                                STATE OF MINNESOTA

                                 IN SUPREME COURT

                                        A15-1605

Tax Court                                                                   Anderson, J.
                                                                 Took no part, Chutich, J.
Archway Marketing Services,

                     Respondent,

vs.                                                                   Filed: July 27, 2016
                                                                Office of Appellate Courts
County of Hennepin,

                     Relator.

                                ______________________


Douglass E. Turner, Hanbery & Turner, P.A., Minneapolis, Minnesota, for respondent.

Michael O. Freeman, Hennepin County Attorney, Jane N.B. Holzer, Thomas F. Pursell,
John J. March, Assistant Hennepin County Attorneys, Minneapolis, Minnesota, for
relator.

                                   __________________


                                     SYLLABUS

       1.     The tax court’s decision to reject the sales comparison approach and instead

rely exclusively on the income capitalization approach was contrary to the evidence and

not supported by adequate reasoning.

       2.     The tax court’s rejection of lease comparables used in the County’s income

capitalization analysis was not clearly erroneous, because it was undisputed that the lease

comparables did not reflect market rates.

                                            1
       3.     The tax court’s rejection of the comparables used to calculate a

capitalization rate was not clearly erroneous, because the appraiser’s report and testimony

do not support the County’s argument that the appraiser’s underlying financial

assumptions were irrelevant to the calculation of the capitalization rate.

       Reversed in part, vacated, and remanded.

       Considered and decided by the court without oral argument.

                                       OPINION

ANDERSON, Justice.

       Respondent Archway Marketing Services (Archway) challenged relator Hennepin

County’s assessment of the market value of two bulk-distribution warehouses for the

assessment dates of January 2, 2009, and January 2, 2010. Following a trial, the tax court

adopted market valuations lower than the recent sale price of each subject property. The

County appealed, asserting that the tax court erred by rejecting the County’s sales

comparison analysis and a large portion of the County’s income capitalization analysis.

Although the tax court did not err in rejecting portions of the County’s income

capitalization analysis, the tax court failed to adequately explain its reasons for rejecting

the County’s sales comparison analysis. We therefore reverse the portion of the tax

court’s decision that rejects the County’s sales comparison analysis, vacate the tax court’s

order, and remand to the tax court for further proceedings consistent with this opinion.

                                             I.

       This appeal concerns the tax value of two neighboring warehouse properties as of

January 2, 2009, and January 2, 2010. Archway Phase I (Archway I) and Archway

                                              2
Phase II (Archway II) are adjacent bulk-distribution warehouses in Rogers. Both were

constructed pursuant to build-to-suit leases held by AHL Services, Inc. (AHL), but are

occupied by AHL’s subsidiary, Archway. In 2010, the owner of the property sold the

fee-simple interest in Archway I for $19,700,000. The fee-simple interest in Archway II

sold for $18,870,051 in 2012.

      For tax purposes, the Hennepin County Assessor valued Archway I at $18,663,000

as of January 2, 2009, and $18,326,000 as of January 2, 2010. The assessor valued

Archway II at $13,774,000 as of January 2, 2009, and $12,000,000 as of January 2, 2010.

Archway challenged these valuations, and the matter proceeded to trial before the tax

court. Archway retained Paul G. Bakken to prepare an appraisal, and Justin J. Massmann

prepared an appraisal on behalf of the County.

      We have recognized three methods of real estate appraisal: (1) the sales

comparison approach, (2) the income capitalization approach, (3) and the cost approach.

Equitable Life Assurance Soc’y of the U.S. v. Cty. of Ramsey, 530 N.W.2d 544, 552

(Minn. 1995). Both appraisers employed the sales comparison approach and the income

capitalization approach. The parties later stipulated that the cost approach was not an

appropriate method for valuing the subject properties.

      The tax court found that Archway had overcome the prima facie validity of the

Hennepin County Assessor’s valuation, and thus the tax court considered the input

provided by the parties’ expert appraisers. See Westling v. Cty. of Mille Lacs, 512

N.W.2d 863, 866 (Minn. 1994) (stating that a county assessor’s valuation of real property




                                            3
is prima facie valid).1 But the tax court found numerous problems with the appraisals

presented by the parties. First, the tax court rejected each appraiser’s sales comparison

analysis due to issues with the underlying data. The tax court then rejected much of the

data that the appraisers relied on for their income capitalization analyses.

        With sparse data left to examine, the tax court completed its own income

capitalization analysis using data from surveys that were cited by the appraisers. The

court valued Archway I at $14,462,000 as of January 2, 2009, and $11,531,000 as of

January 2, 2010. The court valued Archway II at $12,286,000 as of January 2, 2009, and

$9,811,000 as of January 2, 2010. The assessed values, appraised values, and actual sale

prices of each subject property are summarized below.

    Appraisal   Actual Sale       County     County’s            Archway’s     Tax Court
      Year         Price          Assessor   Appraiser           Appraiser       Order
                                            (Massmann)           (Bakken)
                                       Archway I
      2009            -         $18,663,000 $20,900,000         $12,900,000    $14,462,000

      2010      $19,700,000     $18,326,000       $18,600,000   $12,700,000    $11,531,000

                                       Archway II
      2009            -         $13,774,000 $15,100,000         $9,400,000     $12,286,000

      2010            -         $12,000,000       $14,300,000   $9,200,000     $9,811,000

      2012      $18,870,051           -                -              -             -




1
       The County does not dispute that Archway overcame the prima facie validity of
the county assessor’s valuation.


                                              4
       All of the tax court’s valuations were within the range of values proposed by the

parties, except that the tax court’s valuation of Archway I as of January 2, 2010, was

lower than the values proposed by the parties and the county assessor.                 More

significantly, all of the tax court’s valuations were far lower than the actual sale price of

each property.

       The County appealed the tax court’s decision, contending that the court provided

inadequate reasons for rejecting Massmann’s sales comparison analysis and for rejecting

much of the data underlying Massmann’s income capitalization analysis.

       We will not overturn a tax court’s valuation of real property unless the valuation is

clearly erroneous. Equitable Life Assurance Soc’y, 530 N.W.2d at 552. The tax court’s

valuation is clearly erroneous when “the evidence as a whole does not reasonably support

the decision,” Lewis v. Cty. of Hennepin, 623 N.W.2d 258, 261 (Minn. 2001), and we are

“left with a definite and firm conviction that a mistake has been committed,” KCP

Hastings, LLC v. Cty. of Dakota, 868 N.W.2d 268, 273 (Minn. 2015) (internal quotation

marks omitted). But “we will not defer when the tax court has ‘clearly overvalued or

undervalued the property, or has completely failed to explain its reasoning.’ ” Beck v.

Cty. of Todd, 824 N.W.2d 636, 639 (Minn. 2013) (quoting Harold Chevrolet, Inc. v. Cty.

of Hennepin, 526 N.W.2d 54, 58 (Minn. 1995)). Accordingly, when the tax court arrives

at a value that is higher or lower than the range of values proposed by either party, the tax

court “should carefully explain its reasoning for rejecting the appraisal testimony and the

grounds for adopting a lower or higher value, and adequately describe the factual support

in the record for its determination.” Eden Prairie Mall, LLC v. Cty. of Hennepin, 797

                                             5
N.W.2d 186, 194 (Minn. 2011); accord Guardian Energy, LLC v. Cty. of Waseca, 868

N.W.2d 253, 263-64 (Minn. 2015). We have warned that when the tax court fails to take

these analytical steps, “it runs the risk of having its determination overturned.” Eden

Prairie Mall, 797 N.W.2d at 194.

                                           II.

      We first consider the tax court’s rejection of Massmann’s sales comparison

analysis, which led the tax court to rely solely on the income capitalization approach in

valuing Archway I and II. The three valuation approaches “are neither exclusive nor

mandatory upon either the assessor or the factfinding court.” Equitable Life Assurance

Soc’y, 530 N.W.2d at 554 (quoting Alstores Realty, Inc. v. State, 286 Minn. 343, 352, 176

N.W.2d 112, 118 (1970)). The tax court may rely on a single method of appraisal when

the other methods are not supported by accurate and reliable data. See Nw. Racquet Swim

& Health Clubs, Inc. v. Cty. of Dakota, 557 N.W.2d 582, 587-88 (Minn. 1997). But,

whenever possible, the tax court should employ at least two methods to determine the

market value of a property, because the different methods can serve as checks on each

other. Am. Express Fin. Advisors, Inc. v. Cty. of Carver, 573 N.W.2d 651, 657 (Minn.

1998). When the tax court solely relies on one method, as here, it must “clearly explain

the weaknesses of the rejected approaches.”      Equitable Life Assurance Soc’y, 530

N.W.2d at 554-55.

      When a market exists for a property, an analysis of that market provides the most

straightforward way to support an opinion of market value. Continental Retail, LLC v.

Cty. of Hennepin, 801 N.W.2d 395, 402 (Minn. 2011). Thus, the sales comparison

                                           6
approach values property based on the sale price paid “in actual market transactions of

comparable properties,” with adjustments to the sale price as needed to reflect differences

between the comparable property and the subject property. Id. Massmann selected five

real estate sales—including the sales of the two subject properties—to use as

comparables in his analysis. The tax court found that three of these sales comparables

were entitled to no weight, then summarily rejected the remaining two. We address these

sales comparables in turn, beginning with those the tax court addressed in detail.2

       Sales Comparable 2 (Uponor Distribution Center)

       Massmann used the sale of the Uponor Distribution Center in Lakeville as Sales

Comparable 2. Massmann acknowledged that this sale took place between related parties

who were originally partners in a joint venture, but he explained that the partners were

planning to dissolve the partnership and that, after the property had been placed on the

market, one of the partners ultimately decided to purchase the property.

       Sales between related parties, such as partners in a joint venture, generally are not

indicative of market value. See Appraisal Institute, The Appraisal of Real Estate 410

(14th ed. 2013); cf. Lewis & Harris v. Cty. of Hennepin, 516 N.W.2d 177, 179

(Minn. 1994) (explaining that some comparables “were not arms-length transactions

which reflected actual market value”). But Massmann’s report explained that both the


2
       Archway’s expert, Bakken, did not perform a sales comparison analysis for 2009,
and the tax court gave no weight to or otherwise rejected the sales comparables Bakken
offered to support his 2010 analysis. Archway did not appeal these determinations, and
thus we are concerned only with the tax court’s consideration of the County’s sales
comparison analysis.


                                             7
buyer and the seller were publicly traded real estate investment trusts. To satisfy its

investors, the seller needed to ensure that the property sold at market value. Accordingly,

the parties based their sale price on discussions with brokers, who confirmed that the sale

price was consistent with the value of the property in the current marketplace. Based on

these facts, Massmann concluded that Sales Comparable 2 was representative of an

arm’s-length market transaction.

       Yet, “[a]fter a review of the record,” the tax court found that Massmann “did not

overcome the presumption that [Sales Comparable 2] was not an arm’s length

transaction.” The tax court did not discuss the evidence in the record or explain how

Massmann could have overcome the tax court’s presumption that Sales Comparable 2

“was not an arm’s length transaction.”           The court neither evaluated Massmann’s

credibility nor discussed the relevance of the fact that both the buyer and the seller were

publicly traded real estate investment trusts. Rather, the tax court simply restated the

point Massmann had acknowledged—that Sales Comparable 2 was a related-party sale—

without addressing Massmann’s reasons for concluding that the transaction was

nevertheless indicative of actual market value.

       Sales Comparable 3 (Archway I)

       Massmann used the 2010 sale of Archway I itself as the third comparable,

reporting that the property “was listed by” a commercial real estate company and that the

“[b]uyer and seller both stated the sale was an open market, arm’s-length deal that was

exposed to the market.” Massmann observed that the tenants guaranteed the lease in

2006, which potentially could have affected the sale price. But Massmann reported that

                                             8
the “[b]uyer stated the guarantee did not affect the sale price” and that the buyer “viewed

[the local market] as stable with anticipated near term demand.”

       The tax court rejected Sales Comparable 3 due to its “unusual financing,” which

“Massmann did not adequately address . . . in his appraisal or trial testimony.” Based on

our careful review of the record, we conclude that the tax court’s determination is

contrary to the evidence. Massmann was aware of the financing, and he described the

steps he took to verify that the transaction was nonetheless at arm’s length.             Put

differently, the tax court did not identify any additional facts or analysis that Massmann

needed to provide in order to “adequately address the property’s unusual financing.”

       Moreover, Sales Comparable 3 was the 2010 sale of Archway I itself. Although

the sale price of the subject property should not be conclusive, it is an important fact to

consider when valuing real estate. Minn. Entm’t Enters., Inc. v. State, 306 Minn. 184,

188, 235 N.W.2d 390, 393 (1975). The tax court did not address the fact that it was

rejecting one of the subject properties, nor did the tax court explain why it was

impossible to adjust for what it called “unusual financing” in the subject transaction.

       Sales Comparable 4 (Cardinal Health)

       Sales Comparable 4 was the 2011 sale of the Cardinal Health warehouse in

Champlin. Cardinal Health was originally part of a national portfolio of properties, but

the buyer elected to purchase Cardinal Health in conjunction with only one other

property—in other words, as part of a smaller portfolio. According to Massmann, the

“[b]uyer stated the sale was an open market, arm’s length deal that was exposed to the

market.”

                                             9
       At trial, Archway confronted Massmann with a report of the Assessor Commercial

Exchange, which listed the code “allocated sale price” next to this transaction.3

Massmann explained that this code indicates that the sale included more than one

property and that the sale price of the entire portfolio is allocated between the individual

properties to arrive at an allocated sale price for each property. Although Massmann

testified that he had researched the sale, when asked whether he had verified the sale of

the national portfolio, Massmann said that he had not.

       On rebuttal, Massmann explained that he had verified with the buyer that Sales

Comparable 4 was valued independently from the other property the buyer also

purchased. Yet, the tax court rejected Sales Comparable 4, in part because “Massmann

did not verify the sale.” The tax court did not discuss Massmann’s testimony regarding

his verification with the buyer. The County argues that the tax court misconstrued

Massmann’s testimony that he did not verify the whole sale—i.e., the national portfolio.

Archway contends that the tax court did not err, because Massmann should have verified

the sale of the national portfolio.

       We conclude that the tax court should have addressed Massmann’s testimony that

he verified the sale. The tax court may have found Massmann’s verification to be


3
        The County argues that the tax court erroneously relied on a code used by the
Assessor Commercial Exchange (ACE) to reject Massmann’s sales comparables. We
read the tax court’s order differently. The tax court did not rely on the rejection code but
cited the ACE reports for the propositions stated therein. The tax court’s error was not in
citing the ACE reports; rather, the court erred by failing to explain why Massmann’s
testimony did not adequately address the concerns raised by these reports, particularly
because Massmann testified that the ACE rejection code has limited relevance.


                                            10
insufficient, as Archway contends. But we cannot determine from the tax court’s order

whether Massmann’s testimony was rejected or simply overlooked.

       The Remaining Two Comparables

       Massmann’s remaining two comparables were Sales Comparable 1 (the Walgreens

Distribution Warehouse in Rogers) and Sales Comparable 5 (Archway II, one of the

subject properties). The tax court rejected these two comparables without any individual

analysis. Although the tax court did not discuss any issues with these specific properties,

the court implied that its rejection was based on a credibility determination, stating,

“Given the issues that we have previously identified with Massmann’s market analysis,

we are unwilling to derive market values for the subject properties from the analysis of

only two comparable sales.”

       Ordinarily, we defer to the tax court’s credibility determinations. Eden Prairie

Mall, LLC v. Cty. of Hennepin, 830 N.W.2d 16, 21 (Minn. 2013).               But here, the

credibility determination was based on the unexplained rejection of three other sales

comparables. Indeed, the rejection of the last two comparables was not based on the

individual characteristics of those properties but rather the putative weaknesses of three

other unrelated comparable properties relied upon by Massmann.

       And, significantly, Sales Comparable 5 was the recent sale of one of the subject

properties. Although the sale of the subject property is not conclusive, it is evidence that

is “reasonably . . . relied upon” and may be “one of the most important elements to be

considered” when valuing real property. Minn. Entm’t Enters., 306 Minn. at 188, 235




                                            11
N.W.2d at 393. Yet, the tax court rejected Sales Comparable 5 (Archway II) without

explanation. This is an omission that we cannot overlook.

         In conclusion, the tax court’s decision to reject Massmann’s sales comparison

approach was contrary to the evidence and not supported by adequate reasoning.

Accordingly, we remand to the tax court to more fully explain its reasoning. We leave it

to the tax court to determine whether to reopen the matter for an evidentiary hearing.

                                            III.

         We now turn to Massmann’s income capitalization analysis. Although the tax

court’s final valuation was solely based on the income capitalization approach, the tax

court rejected much of the income capitalization data presented by the appraisers.4

         The income capitalization approach is an analysis of a property’s capacity to

generate future income. Appraisal Institute, supra, at 439. Because Archway I and II are

leased properties, market rent is the relevant measure of income. See Eden Prairie Mall,

797 N.W.2d at 195.      Thus, the first step in an income capitalization analysis is to

calculate the market rents of Archway I and II. See id.; see also Appraisal Institute,

supra, at 465-66. The second step is to calculate a capitalization rate, which converts the

expected rental income into an indication of value. See Eden Prairie Mall, 830 N.W.2d

at 23.




4
      The tax court also rejected many of Bakken’s lease comparables and the entirety
of Bakken’s capitalization rate analysis. Archway did not appeal any of these
determinations.


                                            12
       The County raises three issues related to Massmann’s income capitalization

analysis: (1) the tax court’s rejection of three of the lease comparables that Massmann

had used to calculate market rent; (2) the tax court’s rejection of four of Massmann’s

capitalization comparables, which Massmann had used to calculate a capitalization rate;

and (3) the tax court’s reliance on survey data to calculate its own capitalization rate. We

address each issue in turn.

                                            A.

       We begin with the first step of Massmann’s income capitalization analysis—

calculation of market rent. Market rent, or the rent that could be obtained in the open

market, may be different than the actual rent negotiated by the parties to a lease. See

Appraisal Institute, supra, at 447-51. To calculate the market rent of the subject property,

an appraiser often gathers, compares, and adjusts rental data from comparable properties.

See id. at 466. As with sales comparables, lease comparables should reflect arm’s-length

transactions. See Eden Prairie Mall, 797 N.W.2d at 195; see also Appraisal Institute,

supra, at 466 (stating that “lease renewals or extensions negotiated with existing tenants

should be used with caution” because existing tenants may be willing to pay higher rents

to avoid relocating or may be offered lower rents to avoid vacancies).

       Massmann relied on eight lease comparables to calculate market rent. The tax

court rejected five of Massmann’s lease comparables, as well as several of Bakken’s

lease comparables, and used the remaining lease comparables of both appraisers to

complete its own income capitalization analysis.




                                            13
       The County challenges the tax court’s decision to reject three of Massmann’s lease

comparables.5 But these three comparables were lease renewals, and Massmann’s own

report acknowledges that not all of them reflected market rent. Further, Massmann did

not provide any support for using these lease renewals as comparables except for the

statements of parties to the leases, and many of these statements contradicted the

County’s argument that the lease renewals were arm’s-length transactions.        On this

record, we cannot say that the tax court erred in rejecting Massmann’s lease comparables.

                                           B.

       We next address the tax court’s rejection of the capitalization comparables that

Massmann used to calculate a capitalization rate. A capitalization rate “capitalizes a

single year’s income expectancy into an indication of value.” Eden Prairie Mall, 830

N.W.2d at 23. Capitalization rates are often derived from comparable market sales.

Appraisal Institute, supra, at 493-95

       To develop a capitalization rate, Massmann primarily relied on data from the sales

of six comparable leased properties. Additionally, Massmann analyzed national and local

survey data. The tax court rejected four of Massmann’s capitalization comparables.

After finding that the remaining two capitalization comparables did not “provide a large

enough sample to determine a credible capitalization rate,” the tax court rejected



5
       Although the County listed “lease comparables 4, 5, 6, or 7” in its brief, the
County did not explain why the tax court erred in rejecting Lease Comparable 4, and it is
unclear whether the County intended to appeal the tax court’s rejection of Lease
Comparable 4.


                                           14
Massmann’s income capitalization analysis entirely. The County appeals the tax court’s

rejection of Massmann’s capitalization comparables.

       First, the tax court rejected Capitalization Comparables 2, 3, and 4 because they

were derived from the three sales comparables that the tax court had rejected earlier in its

analysis. Capitalization Comparable 2 is the same property as Sales Comparable 2

(Uponor); Capitalization Comparable 3 is the same property as Sales Comparable 3

(Archway I); and Capitalization Comparable 4 is the same property as Sales

Comparable 4 (Cardinal Health). Because we reverse the decision on these three sales

comparables and remand for further explanation, the tax court may, in its discretion,

decide to address its rejection of the three corresponding capitalization comparables.

       Next, the tax court rejected Capitalization Comparable 5 because “Massmann was

unable to verify many of his financial assumptions for the lease with the buyer.” Without

verification, the tax court was uncertain whether the information Massmann provided for

Capitalization Comparable 5 was reliable. The County concedes that Massmann did not

verify his financial assumptions with the buyer, but argues that the unverified information

was irrelevant to Massmann’s calculations.

       The County’s argument is not supported by Massmann’s report.                  When

introducing the capitalization comparables, Massmann stated that “[e]ach comparable[]

will be presented with the corresponding components utilized to develop each rate.”

Moreover, the County’s argument—that underlying financial assumptions are irrelevant

to the calculation of capitalization rates—is not generally accepted.        See Appraisal

Institute, supra, at 495 (“Data [for capitalization rates] must be drawn from properties

                                             15
that are physically similar to the property being appraised and from similar (preferably

competing) markets. When a comparable property has significant differences, it may be

afforded less weight or may be discarded entirely.”).

       The County concedes that Massmann did not verify his financial assumptions for

Capitalization Comparable 5, and nothing in Massmann’s report or testimony indicates

that these underlying assumptions were irrelevant to his analysis.         Accordingly, we

conclude that the tax court did not err by rejecting Capitalization Comparable 5.

                                          C.

       Because the two remaining capitalization comparables would “not provide a large

enough sample to determine a credible capitalization rate,” the tax court “place[d] no

weight on Massmann’s market-derived capitalization rate.” The tax court also rejected

Bakken’s capitalization rate. Having rejected each appraiser’s capitalization rate, the tax

court completed its income capitalization analysis based solely on survey data that both

appraisers had used as secondary support.

       According to The Appraisal of Real Estate, real estate surveys may be used in

combination with other methods of calculating capitalization rates. Appraisal Institute,

supra, at 499. But “surveys are generally used as support rather than as primary evidence

of a capitalization rate.” Id.; see also Carson Pirie Scott & Co. (Ridgedale) v. Cty. of

Hennepin, 576 N.W.2d 445, 451 (Minn. 1998) (observing that the tax court’s

capitalization rate was based “in part” on expert opinions about a national survey of mall

properties). The County challenges the tax court’s reliance on the survey data, arguing

that survey data is inferior to an analysis based on actual comparative sales.

                                             16
      Having rejected much of the underlying data relied on by both parties, the tax

court was left with little to rely on but survey data. Because we conclude a remand is

necessary, we need not decide whether the tax court erred by relying solely on survey

data to determine a capitalization rate.      On remand, however, the tax court may

reconsider its rejection of Massmann’s sales comparison analysis, as well as its rejection

of Capitalization Comparables 2, 3, and 4. If it does so, the tax court may well find it

unnecessary to rely solely on survey data.

                                             IV.

      To summarize, we conclude that the tax court failed to adequately explain its

reasons for rejecting Massmann’s sales comparison analysis and instead relying

exclusively on the income capitalization approach. This error is compounded by the tax

court’s failure to address why its valuation is far below the actual sale price of each

subject property. Archway I sold for a price of $19,700,000 in 2010; yet, the tax court

valued Archway I at $11,531,000—59% of the actual sale price—for the valuation date

of January 2, 2010. Similarly, whereas Archway II sold at $18,870,051 in 2012, the tax

court valued it at $9,811,000—52% of the actual sale price—for the valuation date of

January 2, 2010. Moreover, the tax court’s estimate of the 2010 value of Archway I is

below the estimates of both parties, as well as that of the Hennepin County Assessor.

Accordingly, we reverse the portion of the tax court’s decision that rejected Massmann’s

sales comparison analysis, vacate the tax court’s order, and remand for further

proceedings. We leave it to the tax court to decide whether to re-open the record on

remand.

                                             17
       Reversed in part, vacated, and remanded.



       CHUTICH, J., not having been a member of this court at the time of submission,

took no part in the consideration or decision of this case.




                                             18
