In the Dallas/Fort Worth area, fast food chain locations sell for a fraction of their original construction cost because they no longer operate as chain restaurants or because they are sold to second generation non-restaurant-chain operators. Texas appraisal districts, however, tend to take the opposite approach. That approach is a dollar spent equates to a dollar of taxable market value, so how do you prove that the districts are wrong? Can one prove that the cost approach is not the best approach to use when valuing chain locations? Doesn't the cost approach really determine the fee simple taxable market value of a chain restaurant? Is it true that the income and the sales comparison approaches may not be appropriate in valuing a new chain property? How do appraisal districts measure the going concern value of a chain restaurant? These are some of the questions that are discussed in this article.

VALUING CHAIN~THE COST APPROACH

Is it safe to assume that the cost approach is the best approach to use when valuing a chain restaurant? The answer in this author's estimation is, no. The cost approach should be challenged as the exclusive method of determining the taxable realty value of chain locations. Further, the other two approaches to value, income and sales comparisons, should be modified to truly appraise the taxable restaurant market. In the third quarter, 1990 issue of the Enterprise Valuation Reporter, John D. Emory, value points out that:

Business valuation has to do with the value of the rights inherent in ownership of a commercial, industrial or service organization pursuing an economic activity. Real estate appraisal involves the valuation of land, improvements and associated rights. Real estate appraisal does not deal adequately with the whole area of intangible business assets such as patents, trademarks, copyrights, goodwill, customer lists, employment contracts, covenants not to compete, exploration rights, intangible drilling costs, franchises and licenses. The more a company depends on its intangible assets to generate earnings, the more important such assets are in any business enterprise value. Robert Reilly notes in the January 1993 issue of Valuation, published by the American Society of Appraisers, that:

Traditionally, real estate appraisals of location-dependent commercial encompass a portion of (if not all of) the intangible business enterprise value of the property.. .. The naive application of real estate appraisal procedures to location-dependent businesses will ignore the fact that the real property's highest and best use (and total concluded value) are dependent upon the existence and assemblage of such location-specific intangible assets as business licenses, certificates, permits, and franchises and such non-location-specific intangible assets as a trained and assembled workforce, goodwill, and going concern value. Therefore, by including an economic contribution from these intangible assets, the real estate appraisal may overstate the true market value associated exclusively with the subject “bricks and sticks” for these location-dependent businesses.

It has been this author's experience that Texas appraisal districts believe the primary approach to valuing chains is the cost approach; that is, the acquisition cost of the land plus the cost of personal property, plus the hard and soft costs of the improvements, less accrued depreciation, represent the taxable market value of a chain restaurant. The theory apparently relies heavily on the principle of “substitution,” which The Appraisal of Real Estate, published by the American Institute of Real Estate Appraisers, defines as:

The principal of substitution is basic to the cost approach. This principal affirms that no prudent investor would pay more for a property than the cost to acquire the site and construction improvements of equal desirability and utility without undue delay.. .. Because cost and market value are closely related when properties are new, the cost approach is important in estimating the market value of new or relatively new construction. The approach is especially persuasive when land value is well supported and the improvements are new or suffer only minor accrued depreciation and, therefore, represent a use that approximates the highest and best use of the land as though vacant.