                           NOT DESIGNATED FOR PUBLICATION

                                             No. 121,005

               IN THE COURT OF APPEALS OF THE STATE OF KANSAS

                          In the Matter of the Equalization Appeal of
                                  CITY OF COUNCIL GROVE,
              for the Tax Years 2014, 2015, and 2016 in Morris County, Kansas.


                                   MEMORANDUM OPINION

         Appeal from Board of Tax Appeals. Opinion filed June 19, 2020. Reversed and remanded.


         Linda Terrill, of Property Tax Law Group, LLC, of Overland Park, for appellant City of Council
Grove.


         Michael A. Montoya, of Michael A. Montoya, P.A. of Salina, for appellee Morris County.


Before STANDRIDGE, P.J., ATCHESON, J., and BURGESS, S.J.


         PER CURIAM: The City of Council Grove (City) appeals the valuation by Morris
County (County) of land owned by the City. We find that the appraiser hired by Morris
County to evaluate the land failed to take statutorily mandated factors into account when
conducting the appraisal. We reverse the Board of Tax Appeals' (BOTA) affirmation of
the valuation of the City property and remand for further proceedings.


         When determining fair market value "[s]ales in and of themselves shall not be the
sole criteria of fair market value but shall be used in connection with cost, income and
other factors." K.S.A. 79-503a. Other factors that shall be used include productivity,
rental values, and restrictions or requirements that are imposed by local governing bodies.
K.S.A. 79-503a(f), (h), (j).


                                                   1
       The City owns the Council Grove City Lake (Lake) which serves as the main
water source for the City. The City leases the land surrounding the Lake to individuals
which grant lessees access to the Lake. The leases impose some restrictions on the lessees
including certain actions that might affect the City's water supply. Lessees have the
ability to mortgage the land and to build homes on the land. The lease sets rent and
provides for how the rent can increase year-to-year. The lease is in effect for 30 years and
automatically renews for additional 30-year terms forever.


       The County hired an appraiser to determine the fair market value of the Lake for
tax purposes. The appraiser did not use the rent, as set by the leases, to determine the fair
market value of the Lake. The City appealed the valuation to BOTA who adjusted the
appraiser's valuation down but did not comment on the appraiser's failure to use the rent
as set by the lease.


       The City appeals BOTA's final order and decision.


                         FACTUAL AND PROCEDURAL BACKGROUND

       This case involves the improved land surrounding the Lake. The land, and taxes
involving the land, has already been addressed by this court, most recently in In re Tax
Appeal of City of Council Grove, No. 116,414, 2017 WL 3669088 (Kan. App. 2017)
(unpublished opinion).


       Essentially, the Lake and the land surrounding it is owned by the City. The Lake is
a source of water to the City. The City leases the land to individuals under a lease
agreement that this court has previously noted was "unique and may be the only one in
the State of Kansas." 2017 WL 3669088, at *1. There are 350 lots at the Lake.




                                              2
       The relevant portions of the lease agreement require the lessee to pay the City
$1,000 in 2012, $1,100 in 2013, and $1,200 in 2014. The lease provides that the City may
increase the rent under certain circumstances, such as a significant increase in
maintenance expenses. The lease also allows the lessee to "encumber by mortgage or
deed of trust . . . its leasehold interest and estate in the Leased Premises, together with all
buildings and improvements on the premises . . . however such encumbrance shall be
subject to the obligations of the Lessee to the City." As part of the lease, a lessee is
required to "not do, or permit, anything upon the leased premises that will jeopardize the
water supply of the City." Nor may a lessee use any chemicals on the leased premises
without a permit from the City. The lease also prohibits lessees from pumping water out
of the Lake without the approval of the City Council. Under the terms of the lease, the
City passes the ad valorem taxes through to the lessee.


       The lease is designed to work in a similar way for the foreseeable future. Under
section 4 of the lease:


               "The term of this Lease shall expire on December 31, 2041, regardless of its
       commencement date. Provided, however, this Lease, upon its expiration, shall
       automatically renew for a period of thirty years, and shall continue to renew for
       successive terms of thirty years perpetually. Notwithstanding the perpetual nature of this
       Lease, nothing herein shall be construed as divesting Lessor of legal title to the Leased
       Premises."


       The lease was drafted by the Council Grove City Lake Association (CGCL). At
the time, the mayor advocated for charging $2,500 per lease. According to Dave Fritchen,
"everyone went ballistic" over the proposed lease amount. A committee was formed to
address the rent amount, with members from local businesses, Lake residents, and the
City Council. The committee discussed numbers spanning from $600 to $2,500 a year
and ultimately arrived at a $1,000 per year amount with a slight increase each year.
Fritchen noted that the committee did not seek "a fair market rent, but part of the purpose
                                                    3
of bringing us together was the leaseholders around there were concerned about rent
stability." Fritchen also agreed with counsel that "the impetus behind all this movement
was to get the taxes down because they were going too high."


       The fair market value of the leased land has been a source of contention between
the City and the County for several years. See 2017 WL 3669088. For the 2012 tax year,
this court affirmed the property valuation of just over $2.3 million and dismissed the
appeal of the 2013 tax year for lack of jurisdiction. 2017 WL 2669088, at *2, 4-6. The
fair market value of the land is used to determine the amount of ad valorem tax the City is
required to pay. See K.S.A. 79-1439.


       The County hired Keller, Craig & Associates to appraise the Lake to determine its
fair market value for the tax years 2014, 2015, and 2016. Timothy Keller prepared an
appraisal report for each tax year.


       Keller's reports noted that the lease "was a negotiated settlement with no market
rent study ever performed. There are also some legal opinions that questions whether this
lease is binding. This opinion indicates that one acting City Council cannot enter into a
contract binding future City Councils actions." Based on Keller's assumptions the report
ignores "the below market ground leases which are in place at the subject property in the
analysis for arriving at market value."


       As part of the appraisal, Keller determined that the highest and best use of the
property was continued use as a lake front community. Keller did not use a cost approach
analysis to determine fair market value because it would be the least reliable analysis due
to the "age of the property and market conditions." Instead, Keller applied an income
approach to determine the fair market value.




                                             4
       According to the report:


               "Market rent is defined as the most probable rent that a property should bring in a
       competitive and open market reflecting all conditions and restrictions of the specified
       lease agreement including the rental adjustment and revaluation, permitted uses, use
       restrictions, expense obligations, term concessions, renewal and purchase options, and
       tenant improvements."


       Because of the low amount paid through the current lease, Keller considered three
lake land leases in the Midwest. When comparing the Lake to the other properties, Keller
considered the waterfront, water view, presence of boat docks, occupancy period, lot size,
and lake size. Keller's report acknowledged that the characteristics in the locations
differed and adjusted the valuations accordingly. For example, two of the comparable
properties had an inferior waterfront when compared to the Lake properties. Keller
adjusted their rent by increasing the rent by 100% to account for the difference. But those
same two properties had a larger lake, so he reduced their rent by 30% to account for the
different lake sizes. It is telling that this analysis does not indicate that any of the other
properties studied were owned by a municipality or that the lakes were water sources for
a municipality.


       Given his calculations, Keller estimated that an annual rent between $4,150 and
$5,600 was appropriate. His report settled on $5,500 annually based on "the amenities
that are available such as year-round availability and large sites that support permanent
structures."


       Keller then attempted to determine the net operating income for the Lake, using
his projected $5,500 rent. Keller determined that there would be a total net operating
income of $1,628,418 per year. After calculating the net operating income, Keller divided
that by a capitalization rate of 7%.


                                                    5
       He decided on a 7% capitalization rate after considering a 2013 capitalization rate
study, completed by Keller's firm, in Shawnee County, Kansas. According to the study,
the capitalization rate in Shawnee County for Class A properties was between 6.6% and
9%. Keller classified the Lake as a low risk investment and determined that it would fall
within a Class A property. Keller determined that a 7% rate was appropriate given the
type of property involved.


       By dividing the net operating income by the capitalization rate of 7%, Keller
determined the Lake had a market value of approximately $23,260,000.


       Next, Keller used a discounted cash flow analysis to determine a second market
value for the Lake. Keller determined that average similar lots sold for around $83,000.
Keller also used a five- and seven-year selling period to determine two market values.
Finally, Keller utilized a discounted rate of 10.5% in his calculations. After calculating
the value after a five- and seven year sell out, Keller determined that the average market
value between the two periods was $24,585,000.


       Using the market values derived from the two approaches, Keller determined that
the market value of the Lake, for tax year 2014, was $24,000,000. Using the same
methods, Keller determined that the market value of the Lake for tax year 2015 was
$25,000,00, and tax year 2016 was $26,000,000.


       The County assessed taxes against the City using Keller's appraised fair market
values. BOTA heard evidence and arguments regarding the valuation from the parties in
May 2018.


       Keller testified regarding his appraisals before BOTA. The City called Tom Slack,
a previous member of BOTA, to testify. Slack pointed out some possible problems with
Keller's report. For example, Slack explained that in the some of the reports, it seemed
                                             6
like the comparable landlord was paying taxes and expenses on the leased property,
without passing those costs onto the lessee. A lessee at the comparable location might be
paying $3,950 for rent, but the landlord is absorbing $1,300 in taxes, "if you take the
$3950 and subtract 1300, you're at $2600 net effectively passthrough." Slack called
Keller's report into question, in part, because that was "not identified or explained or
adjusted."


        Slack also thought that Keller's report was not credible because of his adjustments
to rent values based on differing amenities and features of the comparable properties.
When asked about the 100% adjustment due to lake size, Slack said that it was not
credible and pointed out that Keller supposedly chose the comparable properties he did
because "he liked the lake sizes." Slack thought this was confusing because Keller's
report had to adjust the rent so much for the lake size. Slack continued to discuss the
problem, saying "when your net adjustments are 200 percent, 190 percent, 190 percent,
and 100 percent, you have to ask, you know, how comparable are they if you have to
double or triple the rent? Double the rent minimal." Slack also noted that Keller failed to
offer any reasoning for his adjustments in his report.


        Slack also took issue with Keller's classifying the Lake as Class A property for
appraisal purposes. Slack thought it was unrealistic to believe that the Lake would
continue to be at full capacity if rent was to jump from $1,200 a year to around $6,000 a
year.


        Slack also thought Keller's report incorrectly assumed that a majority of the
leaseholds would transfer within five or seven years for purposes of the cash flow
analysis. To buttress Slack's assertion, Gary Catlin, a realtor in Council Grove, testified
on behalf of the City. According to Catlin, in an average year about 25 Lake leaseholds
transfer ownership.


                                              7
       BOTA issued a summary decision in November 2018. The parties requested that
BOTA issue a full and complete opinion. In its full opinion, BOTA briefly explained the
methodology used by Keller, including Keller's assumption that there would be a five- or
seven-year sell off period. BOTA also discussed Catlin's testimony that only 25
leaseholds are transferred in a typical year, leading to what would effectively be a 14-
year sell off period.


       BOTA found:


       "Keller's discounted cash flow analysis shows that the values of the subject properties do
       not change appreciably whether the absorption period is five years or fourteen years.
       Thus, the parameters of the five- and seven-year discounted cash flow do not adapt to a
       discounted cash flow with a substantially longer projected sellout period."


But BOTA noted that the components in Keller's income approach, the "rental range,
vacancy, expenses, inflation, and capitalization rate are supported by the evidence and
reasonable."


       After considering the fact that on average, only 25 leaseholds transfer in a year,
BOTA determined that Keller's appraisal required modification. BOTA


       "modif[ied] the annual rental rates to benchmark market amounts of $4,140, $4,400, and
       $4,500 for tax years 2014 through 2016, respectively. Including expense reimbursements,
       1% vacancy and collection loss allowance, expenses between 37% and 39% and
       capitalized at 7%, yields values of $16,580,614 for 2014, $17,579,400 for 2015, and
       $17,657,143 for 2016."


The values were rounded and ultimately BOTA held that the value of the land was
$16,581,000 in 2014, $17,579,000 in 2015, and $17,657,000 in 2016.



                                                   8
       The City filed a petition for reconsideration. BOTA denied the petition. The City
filed a timely petition for judicial review with this court.


  DID BOTA ERR BY FAILING TO CONSIDER THE ACTUAL RENT PAID BY THE LESSEES?

       In its first issue on appeal, the City argues that BOTA erred when it failed to
consider the City and lessees have a perpetual lease in place which limits the rent that
lessees will pay.


Standard of Review

       The Kansas Judicial Review Act (KJRA), K.S.A. 77-601 et seq., governs appellate
review of BOTA's rulings. K.S.A. 74-2426(c); K.S.A. 77-603(a). The KJRA delineates
specific circumstances under which this court may properly grant relief: (1) the agency
has erroneously interpreted or applied the law; (2) the agency has engaged in an unlawful
procedure or has failed to follow prescribed procedure; (3) the agency action is based on
facts not supported by the record; or (4) the agency action is otherwise unreasonable,
arbitrary, or capricious. K.S.A. 77-621(c)(4)-(5), (7)-(8). Because the City is challenging
BOTA's action, the City bears the burden of proving the invalidity of the action. See
K.S.A. 77-621(a)(1).


       To the extent this issue involves statutory interpretation, this court's review is
unlimited. Neighbor v. Westar Energy, Inc., 301 Kan. 916, 918, 349 P.3d 469 (2015). But
when construing tax statutes, provisions which impose a tax are to be construed strictly in
favor of the taxpayer. In re Tax Appeal of BHCMC, 307 Kan. 154, 161, 408 P.3d 103
(2017).




                                               9
       The most fundamental rule of statutory construction is that the intent of the
Legislature governs if that intent can be ascertained. State ex rel. Schmidt v. City of
Wichita, 303 Kan. 650, 659, 367 P.3d 282 (2016).


Discussion

       Kansas defines "'[f]air market value' [as] the amount in terms of money that a well
informed buyer is justified in paying and a well informed seller is justified in accepting
for property in an open and competitive market, assuming that the parties are acting
without undue compulsion." K.S.A. 79-503a. When determining fair market value,
appraisals shall consider "productivity taking into account all restrictions imposed by the
state or federal government and local governing bodies, including, but not limited to,
restrictions on property rented or leased to low income individuals and families." K.S.A.
79-503a(f). Appraisals are also required to consider "rental or reasonable rental values or
rental values restricted by the state or federal government or local governing bodies."
K.S.A. 79-503a(h).


       The City argues Keller's appraisal failed to consider the rent as set by the lease
agreement between the City and the lessees. The City relies on two cases to support its
arguments.


       First, the City relies on In re Tax Appeal of City of Council Grove, where this
court affirmed the Court of Tax Appeal's (now BOTA) ruling after the appraiser "failed
to consider the long-term ground lease agreement drafted by the City." 2017 WL
3669088, at *3. As this court stated:


       "The record reflects this lease agreement is governed by the City and ultimately provides
       the City with many benefits including the right to control and manage its major source for
       fresh water within the City. The City's lease agreement, entered into between the City and
       the CGLA, is clearly a negotiated agreement between the parties and sets rents for each

                                                  10
       of the Lots at $1,000 for tax year 2012 and $1,100 for tax year 2013. [The appraiser] did
       not take those rates into account; thus, he failed to properly consider the factors set forth
       in K.S.A. 2016 Supp. 79-503a(f), (h), and (j)." 2017 WL 3669088, at *3.


Because the appraiser failed to take into account the actual rent paid, as set through the
lease, this court held that COTA properly rejected part of the appraiser's valuations. 2017
WL 3669088, at *3.


       The City also relies on In re Equalization Appeal of Ottawa Housing Ass'n, 27
Kan. App. 2d 1008, Syl. ¶ 7, 1013, 10 P.3d 777 (2000), where this court held the taxing
authority erred when it did not consider the effect of low-income housing contracts when
valuing the property at issue. In Ottawa Housing, the property being valued was an
apartment complex that was built under contract with the federal government. The
contract provided Ottawa Housing with tax credits, and, in return, Ottawa Housing was
required to rent the apartments at a reduced rate to low-income individuals. The contract
required the rent restrictions to be in place for 16 years. The county valued the apartment
complex and Ottawa Housing appealed to BOTA, claiming that the valuation should be
reduced because the appraisal did not consider the rent restrictions in place. BOTA
disagreed and Ottawa Housing appealed.


       On appeal, Ottawa Housing argued that BOTA erred by not complying with
K.S.A. 79-503a. When determining fair market value, the statute required an appraisal to
consider "'(f) productivity; . . . (h) rental or reasonable rental values; [and] (j) restrictions
imposed upon the use of real restate by local governing bodies, including zoning and
planning boards or commissions.'" 27 Kan. App. 2d at 1010-11 (quoting K.S.A. 79-
503a). The county appraiser said that he did not consider the rental restrictions on the
Ottawa Housing property in his appraisal. This court held it was error to not consider the
low-income housing contract when determining the appraisal value of the property and
remanded the case to BOTA. 27 Kan. App. 2d at 1013.

                                                    11
       The question then is does K.S.A. 79-503a require Keller to consider the lease
between the City and lessees, including the rent as set by the lease, and if so, did Keller's
appraisal do so?


       When determining the fair market value of a property, the plain language of
K.S.A. 79-503a requires an appraiser to consider "productivity taking into account all
restrictions imposed by the . . . local governing bodies . . . rental or reasonable rental
values or rental values restricted by the . . . local governing bodies," and "restrictions or
requirements imposed upon the use of real estate by the . . . local governing bodies."
K.S.A. 79-503a(f), (h), (j). The lease between the City and lessees impacts productivity,
sets rent, and imposes restrictions and requirements upon the use of the property. Under a
plain language interpretation of K.S.A. 79-503a, Keller should have considered the lease
when determining the fair market value of the Lake. See K.S.A. 79-503a.


       The County argues that Keller appropriately considered the rent as set by the lease,
found it wanting, and relied on other factors to determine the fair market value. But that
is a generous description of what Keller did when creating his appraisal.


       In his written report, Keller describes the lease as a "negotiated settlement with no
market rent study ever performed." He went on to say that there are "some legal opinions
that questions whether this lease is binding. This opinion indicates that one acting City
Council cannot enter into a contract binding future City Councils actions." Based on this
assumption, Keller "reviewed the lease and considered comparable rents of similar
properties." He "ignored the below market ground leases which are in place at the subject
property in the analysis for arriving at market value."


       In its written opinion, BOTA did not discuss the rent as set by the lease at all. In
fact, the opinion only mentions the lease in the context of describing the property.


                                              12
       Kansas law provides that to determine fair market value "[s]ales in and of
themselves shall not be the sole criteria of fair market value but shall be used in
connection with . . . other factors" such as productivity, rental values, or restrictions or
requirements imposed upon the use of the property. (Emphasis added.) K.S.A. 79-503a.
The City was free to encumber its property in whatever way it saw fit to manage its
source of water for the city.


       Whether Keller's assertion that the lease is possibly not binding is not something
this court needs to, or should, address. It was not argued below and no decision was
reached on the enforceability or legality of the lease.


       While there is extensive evidence about the assumptions used by the appraiser and
the calculations made to determine a value, this case must be decided on the appraiser's
threshold refusal to consider the established rental values for the lake property. Not
considering the rents as set by the lease does not conform to the statutory requirement to
determine fair market value. See K.S.A. 79-503a.


       Furthermore, it is totally inconsistent for the appraiser to determine a valuation or
for Morris County to rely on a valuation that does not take the lake rentals into account
when that issue has previously been decided in the prior case involving the same parties.
This court held in that case that it was an error for the appraiser not to take those rentals
into account.


       Failing to even address Keller's decision to not consider the rent as set by the
lease, BOTA "erroneously interpreted or applied the law." See K.S.A. 77-261(c)(4); In re
Equalization Appeal of Ottawa Housing Ass'n, 27 Kan. App. 2d at 1011-13; In re Tax
Appeal of City of Council Grove, 2017 WL 3669088, at *3. Keller failed to properly
consider the factors set out in K.S.A. 79-503a(f), (h), and (j). BOTA did not adequately
address Keller's failure in its full and complete opinion. In short, the governing statutes
                                              13
require that the actual rents be considered in arriving at the fair market value of real
property. Neither Keller nor BOTA appears to have done so. The law does not mandate
that the stated rents are necessarily controlling. But we would expect an appraiser and the
reviewing administrative agency to acknowledge those rental amounts and to explain
what weight they have been given in arriving at a tax valuation and, especially if they
have been given little weight, why. The case is reversed and remanded so that the rent—
as set by the lease—is used, "in connection with cost, income and other factors" to
determine the fair market value of the property. See K.S.A. 79-503a.


    WAS BOTA'S ORDER ARBITRARY, CAPRICIOUS, OR UNREASONABLE BECAUSE IT
              EMBRACED AN APPRAISAL THAT VIOLATES USPAP?

       The City argues that Keller's appraisal did not conform with the requirements of
the Uniform Standards of Professional Appraisal Practice (USPAP) because the appraisal
(1) was based on a valuation of a fee simple interest subject to a lease, (2) copied older
work or the work of others to determine the capitalization rate, and (3) used an
impermissible assemblage method to determine the value of the property.


       Keller's appraisal clearly states that he was valuating a fee simple subject to a
lease. That statement is a description of the property in question and an accurate
statement. However, that statement is not the basis of the process Keller used in arriving
at the fee simple value of the property.


       The City argues that Keller impermissibly valued the leasehold estate and added it
to his leased fee valuation. It cites In re Tax Appeal of Lipson, 44 Kan. App. 2d 515, 238
P.3d 757 (2010), for the proposition that Kansas does not allow taxation of a leasehold
estate. Lipson is unlike the present case. Keller's approach was consistent with a taxable
values established by income approach. Keller's approach sought to determine the value
of the land in question by including the value that the leases bring to the landowner.


                                              14
       The City next argues that Keller's appraisal method failed to adhere to USPAP
standards because he relied on outside work or other data in his appraisal. The City
claims that Keller's appraisal failed to use recognized methods and techniques in
developing a capitalization rate for the appraisal when it referenced capitalization rates
that his firm utilized in valuing property in Shawnee County in a previous appraisal.
While the City claims, without particular support, "[c]opying outdated work or the work
of others is not a recognized method or technique," the City's own expert specifically
testified that Keller's process was not a USPAP violation.


       Finally, the City argues that Keller used an assemblage method to determine the
value of the property. The City claims that Keller determined the value of the property by
dividing the property into 350 lots, calculating their market rent, and adding those values
together to establish the value of the whole. Keller did divide the property into 350 lots
and then calculated the value of the entire value of the property using two separate
methods, direct capitalization and discounted cash flow analysis. Neither of these
methods involved the process of establishing a lease value for each individual lot and
adding those values together.


       The highly unusual, if not unique, nature of the property and the unique interests
encumbering the property opens the appraisal process to a variety of broadly reasonable
professional approaches that would be consistent with the requirements of the USPAP.
Some approaches might be better than others, but none probably encompass the unique
situation found in this case. The utilization of these different approaches would be
matters of professional judgment and, in this case, not matters of compliance or
noncompliance with the USPAP. The fatal flaw with the appraisal in question is the
failure to account for the leases encumbering the land as established by a local
governmental entity as has previously been addressed.




                                             15
       BOTA never specifically ruled on the City's claim that the appraisal violated the
USPAP. It did, however, accept the appraisal with certain adjustments. Finding that there
were no violations of the USPAP, BOTA did not err in making no finding on the City's
claim. The failure of Keller to take into account the leases on the land, as required by
K.S.A. 79-503a, is an error that requires the case to be reversed and remanded.


       Reversed and remanded.




                                             16
