use the revenues generated by actual mall occupancy fees in setting assessments, they are imposing a sales tax rather than an ad valorem tax on those properties. Thus, it’s imperative that the owners of regional shopping malls make every effort to alter the perception that actual mall rents should provide the basis for assessment of these shopping centers.


James P. Regan is the senior partner of the law firm of Fisk Kart Katz and Regan, Ltd., the Illinois member of American Property Tax Counsel (APTC).