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Citation: 2004TCC701
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Date: 20041101
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Docket: 2000-1755(GST)G
2001-2725(GST)G
2001-2726(GST)G
2001-2856(GST)G
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BETWEEN:
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VILLA BELIVEAU INC.,
S.A.M. (COLORADO) INC.,
SOUTHPARK ESTATES INC. and
VIRDEN KIN PLACE INC.,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Sarchuk J.
[1] On consent of all parties these
appeals were heard together. The issue in each relates to the
proper method of assessing market value of non-profit
life-lease senior citizen multiple residence complexes for
the purpose of subsection 191(3) of the Excise Tax Act
(the Act). It is not disputed that each of the Appellants
was a non-profit corporation duly incorporated under the laws of
the province of Manitoba.
The Assessments
[2] S.A.M. (Colorado) Inc. (Colorado)
- This Appellant completed construction of a 45-unit
senior's life lease residential complex at 140 Ferry Road, in
the City of Winnipeg in 1997. It self-assessed with respect to
the complex on the basis that the fair market value of it was
$2,740,000 and that the GST payable was $191,800. On February 13,
2001, the Minister assessed the Appellant on the basis that the
fair market value was not less than $5,215,000 and assessed net
tax of $365,050.
[3] Villa Beliveau Inc. (Villa
Beliveau) acquired vacant land located at 500 Beaverhill
Blvd., Winnipeg upon which it arranged for the construction of a
33-unit residential complex which units were leased under
"life leases". Construction was completed in August
1998 and in September, Villa Beliveau self-assessed with respect
to the complex on the basis that the fair market value was
$2,400,000 and that the GST payable was $168,000. In April 1999,
the Minister assessed Villa Beliveau on the basis that the fair
market value of the building was not less than $3,995,327.10 and
that it had failed to account for tax in the amount of
$111,672.90.
[4] Virden Kin Place Inc. (Virden)
completed construction of a three-storey, 22-unit
senior's life lease apartment complex at 489 Frame Streetin
Virden, Manitoba in April 1998. Virden self-assessed with respect
to the building in accordance with subsection 191(3) of the
Act on the basis that the fair market value of the complex
at the relevant time was $1,261,000 and that the goods and
services (GST) payable was $88,270. On July 15, 2001, the
Minister of National Revenue (the "Minister") issued a
Notice of Decision which revised the assessment of GST payable to
$142,282.90 on the basis that the fair market value of the
complex was at least $2,032,612.89.
[5] Southpark Estates Inc. (Southpark)
acquired land at 132 Marrington Road in Winnipeg and arranged for
the construction of a three-storey, 58-unit senior's
apartment complex. Construction was completed in 1997 and the
apartments were granted to tenants subject to life leases.
Southpark self-assessed with respect to the complex on the basis
that the fair market value at the relevant time was $4,100,000
and that the GST payable was $287,000. On April 5, 2000, the
Minister reassessed the Appellant on the basis that the fair
market value was not less than $6,630,000 and thus the GST
payable by the Appellant was $464,100.
[6] Subsections 123(1) and 191(3) of
the Act provide:
123(1) In section 121, this Part and
Schedules V to X,
"fair market value" of property or
a service supplied to a person means the fair market value of the
property or service without reference to any tax excluded by
section 154 from the consideration for the supply.
191(3) For the purposes of this Part, where
(a) the
construction or substantial renovation of a multiple unit
residential complex is substantially completed,
(b) the
builder of the complex
(i) gives, to
a particular person who is not a purchaser under an agreement of
purchase and sale of the complex, possession of any residential
unit in the complex under a lease, licence or similar arrangement
entered into for the purpose of the occupancy of the unit by an
individual as a place of residence,
(i.1) gives possession of any
residential unit in the complex to a particular person under an
agreement for
(A) the supply by way of
sale of the building or part thereof forming part of the complex,
and
(B) the supply by way of
lease of the land forming part of the complex or the supply of
such a lease by way of assignment, or
(ii) where the
builder is an individual, occupies any residential unit in the
complex as a place of residence, and
(c) the
builder, the particular person or an individual who is a tenant
or licensee of the particular person is the first individual to
occupy a residential unit in the complex as a place of residence
after substantial completion of the construction or
renovation,
the builder shall be deemed
(d) to have
made and received, at the later of the time the construction or
substantial renovation is substantially completed and the time
possession of the unit is so given to the particular person or
the unit is so occupied by the builder, a taxable supply by way
of sale of the complex, and
(e) to have
paid as a recipient and to have collected as a supplier, at the
later of those times, tax in respect of the supply calculated on
the fair market value of the complex at the later of those
times.
Appellant's Evidence
[7] A representative of each of the
four Appellants testified with respect to the circumstances
leading to the organization and construction of the respective
properties.
[8]
Colorado: S.A.M. Management
(S.A.M.) is a non-profit corporation which was created in 1973
when the United Church of Canada was attempting to replace a
building which had been destroyed by fire. In so doing, it
constructed St. Andrew's Place which was a mixture of
commercial space and senior citizen's low-cost housing.
John Lyons was the general manager of S.A.M. from May 1975
to March 2001. As such, he was involved in the Colorado and other
projects with the responsibility for contracts with the
developers, overseeing leasing staff, and the overall
coordination of the projects.
[9] In the early part of 1995, the
Y.M.C.A. approached three individuals, Bill Coady, Joe Bova
and Jim Weslake, to undertake a development of the St. James
Y.M.C.A. site which consisted of a building that was no longer
serviceable. They initially approached a Lions group to see
whether it would be the sponsor of a proposed life lease project
but were not successful. As a result, Coady approached Lyons and
asked whether S.A.M. would sponsor the project on that site.
According to Lyons:
... we essentially came to an agreement sometime between
May and June of 1995 that the group, which would include the
Manshield Construction and Smith Carter Architects and RFC
Development, would financially support the marketing of the life
lease project, and S.A.M. Management would provide leasing and
marketing staff to see whether or not we could put together
sufficient numbers to go ahead with the project and purchase the
building from the Y. ...
At this point of time,
... Smith Carter had put together a preliminary set of
drawings. The brochure had been developed. The pricing
essentially was in place. The rent structure was established. The
entrance fees were worked out. We had to massage that as we went
along, but essentially the first draft was there and in a doable
manner. In other words, it looked like it could be marketed
reasonably well.
The first mailout in July 1995 was directed at the "total
community" which initially was St. James and subsequently,
Charleswood. This was followed by town hall meetings, "a
little show and tell sort of thing". Sales personnel were
engaged to find contacts and to follow up with phone calls, etc.
The Winnipeg Free Press was used for advertising and marketing,
more specifically with respect to information such as town hall
meetings and S.A.M.'s office telephone number, etc. Financing
with Royal Trust was arranged in May 1996. According to Lyons,
the bank insisted that the property be registered as a
condominium and there had to be a certain number of leases before
it would commit, in this case 38 out of 45 proposed. Contracts
were signed with the architects in July 1996, a stipulated price
contract was entered into with Manshield Construction on July 29,
and construction commenced that month and was completed in June
1997. The tenants immediately moved in, the building filled up
very quickly and by the time construction was finished, Lyons
noted "one or two units might have been left".
[10] Southpark: Vincent Reilly is a
marketing director in the life insurance business. At the
relevant time, he was resident in Richmond West and was a member
of the Knights of Columbus (the Knights) and of the Mary Mother
of the Church Parish. The former was the sponsoring body of
Southpark. The Knights knew that other organizations were
involved in life lease projects and an earlier effort to do the
same failed because suitable land could not be obtained. They
were also aware of vacant land which had been reserved for a
possible school, approached the authorities, and ultimately
reached an agreement to acquire this land by way of an option to
purchase conditional on their obtaining the required financing,
and undertaking that the project would be a senior's complex.
Southpark was incorporated on July 10, 1995 at which point the
organizational aspects were in their fourth or fifth month. A
general announcement directed at potential tenants was made in
the Church as well as by way of a release in the newspaper and
other forms of promotion. A Southpark brochure distributed at
this time indicated that one of the unique features of Southpark
was that residents would be permitted to sell their interest in
the life lease to another party and that this "allows
residents the opportunity for capital appreciation as demand for
retirement housing increased in the future".[1] Riley noted that although the
project originally contemplated 90 units, commitments slowed up
and stalled at around 50 and a decision was taken to reduce the
plan to 60 units. Fifty-one were "sold" and in order to
commence the project, the architect and general contractor
committed to taking the remaining nine units. He noted that about
40% of the capital cost of $7,200,000 was put up by the tenants
by way of their entrance fees. The options to purchase the land
was exercised on April 14, 1996, financing was arranged and on
October 16, 1996, the Knights entered into a stipulated price
contract with a general contractor. Construction commenced that
same month and the units began to be occupied in October
1997.
[11]
Virden: Doyle
Frederick Piwniuk, an accountant, owns an insurance agency with a
"financial planning and insurance brokerage aspect". He
is a member of the Virden Kinsmen's Club and the Virden
Chamber of Commerce and is vice-president of the Economic
Development Board in Virden. Virden is a community of
approximately 3,500 located in the southwest area of Manitoba. It
has two main industries, agriculture and oil, and is a
transportation hub located on the Trans-Canada Highway midway
between Winnipeg and Regina. A major concern to the community and
to the Kinsmen was the limited available housing in Virden as a
result of which both the younger generation and seniors were
moving to Brandon. There also was a demand for housing by younger
people who lived in nearby small towns but who wished to live
closer to Virden so that their children could attend its schools.
As a result a fairly viable market existed for seniors who wished
to sell their homes and move into something smaller. This led the
Kinsmen to decide that a life lease project for seniors housing
was appropriate.
[12] The first steps were taken in February
1996 when an architect was approached and discussions began with
the administrator of the local Health District with respect to
the acquisition of a piece of land owned by the hospital. The
property chosen was well located in a residential area and across
the street from the hospital and clinic. Shortly thereafter, the
Kinsmen obtained an option on the property. The initial project
contemplated 34 units and advertisements were placed in March
1996. Public meetings were held and although initial interest was
substantial, it became apparent that 34 units would not be sold
and the project was reduced to 21 units. Funding arrangements
were made with Virden Credit Union in June 1997. The delay
was, according to Piwniuk, the result of a Credit Union
requirement that there be 16 units sold before it would provide
financing. Although a substantial number of potential tenants had
indicated interest, the actual signatories amounted to
"about 14 or 15". Ultimately, this hurdle was overcome
and a management contract was entered into on June 30, 1997.
Piwniuk indicated that construction had commenced just before
that date and was completed in March 1998 with the first tenants
moving in on April 1st.
[13] Villa
Beliveau: Douglas
Alexander Leeies is a consultant with Acorn Development (Acorn),
a company which works with charities, non-profit organizations
and other groups who wish to provide housing as a service to
certain constituents. Acorn had previously been engaged by the
Knights on different projects such as non-profit co-ops and
non-profit rental properties. The Knights from the parish of St.
Martyr's located in Southvale, a suburban neighbourhood in
southeastern Winnipeg, had tried to develop a project
independently through a provincial government program designed
for a modest income household. They had also spoken to other
consultants with the intention of "doing a federally funded
project", specifically a senior's co-op, but it never
came to fruition.[2] According to Leeies, both the provincial and federal
governments had stopped becoming involved in such projects
and:
... the only vehicle that was available to develop
non-profit housing in Manitoba was, in fact, the Manitoba Housing
Life Lease program, and we sat and discussed this with them over
a period and recanvassed the community. They felt that it was a
good match and that we should go ahead as a team and try and
develop that project with them.
In or about April 1992, the Knights formalized an arrangement
for a property owned by the Church and entered into a consulting
agreement with Acorn. Leeies testified that prior to Acorn being
engaged, the sponsors had initially:
... hoped to do 50 or 60 units and that was way back,
prior to engaging us, and finally when we were engaged and went
out with the life lease notion about a year after that, we came
to the conclusion that we could not develop anything
significantly more than 30 odd units. So the project was
downsized and a project, I think it was 33 units was designed at
that point in time.
Villa Beliveau was incorporated on November 23, 1994 and on
February 4, 1995, a contingent arrangement for a plan was reached
with Prefontaine Architects. On April 3, 1996, Concorde Projects
was brought into the picture to provide construction estimates.
The project was not intended to provide luxury or high-end units,
but was directed at the low to middle-income group. A design was
developed and drawings were completed by April 1996. As well
during that period, the sponsors were in the community developing
interest in the project since a condition of financing was that a
specific number of suites were to be leased. Leeies noted that
during this period approximately 14 of the units had not been
leased but this situation did not appear to have caused any
particular concern since there were sufficient people expressing
interest in the units. Construction commenced in 1996 and was
completed in August 1998.
[14] Estimates of the market value of the
four properties in issue were provided for the Appellants by O.
William Steele.[3]
Steele defined highest and best use as:
... the most profitable legal use to which a property can
be put. Opinion of such use is based on the highest and most
profitable continuous legal use to which a Property is capable of
being used, or likely in demand, in the near future.
To analyze and estimate the highest and best use, Steele
considered the following factors: zoning classification and land
uses permitted, existing land use, age, design, materials,
workmanship and physical condition of the building, feasibility
and/or viability of alternative legal land uses for the property.
In his opinion, although the two potential highest and best land
uses as at the dates of appraisal were as residential
condominiums or multiple family residential complexes for
seniors, he concluded, for a number of reasons, that their
highest and best use would not be as a residential condominium
for seniors. He noted that as at the date of appraisal the
properties were not residential condominiums for seniors and
accordingly, it would be necessary to estimate the collective
market value for the residential units as condominiums and then
deduct all costs which would be incurred in converting the
property from a non-profit residential complex for seniors to a
residential condominium for seniors.[4] In addition to the foregoing, other
costs which would have to be deducted were the amounts required
to buy out the leasehold rights of those tenants who had been
committed to a long-term lease in the subject property as well as
the profit to the owner. On that basis, Steele concluded that the
market value of the subject properties as condominiums, less
conversion costs, buyout costs and profit to the owner, was
substantially less than their market value as non-profit multiple
family residential complexes for seniors. Therefore, in his
opinion, the highest and best use of the subject properties was
for non-profit multiple family residential complexes for
seniors[5] and more
specifically "for rental purposes".
[15] Steele testified that where real
property being appraised includes land and building, the most
satisfactory procedure is to include the three most widely
accepted valuation processes, namely, the Cost Approach, the
Income Approach and the Comparison Approach. He further indicated
that based on the fact that there was an insufficient number of
conventional multiple family residential complex sales to
estimate market value by the Comparison Approach, the Cost
Approach and the Income Approach were the most precise methods to
estimate market value of the subject properties. Steele
specifically noted that:
In estimating market value by the Cost Approach, the estimates
used are replacement cost estimates based on market conditionsas
at the date of appraisal rather than actual development and
construction costs for the subject property,
since in his view, those costs did not represent development
and construction costs based on market conditions. He
noted that the cost approach is no different than any of the
other approaches, and more specifically said:
the end result has to be what the market would pay for the
property, and if the cost approach, let's say it did cost
more than supposed market value, there has to be a - there is
depreciation that has to be accounted for. In other words, there
is now depreciation inherent in the property.
According to Steele, economic obsolescence is a form of
depreciation resulting in a loss in value:
caused by extrinsic conditions inherent to the subject
property such as deficient location, excessive taxes, special
assessments, government regulations, legislation or encroachment
of inharmonious land uses.
and in his opinion:
there is substantial economic obsolescence negatively
impacting market value of the subject property.
Since in his view their highest and best use was as multiple
family residential rental complexes for seniors, he specifically
referred to rent controls as having that effect on their market
value. This loss he considered to be a form of economic
obsolescence which is measured as the capitalized value of the
annual net income loss due to the deficiency. He noted in his
report that:
An indicator of Annual Rent Loss caused by Rent Controls is
the difference between the Net Income which would be required to
produce a Reasonable Market Return on Investment in the Capital
Cost of the Subject Building and the Estimated Market Net Income
from the Subject Building, only, based on its use as at the Date
of Appraisal.
The objective in calculating such difference is to Estimate
the Loss in Market Value between the Normal Market Expectation
for a Return on Capital Invested in a Multiple Family Residential
Complex and the Market Value resulting after the effect of Rent
Controls.
Utilizing this method, Steele estimated the market value of
these properties by the cost approach for Colorado as at June 1,
1997 as follows:
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ESTIMATE OF REPLACEMENT COST
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Building: 45 Rental Units X $105,000 Per Unit
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$4,725,000
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Yard Work: 41,122 SF X $3.50
PSF
Say,
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$150,000
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Estimate Replacement Cost
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$4,875,000
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LESS ESTIMATE OF DEPRECIATION
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Economic Obsolescence:
$230,607 ÷ .10(%) =
$2,306,070 Say,
($2,300,000)
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Estimate of Depreciation
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($2,300,000)
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ESTIMATE OF DEPRECIATED VALUE
OF SUBJECT IMPROVEMENTS
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$2,575,000
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ADD ESTIMATE OF MARKET VALUE OF LAND AS IF
VACANT 62,500 SF x $6.00 PSF
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$375,000
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ESTIMATE OF MARKET VALUE BY THE
COST APPROACH
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$2,950,000
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Say,
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$3,000,000
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Utilizing the same method, Steele reached the following
estimates of market value by the cost approach for the other
three properties, Virden - $1,150,000, Villa Beliveau -
$2,200,000 and Southpark - $3,800,000.
[16] Steele also estimated the market value
of the properties by the income approach, an appraisal technique
in which anticipated net income applicable to the subject
properties is capitalized into an indication of market value. He
defined market rental value as the rental income that a property
would most probably command in the open market, and indicated
that the rates used in his report are in excess of those rates
generally paid for "comparable conventional, non-senior
multiple family residential complex rental units". That was
so because the non-profit residential complexes for seniors
were generally newer buildings, included attributes which make
them amenable to seniors housing and thus, command somewhat
higher market rentals. Steele specifically noted that rental
values for such properties are restricted in Manitoba by the
Residential Tenancies Act and this is further complicated
by the fact that rents are property-specific, i.e. annual rental
increases are based on annual rent for the respective property in
the previous year and not on the general market. In his view,
rent controls applied to the overall multiple family complex
market had a serious negative impact on the rental value of
newly-constructed multiple family residential complexes.
Accordingly, he concluded that:
In a broad spectrum of both 1 and 2 Bedroom Multiple Family
Residential Complex Rental Units in 1997 and 1998, Market Rental
Values of higher quality Conventional Multiple Family Residential
Complexes in good locations were, generally, from $0.70 to $0.80
per square foot per month, say, $0.75.
Steele then went on to pose the question:
As a result of its new construction in a Market of older stock
of conventional multiple family residential complexes, would
market rental value of the subject property rental units as at
the date of appraisal be substantially higher than $0.75 per
square foot per month?
and concluded that the market rental values for the subject
properties would be only slightly higher than their value as a
conventional multiple family residential complex.
[17] The basis of the Income Approach,
according to Steele, is that components of value including Rental
Value, Vacancy Allowance, Operating Expenses and Overall
Capitalization Rate are based on market conditions for comparable
properties and not, necessarily, based on current or historic
experience of the subject property. In this process, the first
step is to estimate the gross income based on Market Rental Value
at 100% occupancy under market terms and conditions; deduct an
estimate of vacancy and rent loss as well as an estimate of
annual operating expenses based on the physical status of the
subject improvements and conclude by capitalizing the resulting
estimate of annual net income into an indication of market value.
He concluded that while it was difficult to estimate absolutely,
there was sufficient Market Data to make a "reasonably
accurate and reliable Estimate of Market Value". His
ultimate conclusion with respect to the market value by this
approach for Colorado was $3,350,000, Southpark $4,000,000,
Virden $1,200,000, and Villa Beliveau $2,150,000.
[18] For the purposes of his final estimate,
Steele considered the results produced by both the cost approach
and the income approach and concluded, with respect to each
property, that their market value was as follows: Colorado
-$3,300,000,Virden - $1,200,000, Villa Beliveau -
$2,150,000, and Southpark -$4,000,000.
[19] Jeffrey Rabb[6] has been involved in the real estate
business since at least 1986 and currently manages Dorchester
Developments Ltd., a company specializing in the acquisition and
redevelopment of multi-family properties. More specifically he
noted that the renovation of such properties allows them a rent
control holiday for up to five years and enables Dorchester to
bring them up to their maximum market rents and thus "we
create the highest rates of return on multi-family property by
generating the highest rents in the industry". For the
purposes of his testimony, counsel for the Appellants provided
Rabb with the Kellough, Pestl, Sing Associates and the Sterling
Realty Advisors reports and specifically requested his opinion
"as an active participant in the Winnipeg multi-family
residential market as to which set of values is more commercially
reasonable and accurate". Since Rabb does possess special
knowledge and experience in what he described as the multi-family
real estate business, the Appellants were permitted to call him
to testify as to his perception of the market value of the four
properties in issue as rental properties. However, he was not
acceptable as an appraisal expert and accordingly, was not
permitted to testify with respect to the appropriateness or
correctness of either the methodology or conclusions reached by
Stirling Realty Advisors or Kellough, Pestl, Sing Associates.
[20] In Rabb's view, the properties were
not appropriate for condominium conversion because as a result of
their cost it would not be possible to generate enough revenue to
cover the costs based on the value per square foot of what
condominiums sell for in the Winnipeg market. He further
testified that if he were to buy the properties in issue it would
only be for use as a multi-family residential apartment building.
Rabb reached this conclusion by considering the properties'
location, suite size, and amenities to determine rent and actual
operating costs and thus determining their expenses. He then
capitalized the net income based on what he perceived to be the
market price given the conditions in Winnipeg at the relevant
time. Based on the foregoing, his view was that the market values
for Villa Beliveau, Southpark and Colorado were $2,100,000,
$3,678,980 and $3,028,449, respectively.
Respondent's Evidence
[21] Evidence was adduced on behalf of the
Respondent from H.E. Pestl.[7] The purpose of his engagement was to appraise
and to provide an opinion as to the market value of each of the
four properties. The effective date of the value estimates in
each case is the date of first occupancy of each of the subject
properties in accordance with the requirements of subsection
191(3) of the Act. These dates are as follows: Colorado -
June 1, 1997; Southpark - October 1, 1997; Virden - April 1,
1998; and Villa Beliveau - August 5, 1998. Pestl testified that
he analysed relevant information pertaining to the subject
properties including acquisition particulars as well as recent
offerings and listings. In respect of the latter, he learned that
there had not been any. Each of the subject properties and their
surrounding neighbourhoods were inspected and economic market
data was assembled. Consideration was given to land use controls
including the municipal zoning and official plan documents which
affect the subject properties. This was followed by an analysis
and consideration of the highest and best use concept and the
various methods of appraisal. He indicated which methods were
most appropriate to the subject properties and then undertook an
analysis on the basis of those methods.
[22] Pestl stated there are three methods,
which are acceptable and normally used in appraising or
estimating the market value of real property. Each of these
methods has advantages but all are dependent on specific
information which must be available in order for that particular
method to succeed. He described them as follows:
(i) The
Cost Approach is a method of estimating value by appraising
the land upon which the buildings stand, as vacant. This
appraisal of vacant land is done primarily by market comparisons.
The cost of reproducing the buildings when new is estimated and
the value is established by adding the market value of the land
to the depreciated value of the buildings and site improvements.
This approach presupposes sufficient land sales and close
proximity to the subject on or about the date of value to
establish the market value of the land by comparison.
(ii) The Direct
Sales Comparison Approach involves the gathering, analyzing
and comparing of data on similar properties that have been sold
or on which offers have been made. These similar properties must
be logically comparable to the subject in size, location and time
of sale. Assuming that a sufficient number of properties can be
found which can be compared to the subject as a unit; that is
land, buildings and amenities, the direct sales comparison
approach is a good and acceptable test of value.
(iii) The Income
Approach or Capitalization Method of valuation, is a method
whereby the estimated annual income produced by a property is
capitalized at an appropriate rate into an indication of the
capital value of that property. The term capital value is
considered to be synonymous with market value: that is, the
estimated price an investor would pay for a property having
regard to the net income flow and the rate of return expected on
the capital invested. In this approach, an appropriate factor is
applied in order to discount the future income strain to a
present cash worth.
With respect to the income approach, Pestl made the following
specific comments as they related to the properties in issue:
In the subject instance the lands have only recently been
improved with a modern seniors residential complex. Because of
the nature of the Life Lease structure the existing income stream
generated by the project is not market rent. The rents paid by
occupants are reflective of the entrance fee payments, and any
additional payments made by the purchasers of the life leases
interest. Further, market rents have not justified the
construction of new residential projects for many years as such
projects are not economically viable. For this reason the Income
Approach to value is not considered appropriate for the purposes
of valuing the subject complex. It is also noted that an analysis
of market rental values for typical rental apartments is not
appropriate in this instance as such rentals are not based on
similar entrance fee and additional payments, as made by life
lease occupants.
An Income Approach analysis would not indicate the total
market value of the subject property, unless the entrance fee and
additional amounts paid by the occupants is taken into account.
The owner of the subject complex receives both a monthly rental
stream (as in a typical rental property) and also receives the
entrance fee and additional payments made by the purchasers of
the life lease interests. These two forms of capital recovery by
the owner combine to form the market value of the property.
Unlike a typical rental property however there is no incentive to
escalate rents to their maximum potential due to the
not-for-profit nature of the project.
[23] Pestl noted that the four properties in
issue were newly constructed and in each case, the development
costs were available. He also observed that a number of similar
projects had recently been constructed and it was evident that a
market for such complexes existed. None of the properties were
either publicly assisted nor otherwise funded. All were totally
financed by the entrance fees and the mortgage companies. There
was no subsidy granted to any of the projects either publicly or
privately, nor were they funded through "fund raisers"
or similar mechanisms. Thus for the purposes of his analysis, he
utilized the cost and direct sales comparison approaches to
value.
[24] In the cost approach analysis with
respect to each of the four properties, in order to estimate the
replacement cost new of the subject improvements, Pestl took into
account the actual construction costs of the complex, the cost of
similar complexes, and undertook an independent costing using the
Marshall Valuation Computer Costing System. With respect to
Colorado, he described this process as follows:
According to the Financial Statements, the total construction
cost of the subject complex is stated to be $5,552,771. This
amount includes the land cost, shown as $388,501. It also
includes GST paid, an amount of $191,800. Accordingly, net of
land and GST the development cost is about $4,972,470, or for 45
units, $110,499 per unit.
The complex comprises a total net unit area of 48,407 square
feet and the development cost is about $102.72 per square foot
net of land, and $110.75 inclusive of land, both exclusive of
GST. Based on these reported costs for the subject property the
project cost, exclusive of GST but inclusive of land is
$5,360,971.
Included as Appendix #16 hereto is a summary of the
development costs of eleven (11) Life Lease Projects, inclusive
of the subject. One property (No. 9) is an addition to an
existing project and has been adjusted to reflect that
circumstance. That project is also based on a 99-year lease term
with renewal option. As may be seen these projects indicate a
development cost range, excluding land and GST, of from $90.17
per square foot of net unit area, to $116.88 per square foot,
with an average cost of $103.72 per square foot, ($102.72 for the
subject). The cost range inclusive of the land cost is from
$95.71 per square foot to $121.03 per square foot with an average
of $108.95 per square foot, ($110.75 for the subject).
While the subject complex enjoys particularly extensive and
good quality common area facilities, it is, at the same time, of
frame construction. These characteristics are considered to
offset one another. The average indicated values based on the
comparable sales support the actual costs of construction for the
subject complex.
We have also undertaken a cost analysis employing the Marshall
Valuation Computer Costing System, (see Appendix #18). The
building costs exclusive of land, site improvements such as
landscaping, exterior lighting, surface parking, driveways,
signage, fixtures and equipment etc. but inclusive of GST is
$4,710,985, as at current date. The adjustment factor for July 1,
1997 is 1.081 and the adjusted cost is therefore $4,357,988.
Adjusted for GST this is reduced to $4,072,886.
An allowance of from 10% to 15% for site improvement, fixtures
and equipment, and incidental costs results in a cost range of
from $4,480,173 to $4,683,819. This compares with an actual cost,
exclusive of land and GST of $4,972,470. The indicated
cost range by the Marshall & Swift costing method is some 6%
to 10% lower than the actual cost of development. As has
previously been indicated, the common areas are extensive and
finished to a much superior standard than is typical in similar
complexes. These superior characteristics are not reflected in
the cost estimates which are based on average quality frame
construction. For this reason, the actual development costs of
the project are concluded to be the most appropriate
indicator.
We have estimated the market value of the subject land in the
amount of $382,500. We have further confirmed the actual
development cost of the project in the amount of $4,972,470 is
reflective of the likely replacement cost of the subject.
Accordingly the indicated market value for the subject property
by the Cost Approach to value, as at July 1, 1997, exclusive of
GST is $5,354,970 which amount may be rounded to
$5,355,000.
[25] Pestl also used the direct sales
comparison approach to provide a further indication as to the
market value of the subject properties. In his report, he
observed that in order to select appropriate comparable sales, he
considered the nature of the subject properties as life lease
complexes. More specifically he stated:
The definition of Market Value requires the assumption of a
willing seller and a willing buyer, neither of which are acting
under compulsion. In other words, a hypothetical transaction in
an open market and normal market circumstances is to be assumed.
In this regard, there are two prospective scenarios in which the
subject property might be sold.
In the first scenario another not-for-profit group may wish to
provide its members with a similar housing opportunity, and the
present owner and occupant of the subject property are assumed to
be willing sellers.
The purchaser group has available the opportunity to either
acquire a suitable site and construct a complex, or assuming the
subject were available for sale, acquiring it.
In both instances a group would have members prepared to put
up sufficient entrance fees to complete the transaction.
In the second scenario, the owner and occupants of the subject
property could proceed with the sales of the individual units as
condominium units, should they be in agreement to do so.
In most instances the life leases of such projects are
structured so that the individual occupants, or their estates,
received the initial entrance fees, and any additional capital
contributions for each unit, at the termination of the lease
term. That is the actual acquisition costs are refunded and the
unit is resold in the form of a new life lease to a subsequent
purchaser. The market for life lease units is comparatively new
and few resales have in fact occurred in the subject project.
However, in some similar projects occupants are permitted to
arrange their own sales and achieve market appreciation.
The life lease form of occupancy is, in most respects, similar
to condominium ownership. Both are a form of unit occupancy, with
shared common elements. Because life leases are anticipated to be
resold not subject to the life term of the vendor, but the life
term of the purchaser, the rights of ownership are significantly
enhanced as compared with a typical leasehold interest.
The life lease concept provides additional benefit by catering
to the mature (55+) market. Not only are the common area
facilities typically more extensive than in comparable
condominium projects, the concept also allows for regulation of
the complex with respect of prospective occupants. It creates an
attractive senior's environment.
The principal financial difference between a life lease tenure
(operated on a not-for-profit basis) as compared with a
condominium ownership is the opportunity to realize the capital
gain on any potential value appreciation of the unit on its
ultimate sale or disposition. This impact however is relatively
modest.
For example, assuming a $110,000 unit value, held for say 20
years at an annual appreciation of 1% per year, compounded, would
have a future worth of $134,220.90 at the end of that time frame.
This is a capital appreciation of $24,220.90. However, the
present worth of that capital gain at say an annual interest rate
of even only 5% is $9,128.59 (f = .376889). At 10% (f = .148644)
the present worth is only $3,600.29. Based on this consideration
the life lease tenure would appear to carry a financial cost of
from 3% to 8%.
However, this modest financial expense appears to be more than
offset by other benefits of the life lease tenure. Not only is
the life lease complex, a more structured environment
particularly attractive to the seniors market, the projects
typically also feature more extensive common and recreational
facilities than typical condominium projects, and often include
monitoring equipment for emergency assistance etc.
While it is not uncommon for life lease complexes to be
registered as condominium units, and some projects are in the
process of such registration, others are not. We are aware of
only one complex, Assiniboine Links on Roblin Boulevard
which had been a not-for-profit life lease project and was
subsequently sold as condominium units.
In that instance, the project was however a sale under
distress conditions. The members of the original life lease
occupants contributed additional funds to buy their units under
condominium tender, however, the additional funds were to meet
the financial obligations of the corporation and to preserve
their original investments.
The decision as to whether or not the life lease occupant may
resell the unit at market value is typically governed by the
terms of the life lease agreement. However, whether or not the
owner corporation decides to benefit from such appreciation by
resale at market value, or permits the occupant to benefit
thereby is not material to the actual market value of the
property. Some projects permit the resale of the units by the
occupants at their market value.
Pestl considered a number of condominium unit sales in a
variety of projects throughout Winnipeg and surrounding area and
used approximately ten as comparable sales. His conclusion that
the market value of Colorado by the direct sales comparison
approach was $5,422,000.[8]
[26] Based on his view that the most
probable purchaser of the subject property would be another
not-for-profit operator and considering the benefit of a
significant timesaving through the acquisition of an existing
project, Pestl concluded that more weight should be given to the
cost approach considerations and accordingly, appraised the value
of Colorado as at July 1, 1997 in the amount of
$5,355,000. Utilizing the same methods, Pestl put forward
the following estimated values with respect to:
(a) Villa Beliveau: cost
approach - $4,345,000, the direct sales comparison approach -
$4,332,000. Thus, Pestl's estimate of the market value as at
August 1998 was $4,345,000.
(b) Southpark: the approaches utilized
indicate values of $6,457,000 and $6,541,000, respectively, and
the estimated market value property as at October 1998 was
$6,460,000.
[27] With respect to Virden, the indicated
values were $2,246,500 and $2,065,000, respectively. In this
instance, Pestl favoured the lower indicated value range, that of
the direct comparison approach primarily:
because of its rural location and presumably a smaller market
for that kind of property in that location as compared to
properties located here and therefore concluded that the value
would be at the lower end of the range indicated by the two
approaches.
Thus, the estimate of the market value as at April 1, 1998 was
$2,100,000.
[28] Pestl further testified that the market
value is not complete without an estimate of exposure time linked
to the value estimate. Exposure time, he said, is the estimated
period the property being appraised would have been offered on
the market prior to the hypothetical sale at market value on the
effective date. Exposure time is always presumed to precede the
effective date of the value estimate and is based upon an
analysis of past market events and trends as they apply to the
type of real property under consideration. Based on his research
and analysis it was concluded that a reasonable exposure
time-period would be in the range of three to six months.
Appellants' Submissions
[29] At the outset of his submission,
counsel for the Appellants set out several points of agreement
between the parties. First, there is no dispute regarding the
definition of fair market value. Second, the process does not
relate to the life leases but rather relates to valuing multiple
unit residential complexes. Third, it is not disputed that no one
would buy these complexes for their cost to operate as
conventional apartment buildings since market rents have not
justified the construction of new residential projects for a
number of years as they are not economically viable. Counsel
further noted that the replacement costs were not seriously in
dispute, conceded that Pestl's estimates of those costs were
in each instance consistent with the actual cost of construction,
and noted that with the exception of Villa Beliveau were very
similar to those reached by Steele. On the other hand, counsel
argued, there was a very substantial difference between the two
appraisers as to the manner in which each considered and applied
the concept of economic obsolescence to the cost approach values.
Counsel noted that Pestl agreed that the depression of value due
to rent controls would create economic obsolescence for
conventional apartment buildings and that if one were dealing
with such a building, in the cost approach an appraiser would be
required to consider that economic obsolescence. Furthermore, it
was not disputed that an acceptable method to measure economic
obsolescence would be to capitalize the rent loss attributable to
rent controls. This, counsel said, was what the Appellants'
appraiser did but the Respondent's failed to do. Instead,
Pestl assumed that another not-for-profit life lease project
would purchase the properties in issue for cost with the result
that they would not be considered or treated as conventional
apartments and, therefore, there would be no economic
obsolescence. This assumption raises the question whether there
was a separate market that would be willing and able to buy the
properties in issue for their cost for the purpose of developing
new life lease projects or whether these properties would end up
on the normal market. Counsel argued that there was no
evidentiary basis for the Respondent's position, whereas on
the other hand, the testimony of the four witnesses representing
the non-profit groups involved in the development of the
properties in issue established that there was "no realistic
possibility that another life lease project would be in a
position to acquire an existing building" since non-profit
groups undertaking projects such as this do not have immediate
funds available to make an offer for an existing property. By way
of example, counsel referred to the testimony of Leeies to the
effect that there would not be a circumstance where a life lease
could acquire another building unless there was a philanthropic
lender, as he put it, or government funding, both of which would
take it out of the definition of market value. Other factors
which precluded the acquisition of an existing property by a life
lease group was that the physical location of the development was
of substantial importance, i.e. proximity to the parish Church,
such as was the case with Villa Beliveau. Particular reliance was
placed on the testimony of Leeies to the effect there are
"fairly rigid geographic limitations as to the suitability
of building locations".
[30] The Appellants' second point of
disagreement with respect to Pestl's cost approach conclusion
is that even if there was an acquisition of the hypothetical
property by a not-for-profit life lease group, it would not be a
market transaction within the definition of "market
value" since the parties to such a transaction are not
motivated by market place objectives. The sponsors who own the
buildings are motivated by social and community needs and
according to counsel:
When we are talking about a market, we're talking about
entrepreneurs; we are not talking about social projects.
Typically motivated people in the market do not do things for
free; they expect a benefit. But the owners of each of the
subject properties here are not typical. They are providing
social services. They are not doing business.
The Appellants further contend that since life lease
transactions cannot take place without creative financing schemes
and concessions from persons associated with the projects,
"one can't seriously argue that the life lease model is
typical or normal financing for the construction of a multiple
family residential building".
[31] The Appellants also challenge
Pestl's conclusion that a reasonable timeframe for the
disposition of such properties would be three to six months. This
is so even if complexes such as the ones in issue were available
on the market, it would be virtually impossible for an interested
sponsor to organize a tenant group in the short period of time
suggested by the Respondent. Counsel noted that the periods for
the properties in issue once the location was identified and
plans were available to show to potential tenants range from 14
months to 2½ years. Thus the fundamental assumption
underlying Pestl's exclusion of economic depreciation i.e.
that there is a pool of non-profit buyers for these complexes is
unsupported by any acceptable evidence. The Appellants also
contend that even if there were such buyers, those purchases
would not meet the definition of market value and that the cost
approach, if properly applied, accounting for the obsolescence
which Pestl admitted existed in the market generally, does not
support the values put forward by the Respondent.
[32] With respect to the direct comparison
approach utilized by the Respondent's appraiser Pestl, the
Appellants submit that to properly evaluate a property in the
case of the sale of a condominium complex, the process must
include provision for the cost of the conversion of the complex
to a condominium, having regard to the costs of any physical
modifications, legal and professional fees, marketing and
operating costs during a reasonable marketing period, as well as
provision for the profit that a developer expects to obtain on
the sale of the individual units. This method was used by Steele
and it was wrong for Pestl to support his direct comparison
condominium approach by estimating the aggregate retail value of
the units as condominiums and using that total to establish what
the complexes were worth. He also failed to estimate the amount
and timing of capital outlays or marketing costs nor did he
provide any analysis of the timing of potential sales. In
substance, Pestl's condominium approach valued the individual
units in the respective properties but did not value the
complexes. This was incorrect according to both the appraisal
format and the Excise Tax Act. The result was that Pestl
accounted for the revenues of selling the units but failed to
take into account the costs and made no provision for a normal
market return.
[33] With respect to the income approach
utilized by Steele, the Appellants contend that it was used
customarily when the property to be valued is an income-producing
property. First, Steele's estimate was made of the market
rental values of the units rather than the contract rental values
and, thus, the rentals used were unaffected by the life lease
arrangements. Steele then deducted the costs associated with
operating the complexes and capitalized the net income stream
based on a market capitalization rate. Counsel observed that the
Respondent's appraiser did not contest Steele's testimony
as to what market rent values or operating costs were nor did he
contest the capitalization rate utilized. Specific reference was
made to the following comment by Pestl in rejecting this
approach:
An analysis of market rental values for typical rental
apartments is not appropriate in this instance as such rentals
are not based on similar entrance fee and additional payments as
made by life lease occupants.
Counsel argued the fact that they were originally financed
through life leases was not relevant to their current value
because it is necessary to assume the
"non-existence" of the life lease for the purpose
of marketing the full fee simple. Furthermore, the entrance fees
and additional payments are, according to counsel, "red
herrings" and do nothing more than explain how the building
was built in a market that had depressed rental values. For these
reasons, the Appellants contend that hypothetical buyers in this
market would establish value based on the income approach and
that reflects the appropriate current valuation of the properties
in issue as determined by the Appellants' appraiser
Steele.
Respondent's Submissions
[34] The basic issue before the Court is
whether the assessments made pursuant to subsection 191(3) of the
Act which requires the Appellants to perform a
self-assessment of the fair market value of the four life
lease complexes should be upheld. Subsection 123(1) of the
Act provides that fair market value of a property or
service supplied to a person means the fair market value of the
property or service without reference to any tax excluded by
section 154 from the consideration for the supply. There is, as
was conceded by the Appellants, no disagreement as to the
definition of fair market value as put forward by the
Respondent's expert Pestl.
[35] Counsel noted that albeit the issue
before the Court is the fair market value of the properties and
appraisal evidence was introduced, a representative of each of
the four Appellants testified regarding the inception and
development of their respective projects. This testimony made it
clear that life lease properties are anything but conventional
rental properties and also established that they are
substantially different from a typical tenancy arrangement. In
the first place, the properties have physical amenities that are
conducive to the lifestyle of life lease tenants. Furthermore,
the entrance fees typically finance up to half of the cost of
construction and are tied to the rental payments made by the
tenants. The tenants have an interest in their units that is
evidenced by the life leases and in some cases, the entrance fees
are considered in the relevant documentation to be an investment
secured by second mortgage in favour of the tenants. In the
Respondent's view, the testimony of these four witnesses
clearly established the existence of a demonstrated market and
need for life lease complexes.
[36] The Respondent contends that the
Appellants' reliance on the Steele appraisals was misplaced
in that the content and quality of his reports fell below the
required standard of expert evidence and should not be accepted
by the Court. In particular, Steele failed to take appropriate
steps to ensure that the information and analysis provided are
sufficient for users to understand the rationale for any opinion
given. More specifically, there was a failure on his part to
provide anything more than minimal identification of information
or data to support his assumptions and conclusions which in many
instances reflected nothing more then his reliance on personal
experience. A number of specific items were raised by counsel.
First, Steele utilized an income approach with respect to the
properties and appears to have valued them as conventional
apartment buildings. In so doing, no consideration was given to
the entrance fees even though he admitted that they formed part
of the financing of the complexes and that the Appellants could
never have charged the existing rents absent those fees. Thus,
Steele's income approach was flawed because it failed to take
into account the tenants' substantial equity injections into
these properties. Furthermore, with respect to the capitalization
of the estimated net income of these properties in his income
approach, Steele's method for calculating the capitalization
rate by the band of investment theory was overly simplistic and
inaccurate in light of the more technical and detailed method set
out in the requirements of the Appraisal Institute.
[37] With respect to the cost approach
utilized by Steele, counsel noted that although he considered the
actual cost to construct each property, he ultimately used a
lower figure in his calculation of the estimated replacement cost
without setting out the basis for so doing. Furthermore, although
he asserted that he did not believe the actual costs were normal
market costs he provided no definition of what constituted a
normal market cost and no evidence of other costs or examples to
back up his assumption. Regarding Steele's use of economic
obsolescence to depreciate the improvements, his concept was, on
the face of it, premised on the provisions in the Residential
Tenancies Act that had the effect of reducing the potential
for a return on investment in reduced profit for conventional
apartments operated for commercial purposes. Counsel argued that
in fact the rent control provisions of the Residential
Tenancies Act do not apply in the present case and that
Steele's analysis is irrelevant in the context of the
not-for-profit life lease projects where the entrance fees
compensate for the fact that the rents alone could not support
the properties. Counsel also noted that both Steele's
definition of economic obsolescence and the formula he utilized
were based on his personal experience and was inconsistent with
the approach recommended by the Appraisal Institute. Since his
formula for calculating economic obsolescence required him to
incorporate the net income derived in his income approach, any
flaw in the latter would impact on his cost approach with the
result that the conclusions reached in both are flawed and
questionable. For these reasons, no reliance can be placed on
Steele's estimate of value by either the income or cost
approaches.
[38] Counsel submitted that the evidence of
the project representatives established that the arrangements are
very different from a typical tenancy agreement. The properties
in issue have physical amenities conducive to the life styles of
this particular group of tenants. The entrance fees in most cases
finance up to half the cost of construction and are tied to the
rental payments made by the tenants. The entrance fees are
considered to be an investment secured by a second mortgage in
favour of the tenants. Thus, the tenants have a very special
interest in their units that is evidenced by their life leases
and the beneficial interest in those second mortgages. For
financing purposes in almost all cases the banks treated these
projects as condominium developments and require registration as
such. There is obviously a demonstrated market and demand for
these complexes as contrasted to conventional apartments and
which, unlike conventional apartments, are supported in the
market place by a combination of tenant equity and monthly
payments.
[39] The Respondent asserts that in
determining the appropriate methods for valuing the properties in
issue, Pestl reviewed the three approaches and noted that the
income approach is ordinarily utilized to determine what an
investor would pay for the property having regard to the net
income flow and the rate of return expected on the capital
investment. It is the Respondent's position that as the
highest and best use of the property has been properly determined
to be a continuation of its existing use, the income approach is
not appropriate to valuing these properties. Given the life lease
structure, the existing income stream generated by the project is
not market rent. The rents paid by the occupants are reflective
of the entrance fee payments and any additional payments made by
the purchasers of the life lease interest. Market rents have not
justified the construction of new residential projects for many
years as such projects are not economically viable. Furthermore,
an analysis of market rental value is not appropriate as there
are no comparable rental units available and such rents are not
in any event based on similar entrance fees and additional
payments. An income approach analysis would not indicate the
total market value of the subject property unless the entrance
fees and additional amount paid by the occupants were taken into
account as the owner receives both the monthly rent and the
entrance fee.
[40] In her conclusion, counsel made
reference to several decisions supporting the proposition that
the actual cost to construct is highly representative of value
and fair market value for GST purposes. These comments reflected
situations in which both non-profit and for-profit projects were
being valued. The Respondent to that extent relies on these
decision as being determinative.[9]
Analysis
[41] The Manitoba Life Leases Act[10]defines a life lease as follows:
"life lease" means a written tenancy agreement under
or in respect of which
(a) an
entrance fee has been paid or is payable in respect of a rental
unit; and
(b) the
person first entitled to occupy the rental unit under the
agreement is granted a right of occupancy for life or for a fixed
term of not less than 50 years, if the agreement is entered into
after the coming into force of this Act in respect of a
rental unit in a residential complex in which no unit has been
the subject of a life lease that was entered into before the
coming into force of this Act,
and includes any separate agreement under which the entrance
fee has been paid or is payable; ("bail viager").
[42] A brief review of the life lease
program in Manitoba is warranted. The imposition of rent controls
in Manitoba in the 1980s resulted in a shortage of available
rental accommodation because the market rents obtainable for new
apartments were not sufficient to support their construction.
This created a problem with respect to seniors' housing. The
life lease program was initiated by the provincial government at
a time when it and the federal government were backing out of new
initiatives for social housing and deep subsidies. Leeies, at one
time an employee of the department involved in these issues,
testified that the provincial government of Manitoba decided to
address the fact that there were a number of communications from
user groups, particularly seniors, whose incomes were just high
enough to disqualify them for the deeply subsidized rent geared
to income program. A decision was taken to assist this particular
user group which consisted of seniors in a home or rental
property and the life lease program was developed to address
their needs. Leeies observed that it was a program designed
for:
... home owners, who were somewhat equity rich, income
poor, is how they were came to be categorized, or they had a home
free and clear, they had some equity tied up in it, but they had
very low incomes, maybe only a Canada Pension. And those folks
were somewhat trapped in that house, in many cases, was
depreciating. They couldn't look after the house. It was no
long really a suitable accommodation for them, but they were not
eligible to move into the government-sponsored housing. So they
could take the equity from the home and transfer it into this new
form of shelter that accommodated their different lifestyle
basically.
In an effort to deal with this problem, the Appellants (and
others) became involved in programs whereby they acted as the
sponsors of seniors' housing projects using the concept of
life lease apartment rentals. It must be noted as well that as
contrasted to non-profit housing which was subsidized by
federal/provincial programs, life lease projects in Manitoba at
the relevant time did not receive funding assistance from any
level of government as a result of which all of the required
capital was raised privately.
[43] The issues in dispute relate to the
fair market value of the four complexes at the time the
Appellants were required to perform self-assessments. Counsel for
the Appellants has indicated that with respect to the meaning of
fair market value in appraisal theory and practice the following
definition put forward by the Respondent's expert, Pestl, is
acceptable:
For general purposes, market value may be defined as: - The
probable price estimated in terms of money which the property
would bring if exposed for sale in the open market by a willing
seller allowing a reasonable time to find a willing buyer,
neither buyer nor seller acting under compulsion, both having
full knowledge of the uses and purposes to which the property is
adapted and for which it is capable of being used, and both
exercising reasonable judgement..
Implicit in this definition are the following: -
(i) the
parties to the transaction are typically motivated;
(ii) both parties
are well informed or well advised, and acting in what they
consider their best interests;
(iii) a reasonable time is
allowed for exposure in the open market;
(iv) payment is made in
terms of cash, in Canadian dollars, or in terms of financial
arrangements comparable thereto; and
(v) the price
represents the normal consideration for the property,
unaffected by special or creative financing or concessions
granted by anyone associated with the transaction.
A definition of market value is not complete without an
indication as to the estimate of exposure time linked to the
value estimate. Exposure time is the estimated period the
property interest being appraised would have been offered on the
market prior to the hypothetical consummation of a sale at market
value on the effective date. Exposure time is always presumed to
precede the effective date of the value estimate, and is based
upon an analysis of past market events and trends, as they apply
to the type of real property under consideration.
[44] There is substantial disagreement
between the parties with respect to three issues. First, the
Appellants maintain that the highest and best use of the
properties was as multiple family residential rental complexes
for seniors. On the other hand, the Respondent argues that the
highest and best use was a continuation of the existing use, i.e.
as a life lease complex. Second, the Appellants maintain that
there was no separate market in which the life lease complexes in
issue would be purchased at their cost price by a life lease
group. Third, that even if such a sale, at cost, was to take
place it would not constitute a fair market transaction. The
first two are interrelated. If there is a separate market for
life lease complexes then a basic premise upon which the
Appellants' economic obsolescence theory is founded becomes
questionable.
[45] I turn first to the "separate
market" issue which requires consideration from two aspects.
First, is there a market for life lease projects in Manitoba and,
second, would a sale of a complex to another not-for-profit life
lease sponsor meet the definition of a fair market transaction?
Given the Appellants' position, it is appropriate to consider
the history of such projects in Manitoba. In his report, Pestl
observed that the first such complex in Winnipeg, Kiwanis
Chateau, a 122-unit building was constructed in 1988. After
this initial project, this housing type became popular with
seniors in the Winnipeg community and in 1998, there were 18
completed life lease projects in Winnipeg, with a total of 1,073
units and another six projects in the construction or planning
stages. The CMHC Report also indicated that the sponsors of these
projects included community organizations, church groups,
property management firms and the like. The existence of a
growing market is further established by the representatives'
testimony that they wished to be active participants. For
example, Lyons observed that in the past, S.A.M. had developed
projects through CMHC's guaranteed mortgages and/or the
provincial guaranteed subsidy programs, but these programs had
ceased. He further indicated that the motivation which led to the
involvement of S.A.M. in the Colorado project and others was, in
part,the difficulty of maintaining a paid professional staff
since "you need a certain level of projects to sustain
yourself" and in this context, they saw "the future of
senior housing in the life lease area within Winnipeg at the time
and we wanted to be active in supplying it". As a result,
S.A.M. currently manages six life lease projects, was the sponsor
of one, Colorado, and was also involved in the development of
Vasalund, another life lease project by providing staff for
marketing and other duties. Acorn and its president, Leeies,
provide professional consulting to various non-profit
groups. He is also the president of Murdoch, a property
management company. Leeies was the consultant in the Villa
Beliveau project and Murdoch, in due course, was retained as
property manager. Both are substantially involved in the life
lease development area. In fact, the Murdoch website contains the
following commentary:
Murdoch Management currently manages the homes of over 750
non-profit households valued in excess of sixty million ...
current waiting list details are as follows - over 3,500
households for market life lease projects, over
600 households for subsidized seniors ...
(My
emphasis)
I also note that Pestl conducted appraisals of nine life lease
projects and "investigated, I think, 11 or 12 where we
looked at all the documents and that sort of thing". He
specifically asked each of the administrators in the projects
involved whether there was a waiting list of prospective
occupants for their building and was told that in many instances,
there was an active list and that there had been very little
turnover of the units in the time prior to his inspection of the
building. Given these facts, it is reasonable to conclude that
there was a substantial demand and a market for the life lease
concept during the relevant period of time.
[46] Notwithstanding the existence of a life
lease market, the Appellants reject the conclusion reached by the
Respondent's appraiser that a typical willing buyer for the
properties in issue would likely be another not-for-profit group
wishing to provide similar residential accommodation to the
community. The disagreement comes down to the question whether
not-for-profit groups would be willing and able to purchase a
complex for the purposes of developing life lease projects or
whether these would end up on the "normal market". In
support, several propositions were advanced by the Appellants:
(a) there are fairly rigid geographic limitations as
to the suitability of a building location; (b) there is no
example of a not-for-profit group buying or attempting to buy an
existing building; (c) delays associated with the promotion
of these projects preclude a market purchase within a reasonable
time of exposure; and (d) the method of financing is not
conducive to acquiring an existing project since the non-profit
groups involved do not have funds whereby they can obligate the
group to purchase any property.
[47]
Location: Counsel for the
Appellants emphasized the importance of the "geographic
location" to a "community" such as the church
group involved in Villa Beliveau and that each community's
particular requirements limited the size of the market.[11] While this may have
been a factor in Villa Beliveau which was strongly connected to
the local parish and was promoted and developed for a
lower-income group, it was in my view, atypical. In direct
contrast to Villa Beliveau is the Southpark project. It too was
initially directed at a community affiliated to the local church.
However, it quickly became apparent that such an approach would
fail and the doors were opened to "anybody over age 55 who
were of any denomination, any church, and had the ability to
pay". Riley described the first occupants of the property in
1997 as:
... I would say that 40% of the people were from our own
church community and then the rest of them, the other maybe 40%
would be from the community, Fort Richmond, Richmond West. So
there was lots of different denominations there as far as
church-going people are concerned. And because of the
advertising, we even attracted a lot of people, i.e. - I'm
thinking of all the people that we went through here, but just
about the tenants, there was some people moved in from Dauphin, I
know of that are still there, that type of thing, from other
areas in the City, but I would say that 80% of the people were
from that community.
With respect to Colorado, Lyons testified that there was no
parish or other specific group involvement in its development,
and no particular group was being targeted. The initial
advertising covered the whole area of St. James and since a new
bridge was to be constructed across the Assiniboine River, the
Charleswood community was also approached. In the case of Virden,
there is no evidence that any specific group was targeted to the
exclusion of others. Given these facts, I am not convinced
that the location factor is as relevant as the Appellants
contend. The particular inclination of any individual to reside
in a specific sector of the City, either as a purchaser or tenant
is not unusual and exists in the housing, condominium and rental
markets.
[48] Purchase of an existing non-profit
building: Leeies testified that Acorn has never
undertaken the acquisition of a completed life lease project and
did not believe it could occur. He also made specific reference
to two life lease projects "that have gone under" and
"couldn't really be sold for a long time, and
ultimately, they were purchased at a very low cost and turned
into rental, I believe". However, he was either unaware
or did not mention that these projects collapsed because, as was
noted by Lyons:
... the Doulton was a strange little building because it
was more of a high-rise building. It was structured on a very
small floor plate. That kind of building attracts or is
attracted, or attracts the kind of tenants that are of an older
nature, usually getting into the 75 or 80s. The high-rise,
smaller units, you know, no walking up and down stairs, it's
all elevator transport, that kind of stuff generally appeals to
an older group.
The three-storey walk-up kind of townhouse style that we
were trying with the Mager, the Villa Mager, was attracting the
younger group. I think our biggest problem there was again the
fact that St. Vital, on that strip, had some very low-cost
condominiums and our rents were just a little too pushy.
The Islands was an attempt to develop bungalow-style
residences and this:
... style has not worked with life lease. It doesn't
have the amenity space. It doesn't have the congregant kind
of community living that the seniors are looking for and it's a
very hard sell.
As a result, Lyons said:
... essentially we couldn't make the numbers. In
other words, through all of our marketing on both the Doulton,
the Villa Mager and The Islands, we never got to the level of
comfort that the bank was happy with.
Given their obvious unsuitability, it is not surprising that
these projects failed. Furthermore, the absence of a sale does
not lead to a conclusion that there was no circumstance where a
life lease sponsor would acquire an existing building. Lyons
testified that as far as he knew, S.A.M. had never been
approached with respect to such a purchase nor had they ever
contemplated doing so but, he noted "nobody came to us to
say they wanted to get out of whatever they were currently
owning, no". He conceded the possibility of such a purchase
if S.A.M. had a waiting list of individuals interested in
acquiring a life lease and if an appropriate building became
available on the market, stating: "I guess there is a
theoretical possibility, I would if I had all the tenants already
in place, yes". It is reasonable to conclude that there was
a demand for non-profit life lease projects and the fact that no
sale of an existing non-profit building had occurred establishes
nothing more than that an appropriate project had never been put
on the market.
[49] Delays - financing: Counsel for
the Appellants made particular reference to Leeies' description
of the steps involved in the development of a life lease project
which included, inter alia, finding a suitable location,
retaining a development consultant, creating a non-profit housing
corporation, controlling the land preferably by way of an option
and identifying interested potential life lease tenants. At this
stage, preliminary capital cost estimates and first year
operating costs were considered, preliminary marketing and
advertising material was disseminated, and initial efforts were
made to obtain tenant deposits (refundable) and commitment
agreements with potential tenants to provide the equity to secure
financing. When the sponsors had a sufficient number of
commitments from tenants to proceed, the process entered stage
two at which time the architect and engineers proceed to working
drawings and contract documents, obtain firm construction costs
and continue marketing. The Appellants contend that the length of
time it took the sponsors to obtain commitment agreements and
tenant deposits clearly indicated that there is no prospect that
a life lease sponsor could put together a tenant group in the
three-to-six month period of time suggested by the
Respondent's appraiser as a timeframe for the hypothetical
sale of one of these complexes.
[50] Although I have reservations regarding
Pestl's assessment that a three-to-six month period was
reasonable for the hypothetical sale of one of the subject
properties, the Appellants' contention that a period in
excess of two years would be necessary is equally questionable.
The project representatives made it clear that the substantial
delays during the early stage of development when the property
was being advertised and promoted occurred, in part, as counsel
for the Appellants observed, because "you can't approach
tenants without having a building, or at least a location and a
plan in mind, that's not practical, and you can't simply
tell a seller to wait for two to four years, with no guarantee
that you could ever go through with the deal". That is
understandable but as Leeies noted, the delays occurred
because:
we find a very large number of people sit on the fence, the
undecided people. There's a group of people who tell us,
'we've been with the project for two years. We like it,
but we're not going to lease one until we see the bricks and
mortar'. And some people have difficulty in reading the
drawings and, you know, understandably, they want to walk around
the building.
Furthermore, life lease projects provide the congregant social
amenities this particular market demanded. By way of example,
Colorado included a recreation area consisting of a sunroom, a
library, a billiard room, an exercise room and a lounge which had
"a kitchen and dishwasher and that kind of thing" and,
Lyons said, that without these additional facilities "we
would never be able to market the building". It is
reasonable to conclude that the existence of a newly completed
life lease residence would have a positive impact on potential
lessees and would substantially reduce the length of time it
would take to obtain the necessary commitments and thereby enable
the sponsor/purchaser to secure the necessary bank financing.
[51] I turn next to the second branch of the
Appellants' argument, the economic obsolescence issue. There was
no significant disagreement as to the replacement cost
attributable to the properties. The principal issue between the
parties is whether the properties were affected by the economic
depreciation that affected other multiple residential rental
complexes. More specifically, it relates to the application of
economic obsolescence to this approach, by the Appellants'
appraiser, Steele. This concept was based on his conclusion that
the highest and best potential use of the properties would not be
as a life lease project or a residential condominium complex for
seniors but rather, as leased premises for seniors. The alleged
obsolescence was based primarily on the fact that rent controls
had a significant negative impact on the apartment rental market
as a result of which no new apartments have been built since the
rent structure was not sufficient to justify their construction.
He concluded that as a result, there was substantial economic
obsolescence negatively affecting the market value of the
properties in issue. That approach was correct, the Appellants
say, and that being the case, the Respondent's appraiser was
wrong in excluding economic obsolescence from his appraisal and,
more particularly, that it was rejected on the basis that there
was a separate market for complexes to be purchased by
non-profit groups looking to develop a life lease
project.
[52] In view of the Appellants' reliance
on Steele's opinion that economic obsolescence existed, the
basis for his conclusion must be carefully examined. I turn first
to his qualifications. Steele stated that he was no longer a
member of the Canadian Appraisal Institute and that he did not
"live by the Appraisal Institute". He was not aware
that the former U.S. Professional Appraisal Practice standards
were no longer adopted by the Canadian Appraisal Institute since
Canadian uniform standards were introduced in January 2001. He
was aware of their existence but had not read them and had no
intention of doing so but rather chose to apply his own methods
and approaches to appraisal.[12] Thus, while he has a significant amount of
experience, his failure to adequately document the information
relied upon and to establish that the methods utilized by him
were sound in principle creates concern as to the factual basis
upon which his conclusions were drawn. This is so particularly
with respect to his opinion that there was substantial economic
obsolescence negatively affecting the market value of the
properties. In his view, the actual development and construction
costs for the properties did not accurately reflect costs and
were, he said, in general higher than if the product had been
developed in "normal market conditions". He attributed
this increase as being stimulated by fees and profits for
developers, consultants and contractors, as well as the lack of
appropriate project management and maintains that in estimating
the market value of the properties in issue, care must be
exercised not to use these "excess development costs even if
they are actual costs".[13] As was noted by the Respondent's appraiser,
this resulted in his concluding that in the case of Colorado, the
cost was 91.5% of the actual cost, Southpark was 89.7%, Villa
Beliveau 77.2% and Virden 92.5%. As a result, the value of the
new complexes was reduced by 42.5% to 51.8% of their estimated
replacement cost new, an amount significantly less than their
actual construction costs. It is difficult to accept these
results given the fact that there was virtually no supporting
data for his conclusion. With respect to Steele's replacement
cost analysis, Pestl made the following comment:
As a result of the appraiser dismissing the actual development
costs of the projects, substituting unsupported cost estimates
and land values, and most significantly due to the application of
the substantial estimated economic depreciation to the
improvements, the indicated value by the cost approach is grossly
understated.
I agree with this conclusion.
[53] The second branch of Steele's analysis
relates to his application of economic obsolescence to depreciate
the value of the properties in issue. In this context, Pestl
observed as follows:
With respect to the estimated economic depreciation applied by
Sterling, we note that this is premised on the fundamental theory
that the subject complexes are apartment rental units. That is
the depreciation applied is reflective of the shortfall in net
income which would normally be required on an investment of
capital in the construction costs of the complex. This theory is
not consistent with the facts, nor with the market. Fundamental
to this theory is that the entrance fees, paid by each and every
occupant in the complex, should be ignored for the purposes of
valuation. We do not consider this a reasonable proposition. The
Entrance Fees are in fact paid, and are initially used to finance
the project construction. These fees are recoverable on the
termination of the lease, and are paid by subsequent occupants of
the units. The fees directly affect the amount payable as monthly
rent during the term of the lease.
No interest is paid on the entrance fees and they benefit the
owner of the complex by reducing the amount of the total
financing required for the development of the complex. In most
instances, the additional capital payments may be made by unit
occupants, further reducing the monthly rental amounts specific
to their unit.
There is an obvious relationship between the entrance fees
paid by the tenants and the monthly rents, which Steele chose to
ignore.[14] It
was wrong to do so since as Pestl noted, the income approach
would not indicate the total market value of the subject property
unless the entrance fees and additional amounts paid by the
occupants were taken into account.
[54] A question was also raised regarding
the manner in which Steele utilized the cost and income
approaches in his analysis. Pestl observed that the three
approaches:
... are standalone processes and they're designed to
be standalone processes because you are hoping to develop at
least one, but hopefully two, methodologies of valuing the
property, independent of each other, in order to get an assurance
that that is the value of the property. So you're getting
more than one indicator of value by two independent
methodologies. What Mr. Steele has done is he's combined the
two, the cost approach with the income approach by extrapolating
an economic depreciation on one approach and transposing it into
the other to justify a reduction for economic obsolescence in the
other approach. So if one approach is incorrect, it automatically
renders the other result incorrect and if it's a transferred
over adjustment, then it depresses both values.
I have concluded that Steele's appraisals must be rejected
and in so doing, I adopt the following comments of Pestl with
respect thereto:
... both the Cost Approach and the Income Approach to
value as developed in the report are fundamentally flawed. The
Income Approach is based upon an examination of rents paid by
occupants of Conventional Multiple Family Residential Complexes,
which are no longer being built in the rent controlled
environment, and/or on Non-Profit Multiple Family Residential
Complexes in which instance entrance fees are prepaid and not
reflected in the income stream. As a result, the Income Approach
to valuation results in a substantially understated indication of
value. This understatement is then carried over into the Cost
Approach to value analysis by the attribution of the significant
economic depreciation applied to the cost estimates, which
depreciation is directly based on the revenue shortfall resulting
from the income analysis ignoring the entrance fee payments
required in order to occupy units in the subject complex.
[55] Life Lease Projects - Not Fair
Market
Transactions:
The Appellants further argue that since none of the life lease
projects occur without concessions from the individuals involved
and could not have occurred without special or creative
financing, the transactions involving the development of
non-profit life lease housing do not meet any element of the
definition of fair market value. The basis for this proposition
is a concept espoused by Steele and accepted by the Appellants
that such transactions would not be reflective of "market
value" because there was no financial return, i.e. there was
no profit motive. As counsel put it "they're not seeking
personal gain. They're not seeking a return on investment.
These are social projects, not market transactions". As a
result, the Appellants maintain that even if another charity were
to buy one of these complexes to develop a life lease project and
even if it did pay the replacement cost, it would not be a market
value transaction because the vendor was not seeking a return on
investment. I do not agree. This argument is premised on the
assumption that an entrepreneurial profit is a necessary element
which must be considered by the appraiser in his determination of
market value. Counsel supported this proposition by reference to
Moss v. The Queen.[15] In that case, the taxpayer was in the business
of construction and sale of residential properties. He failed to
include in his income amounts earned from the business as a
result of which the Minister assessed to increase his income and
assessed penalties. One of the issues was the taxpayer's
credibility with respect to his construction costs and profit
margins as well as his allegations of losses incurred on the sale
of properties in issue. Both parties tendered appraisal evidence
to establish construction costs but in each instance it was of
dubious quality. Absence of acceptable evidence was of
substantial concern to the Court since, as was observed in The
Appraisal of Real Estate:
Because the extent of entrepreneurial profit varies with
economic conditions, a typical relationship between it and other
costs is difficult to establish; however, entrepreneurial profit
should not be omitted from the cost approach. Entrepreneurial
profit is a necessary element in the motivation to construct
improvements ...
There is no dispute that entrepreneurial profit is a necessary
element and should not be omitted or ignored when the cost of
construction is being determined by an appraiser. But that is not
in issue in these appeals and is not relevant to the issue before
this Court. It is also a fact that both appraisers had access to
the actual costs of construction and, in each case, made their
own determination with respect to replacement costs. Furthermore,
the Appellants conceded that there was virtually no dispute
regarding replacement costs. The Appellants' position that the
absence of profit motivation on the part of the sponsor/owner
would convert a sale of the life lease property into something
other than a market value transaction is simply not tenable and
is inconsistent with the accepted definition of fair market
value.
Conclusion
[56] The ultimate aim of the appraisal
process is to determine the probable price which the
property would bring if exposed on the open market. The evidence
before the Court leads to the following conclusions:
(i)
the highest and best use of the properties in issue is a
continuation of the existing use, i.e. a life lease senior
citizen's multiple residence;
(ii)
there was a substantial market for life lease projects in
Manitoba at the relevant time;
(iii)
the sale of a complex to another not-for-profit life lease
sponsor would meet the definition of a fair market transaction;
and
(iv)
the fair market values of the properties in issue are as
determined by the Respondent's appraiser, Pestl.
It is also necessary to consider the Appellants' contention
that no such sale could occur within a reasonable time. In this
regard, it is common ground that with respect to the projects in
issue, the time it took to secure sufficient commitments was 13
to 14 months for Colorado, 18 to 19 for Southpark, 19 for Virden
and 2½ years for Villa Beliveau.[16] Given the advantage of having a
completed building ready for occupancy, it would not be
unreasonable to consider a range of 12 months to 18 months as an
appropriate hypothetical timeframe for the sale of one of the
properties in issue.[17]
[58] For the foregoing reasons, the appeals
are dismissed, with one set of costs to the Respondent.
Signed at Ottawa, Canada, this 1st day of November, 2004.
Sarchuk J.
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