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IN THE OREGON TAX COURT
REGULAR DIVISION


LINUS OAKES, INC.,
an Oregon nonprofit corporation,
fka Parkway Medical Buildings, Inc.,
Plaintiff,
v.
DEPARTMENT OF REVENUE,
Defendant,
and
DOUGLAS COUNTY ASSESSOR
Intervenor-Defendant.
(TC 4234)

Plaintiff, owner of a continuing care retirement center, appealed the 1995-96 assessed value of its property. The court found that all three methods of valuation were appropriate to use in determining the property's real market value, lending the greatest weight to the cost approach. The court determined that the total indicated real market value of Plaintiff's property was $9,455,000.
Property taxation-Income approach

1. When using the income approach for valuing tangible real property of a going concern that provides many services for which income is received, there is some danger of incorrectly valuing the property. That danger arises from the difficulty of separating income for services from income for property use.
Property taxation-Income approach

2. Refundable entrance fees are part of the flow of benefits to property; therefore, they should be considered in
determining a property's value under the income approach.
Trial was held May 22, 23, and 24, 2000, in the courtroom of the Oregon Tax Court, Salem.

Marc K. Sellers, Schwabe, Williamson & Wyatt, Portland, argued the cause for Plaintiff (taxpayer).
James C. Wallace, Assistant Attorney General, Department of Justice, Salem, argued the cause for Defendant (the
department).

Paul E. Meyer, Assistant County Counsel, Douglas County, Roseburg, argued the cause for Intervenor-Defendant (the
county).
Decision for Defendant and Intervenor-Defendant rendered July 20, 2000.

CARL N. BYERS, Judge.

Plaintiff (taxpayer) appeals from an opinion and order of Defendant Department of Revenue (the department) setting the assessed value of taxpayer's real property for the 1995-96 tax year. Douglas County Assessor (the county)
intervened and filed a motion for partial summary judgment to resolve a dispute as to whether taxpayer qualified for special assessment under ORS 307.375 through 307.490. (1) After considering the motions and arguments of the parties, the court issued its order on November 4, 1998, holding that taxpayer did not qualify for special assessment as of July 1, 1995. See Linus Oakes, Inc., v. Dept. of Rev., 14 OTR 412 (1998). Thereafter, the parties had the property appraised to determine its real market value, and evidence of value was submitted at trial.

FACTS
The subject property is operated as a continuing care retirement center (CCRC) in Roseburg. It is situated on 16.34 acres adjacent to Mercy Hospital. (2) The improvements consist of 2 main buildings or lodges and 15 separate smaller buildings called cottages. The cottages vary in size from 16 units to duplexes. As of the assessment date in question, 105 of the total 123 units were completed; 10 were 60 percent complete and 8 were 10 percent complete.
The main buildings contain large common areas as well as living units. The common areas consist of the main dining area, social and recreational rooms, exercise rooms, activities and sitting rooms, beauty and barber shop, bank, library, post office, chapel, and storage areas. The main buildings also contain administrative offices.
Elderly housing facilities can provide varying levels of service, ranging from almost no services (i.e., simply a retirement community setting) to acute nursing care. The subject facilities were designed for "independent living," which entails a relatively low level of services. Taxpayer provides its residents with one meal per day, one hour of housekeeping per week, bed and bath linen service, maintenance of the unit (both interior and exterior), transportation for activities and medical needs, and a resident nurse who mainly serves as an educational resource to the residents. Taxpayer also sponsors activities, seminars, classes, and outings.
At the highest service level, a CCRC provides care for its residents until their death, which normally requires nursing facilities on site. Taxpayer has elected to be at the lowest end of the CCRC level of service scale. Taxpayer's residents are entitled to remain in their units until death, but taxpayer provides no nursing care on site. It does provide up to ten days of offsite-nursing care per year for its residents. A resident chooses an offsite provider and taxpayer pays the bill.
Like many such facilities, taxpayer charges an entrance fee as well as a monthly maintenance fee. For example, as of July 1, 1995, to become a resident and live in the smallest one -bedroom unit, a resident would have had to pay an entrance fee of $40,900 and a monthly maintenance fee of $963 ($1,301 double occupancy). The cost of the largest unit as of the assessment date was $89,332 entrance fee and $1,767 monthly maintenance fee ($2,105 double occupancy). By agreement, if a resident leaves or dies, up to 75 percent of the entrance fee is refundable without interest. There are additional elective charges for such amenities as cable television, covered parking, tray service, and charges for guests who may use the facility's guest rooms and meals.
Summary of Appraisal Evidence
Taxpayer's appraiser, Donald Palmer, is experienced and knowledgeable with regard to retirement facilities. He applied only two of the three traditional approaches to value. He declined to use the cost approach because he concluded that the market does not use that approach when setting sale prices and the subject property suffered some functional obsolescence. Using the income approach, he concluded that taxpayer's actual charges and expenses were representative of the market. Based on his analysis, he found an effective gross income of $1,768,198 from which he deducted expenses of $1,364,607 to find a net-operating income of $403,591. Inasmuch as the expenses did not include property taxes, he added 1.5 percent for property taxes to a direct capitalization rate of 11 percent. Dividing $403,591 of net income by 12.5 percent gave him an indicated value of $3,228,730 ($3.2 million rounded). (Ptf's Ex 10 at 64.)
Using the direct sales-comparison approach, Palmer used five sales that ranged from $52,519 to $89,888 per unit. After considering the differences in levels of care, design, and other factors, he selected $50,000 to $55,000 per unit as the most probable value for the subject property. (Ptf's Ex 10 at 69.) That gave him an indicated range of value by the sales comparison approach of $5,550,000 to $6,105,000. Palmer viewed the sales comparison approach as unreliable and placed no weight upon it.
The department's appraiser, James Brown, is also very experienced and knowledgeable in appraising elderly housing facilities. He utilized all three approaches to value. In applying the cost approach, he used the segregated component method, estimating the amount and quality of the improvement components, determining their cost, and then deducting any depreciation. Brown utilized Marshall Valuation Services for his cost data, which is a national firm that provides cost information to appraisers for a fee. Based on his estimates and the costs obtained, he found an indicated cost of $11,128,000 new. Brown analyzed bare land sales and determined that the value of the land was $710,000. He deducted physical depreciation based upon his judgment that the completed improvements had an effective blended age of eight years. A deduction was also made for improvements that were not complete as of the assessment date. After these deductions, Brown had an indicated value by the cost approach of $9,360,000. (Def's Ex A at 52.)
Applying the direct sales comparison approach, Brown used four sales, one in Oregon and three in California. Based on the price per unit, he found that the sales gave a range of $61,129 to $88,764 per unit. Determining that the average units in the sales were smaller than the subject, he adjusted the sales 28 percent for size, which gave him a range of $80,000 to $88,764 per unit. Selecting $85,000 as the best indicator and multiplying by 123 units gave him a gross value of $10,455,000. He then deducted for the incomplete units and personal property to find an indicated value by the sales comparison approach of $9,320,064 ($9,320,000 rounded). (Def's Ex A at 62.)
In the income approach, Brown also used the actual rents charged by taxpayer. However, he included imputed earnings on the refundable portion of the entrance fee as additional rent. He calculated entrance fee income by attributing a 9 percent return on the total amount of entrance fees for ten years, at which time 75 percent would be refunded. He then discounted the earnings and the retained portion of the entrance fees back to a present value and then amortized that present value forward over ten years at 9 percent. The net result is to increase the income of the subject facility by $776,616 per year. (Ptf's Ex 7.) That approach resulted in an effective gross income of $2,500,000 (rounded). Brown used eight rent comparables to estimate expenses of $1,335,000 (rounded), leaving him with a net operating income of $1,165,000. When that amount is divided by a direct capitalization rate of 11 percent, it results in an indicated value of $10,590,909. (Def's Ex A at 79.) From this amount, Brown deducted for the incomplete units and personal property, leaving him with an indicated value of $9,450,000 by the income approach. In his reconciliation, Brown relied primarily on the cost approach and determined that the real market value of the subject property was $9,800,000.

ANALYSIS
As property that does not qualify for special assessment under ORS 308.490, the subject must be assessed at its real market value. Therefore, the court must determine the lowest amount for which the property would have exchanged hands between a willing buyer and a willing seller during the period of July 1, 1995, to June 30, 1996. ORS 308.205.
As is often the case, there are many areas of agreement between the two appraisers. Here, they agree that the highest and best use of the property is as a retirement facility. They agree that the quality of the improvements is average to good or average plus. (Ptf's Ex 10 at 34; Def's Ex A at 25.) They agree that the management is excellent, and they agree that there is a strong market demand for elderly facilities. They also agree that if the property were put on the market, it would sell within one year or less; however, there are few market sales and such properties are not usually listed on the open market. (Ptf's Ex 10 at 70; Def's Ex A at 5.) As will be seen below, those points of agreement are important.
Cost Approach
The fact that there is market demand for elderly facilities and few sales suggest that such properties should be able to obtain a good return on investment. Palmer disagrees. Palmer concluded that cost is not a good indication of value because the costs were "outrageous" when compared to rents obtainable. (Ptf's Post-Trial Br at 6.) However, the court finds that the evidence is to the contrary. In fact, as of the assessment date, taxpayer was in the process of adding an additional 30,000 square feet to its facilities because of market demand. Also, a new competing facility was built in Roseburg two-to-three years after the assessment date. Investors choosing to construct new facilities rather than purchase existing properties is evidence that investors can and do obtain a market rate of return on new construction.
Palmer also rejected the cost approach because of perceived functional obsolescence. However, he appears to have confused the value concepts applied under ORS 308.490 (special assessment) and those applied under ORS 308.205. If property qualifies for special assessment under ORS 308.490, that statute requires the income approach to consider how much gross income the property could receive if "leased or rented to the public generally." Under that test, the common areas in the subject property would probably be too large and therefore include some functional obsolescence. However, the property does not qualify for special assessment and must be valued at its real market value. The appraisers agree that the property's highest and best use for market value purposes is as a CCRC. When used as a CCRC, the common areas are not too large and are not a source of any functional obsolescence. Therefore, Palmer's rejection of the cost approach in part because of functional obsolescence due to the common areas is an error and weakens his opinion.
1. As Brown testified, the cost approach gives the best indication of value in this situation. Here, the objective is to value tangible real property, not going concern or business value. A CCRC is a going concern that provides many services for which income is received. Consequently, there is some danger of overvaluing or undervaluing the real property due to inability to separate income for services from income for use of the property. In the income approach, a typical method is to deduct the expenses of providing the services. However, if the operator is charging too little for the services, the income approach will undervalue the property. If the operator is charging too much for its services, the income approach will overvalue the property. The cost approach eliminates this danger by avoiding any going

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