598	                          August 6, 2015	                           No. 30

              IN THE SUPREME COURT OF THE
                    STATE OF OREGON

               HEWLETT-PACKARD COMPANY,
                     Plaintiff-Respondent,
                                v.
                BENTON COUNTY ASSESSOR,
                          Defendant,
                               and
                DEPARTMENT OF REVENUE,
                     Defendant-Appellant.
                  (TC4979, TC4980, TC4987;
              S061456 (Control), S061457, S061458)

    En Banc
    On appeal from the Oregon Tax Court.*
    Henry C. Breithaupt, Judge.
    Argued and submitted on June 24, 2014.
   Joseph A. Laronge, Assistant Attorney General, Salem,
argued the cause and filed the briefs for appellant. With him
on the brief was Ellen Rosenblum, Attorney General.
    David L. Canary, Garvey Schubert Barer, Portland,
argued the cause for the respondent. Cynthia M. Fraser
filed the brief for the respondent. With her on the brief was
David L. Canary and William K. Kabeiseman.
    BALMER, C. J.
    The judgment of the Oregon Tax Court is affirmed.
    Case Summary: The Department of Revenue sought direct judicial review of
a decision of the Tax Court determining the real market value of real property.
Held: (1) the department’s rules require the real market value of real property to
be based on the property’s highest and best use; (2) the department’s rule defin-
ing “value of the loss,” OAR 150-308.205-(F)(3)(k), must be applied consistently
with the Tax Court’s highest and best use determination.
    The judgment of the Oregon Tax Court is affirmed.

______________
	*   21 OTR 186 (2013).
Cite as 357 Or 598 (2015)	599

	       BALMER, C. J.
	        In this direct appeal from the Oregon Tax Court
Regular Division (Tax Court), we must decide whether the
Tax Court properly applied administrative rules governing
property tax appraisals. Specifically, this case requires us
to consider the relationship between two terms defined in
the Department of Revenue’s administrative rules: “highest
and best use” and “value of the loss.” See OAR 150-308.205-
(D)(1)(c) (defining highest and best use); OAR 150-308.205-
(F)(3)(k) (defining value of the loss). A property’s highest
and best use is, among other things, the most profitable use
that a potential owner could make of the property. The value
of the loss measures the negative value created by compo-
nents of the property that prevent it from cost-effectively
serving its highest and best use.
	        The department appeals from a decision of the
Tax Court that accepted the property valuation proposed
by taxpayer Hewlett-Packard (HP). In reaching that con-
clusion, the Tax Court held that the highest and best use
of HP’s property was a continuation of its current use as
a single-tenant, owner-occupied research and manufactur-
ing facility. The Tax Court also held that, of the numerous
buildings on the campus, a potential owner would anticipate
using only certain “core” buildings and would not anticipate
using the “non-core” buildings. As a result, those non-core
buildings were components of the property that prevented
it from cost-effectively serving its highest and best use. The
Tax Court, therefore, assessed the value of the loss caused
by the presence of the non-core buildings. To do so, the Tax
Court calculated the additional operating expenses that an
owner would incur while operating the subject property—
which has both the core and non-core space—as compared
to the operating expenses that an owner would incur while
operating a cost-effective version of the property consisting
of only the core space.
	       In this appeal, the department does not challenge
the Tax Court’s findings that the non-core buildings were
an overdevelopment or that the highest and best use of the
property was as a single-tenant, owner-occupied research
and manufacturing facility. Instead, the department raises
600	         Hewlett-Packard Co. v. Benton County Assessor

the narrow issue of whether the Tax Court properly applied
the administrative rule defining the value of the loss,
OAR 150-308.205-(F)(3)(k). According to the department,
the Tax Court erred by calculating the value of the loss
as if a potential owner would make no alterations to the
subject property. The department contends that the Tax
Court should have calculated the value of the loss as if a
potential owner would convert the non-core space into mar-
ketable rental space, which, according to the department,
would result in more value than leaving the non-core space
vacant.
	         We reject the department’s argument because it
presumes that the most valuable use of the non-core build-
ings is as marketable rental space. That presumption is
inconsistent with the Tax Court’s analysis of the highest
and best use of the property. The department, however, does
not challenge that analysis. That is, the department does
not ask us to review the factual basis for the Tax Court’s
determination that the highest and best use of the property
is as a single-tenant, owner-occupied research and manufac-
turing facility or the Tax Court’s application of the depart-
ment’s administrative rules that govern the highest and
best use determination. See ORS 305.445 (scope of review).
As a result, we assume that the highest and best use of the
non-core buildings is to leave them unaltered rather than
to convert them to marketable space. Given that assump-
tion, the Tax Court properly identified the value of the loss
as the additional operating expenses that an owner would
incur to operate the subject property compared to a more
cost-effective option. We therefore affirm the decision of the
Tax Court.
	        The department’s rules defining the highest and
best use and the value of the loss are part of a complex
scheme of administrative rules outlining the methods and
procedures that the department requires for appraising
industrial plants, like HP’s property. See generally OAR
150-308.205-(D) (describing the valuation process); OAR
150-308.205-(F) (describing methods for valuing property
inefficiencies). To assess the department’s contention that
the Tax Court misapplied those rules, we must consider how
the highest and best use and the value of the loss fit within
Cite as 357 Or 598 (2015)	601

the department’s larger scheme of methods and procedures
as well as the Tax Court’s relevant factual findings.
	       The subject property is HP’s 178-acre manufactur-
ing and research campus in Corvallis, Oregon. HP pays
taxes on both its real property and personal property. The
real property consists of the land and its improvements.
The personal property is HP’s equipment located on site. In
this case, the parties dispute the value of the real estate
improvements for the three tax years beginning in 2008 and
ending in 2011.
	         Those improvements include 28 buildings contain-
ing about 2 million square feet. The buildings share common
utilities and are linked by a long corridor. HP constructed
the buildings between the 1970s and the 1990s and has used
the buildings to support as many as 8,000 employees while
developing and manufacturing parts for scientific calcula-
tors and ink-jet printers. By 2007, however, HP had reduced
the number of components manufactured at that property
and needed only about 2,000 employees on site. At that
time, HP identified the property’s “core space” as 1.2 mil-
lion square feet contained in 17 buildings. The remaining
800,000 square feet was identified as the “non-core” space.
Over the next couple of years, HP consolidated its operations
into the core space and vacated the non-core space. After the
consolidation, HP began leasing out a small portion of the
recently vacated non-core space to outside firms.
	        For the tax years of 2008-09 and 2009-10, Benton
County assessed the total value of the improvements at
$76 million and $79 million respectively. HP did not chal-
lenge those assessments but asked the Tax Court to review
Benton County’s assessment of HP’s equipment on the prop-
erty. Benton County counterclaimed, contending that it had
undervalued the improvements in 2008-09 and 2009-10.
For the next tax year, 2010-11, Benton County assessed the
value of the improvements at $200 million.
	       After a partial settlement resolving the value of
HP’s equipment, the parties presented evidence to the Tax
Court on the only remaining issue—the extent to which HP’s
improvements contributed to, or detracted from, the “real
market value” of HP’s property. See ORS 308.232 (requiring
602	              Hewlett-Packard Co. v. Benton County Assessor

“ad valorem property taxation” to be based on the proper-
ty’s “real market value”). Generally, a property’s real market
value is the amount of money an informed and disinterested
seller could reasonably expect an informed and disinterested
buyer to pay for the property on the date of the assessment.
See ORS 308.205(1) (defining real market value).
	         To find how much a potential buyer would pay to
own the property, an appraiser must follow the appraisal
methods and procedures adopted by the department. ORS
308.205(2) (requiring a property tax appraisal to be com-
pleted “in accordance with rules adopted by the Department
of Revenue”). The department’s rules call for an appraiser to
value the property according to its “highest and best use.”
OAR 150-308.205-(D)(3)(i) (“Determining the highest and
best use for the unit of property is necessary for establishing
real market value.”). The department requires valuing prop-
erty according to its highest and best use because a seller
“can expect to receive the highest offer from a prospective
buyer who intends to put the property to its most profitable
use.” STC Submarine, Inc. v. Dept. of Rev., 320 Or 589, 592
n 5, 890 P2d 1370 (1995).
	         The department defines “highest and best use” as
“the reasonably probable and legal use of vacant land or an
improved property that is physically possible, appropriately
supported, and financially feasible, and that results in the
highest value. See The Appraisal of Real Estate, 12th edi-
tion (2001).” OAR 150-308.205-(D)(1)(c).1 To find a proper-
ty’s highest and best use, an appraiser identifies the prop-
erty’s potential alternative uses and tests them against the
criteria set out in the department’s definition of highest and
best use. Those alternative uses “may include, among oth-
ers, all possible uses that might result from retaining, alter-
ing or ceasing the integrated nature of the unit of property.”
OAR 150-308.205-(D)(3)(i). For an improved property, those
alternative uses often consist of “continuation of the existing
	1
       The last criterion, requiring that the highest and best use “result[ ] in the
highest value,” OAR 150-308.205-(D)(1)(c), is frequently described as requir-
ing that the use be “maximally productive.” See, e.g., Appraisal Institute, The
Appraisal of Real Estate 307, 314, 318 (12th ed 2001) (referring to a use as being
“maximally productive” or resulting in the “maximum productivity”). We under-
stand the terms “highest value” and “maximally productive” as having the same
meaning in this context.
Cite as 357 Or 598 (2015)	603

use, renovation or rehabilitation, expansion, adaptation or
conversion to another use, partial or total demolition, or
some combination of these alternatives.” Appraisal of Real
Estate at 315.2
	        An appraiser uses the results from the highest and
best use analysis to produce a final valuation opinion. See
id. at 60 (“Through the highest and best use analysis, the
appraiser * * * identifies the use or uses on which the final
opinion of value is based.”). As a result, “[t]he first issue is
the highest and best use of the property; the second issue is
the market value of the property at that use.” Freedom Fed.
Savings and Loan v. Dept. of Rev., 310 Or 723, 727, 801 P2d
809 (1990) (emphasis in original); see also Appraisal of Real
Estate at 305 (“[H]ighest and best use can be described as
the foundation on which market value rests.”).
	        After establishing the property’s highest and best
use, an appraiser develops a final opinion of the property’s real
market value by considering three different “approaches” to
value: cost, income, and sales comparison. OAR 150-308.205-
(D)(3)(a); see also ORS 308.411(1) (requiring the use of cost,
income, or sales comparison approaches). The cost approach
relies on the cost of constructing a substitute property that
provides the same utility as the subject property at its high-
est and best use. The income approach relies on the profits
that the property can generate at its highest and best use.
And the sales comparison approach relies on sale prices of
other properties that can serve the same highest and best
use as the subject property. An appraiser must consider
each approach even though the appraiser may determine,
after consideration, that not all three approaches are appro-
priate in a specific case. OAR 150-308.205-(D)(3)(a). An
appraiser then reconciles the indications of value produced
by the appropriate approaches and concludes the analysis
with a final valuation opinion.
	2
       The definition of highest and best use refers to the “use of vacant land or
improved property.” OAR 150-308.205-(D)(1)(c). There are differences in the
analysis of the highest and best use of property as if vacant and the highest and
best use of property as improved. See, e.g., Appraisal of Real Estate at 309-19 (out-
lining steps for the highest and best use as if vacant and highest and best use as
improved). The parties have not argued that those differences affect the highest
and best use conclusions reached in this case.
604	             Hewlett-Packard Co. v. Benton County Assessor

	         Although the highest and best use analysis nec-
essarily precedes the final valuation opinion, an appraiser
often must apply the three approaches to value while devel-
oping preliminary valuation estimates of the property’s
alternative uses for the highest and best use analysis. After
all, the final step in the highest and best use analysis is to
identify the use that produces the “highest value.” OAR 150-
308.205-(D)(1)(c). Doing so is consistent with Appraisal of
Real Estate, which is cited as the source of the department’s
definition of highest and best use. Id. According to Appraisal
of Real Estate,
   	 “Highest and best use analysis often incorporates
   techniques and data from the application of all three
   approaches to value. * * * In many appraisal assignments,
   the final tests of financial feasibility and maximum produc-
   tivity require information that is obtained from the appli-
   cation and development of the approaches. Therefore, even
   though the discussion of highest and best use traditionally
   precedes the approaches to value in narrative appraisal
   reports, the conclusion of highest and best use often can be
   finalized only after a preliminary analysis of alternative
   uses has been performed.”
Appraisal of Real Estate at 319.
	        At the hearing before the Tax Court, the parties
disputed both the highest and best use of the property and
the real market value of the property at that use. They pre-
sented evidence from expert appraisers in support of their
respective positions. On both issues, the Tax Court accepted
the factual analysis and opinions offered by HP’s expert. See
Hewlett-Packard Co. v. Benton County Assessor, 21 OTR 186,
188-97 (2013) (determining the highest and best use and the
real market value).
	        According to HP’s expert, the highest and best use
of the property was to continue using it in the same manner
that HP had been using it—a single-purpose, owner-occupied
facility serving a variety of “manufacturing and research
and development operations.” Id. at 189.3 In reaching that
	3
      In his report, HP’s expert described the highest and best use as the “con-
tinued use as a specially designed single purpose campus style owner occupied
manufacturing facility.”
Cite as 357 Or 598 (2015)	605

conclusion, HP’s expert determined that, given the market of
potential buyers for that type of property, a potential owner
could not cost-effectively make productive use of the non-
core space. Instead, HP’s expert concluded that a potential
owner would simply leave the non-core space vacant while
making productive use of the core space. Based on that opin-
ion, the Tax Court found that the highest and best use of the
property was “use by a single manufacturer using the core
space and leaving the [non-core] space empty.” Id. at 192.
	        The parties spent considerable time at the hearing
addressing whether a potential owner could make produc-
tive use of the non-core space. According to the Tax Court,
the department’s expert offered her opinion that “the space
not used by a hypothetical purchaser of the property—the
so called ‘non-core’ space—would be absorbed by other users
in the market, at very healthy lease rates and with few, if
any, conversion costs to make the existing space attractive
at such lease rates.” Id. at 190-91. Under the department’s
reasoning, the property’s highest and best use would have
multiple uses, where a potential owner would use the core
space for its own research and manufacturing and use the
non-core space as marketable rental property generating
rental income.4
	        HP’s expert disagreed and concluded that the con-
version to marketable rental space could not satisfy all of the
criteria for the highest and best use—that the use be legally
permissible, physically possible, financially feasible, and
result in the highest value. See OAR 150-308.205-(D)(1)(c)
(defining highest and best use). First, HP’s expert found
that the property was not zoned to be used as rental prop-
erty and questioned whether the department’s proposed con-
version was legally permissible. Second, the expert deter-
mined that the department’s proposed conversion was not
financially feasible. He reached that conclusion by “look[ing]
at the costs, over time, of converting the existing space into
space suitable for leasing to others and then weigh[ing]
that cost against reasonably expected returns over time.”
Hewlett-Packard, 21 OTR at 189. Based on that analysis,
	4
      See Appraisal of Real Estate at 325 (“Highest and best use often include
more than one use for a parcel of land or an improved property.”).
606	         Hewlett-Packard Co. v. Benton County Assessor

HP’s expert concluded that “the cost of conversion to mar-
ketable space exceeded the benefits of such conversion.” Id.
Specifically, HP’s expert asserted that converting the non-
core space into income-generating rental property would
result in a net loss of about $13 million. As a result, HP’s
expert stated that such a conversion was not financially fea-
sible. Id.
	         The Tax Court adopted the opinions offered by HP’s
expert on those issues. According to the Tax Court, “the
record shows that there are not insignificant questions about
the legal obstacles that would be presented by trying to lease
out the excess space.” Id. at 191. Further, the Tax Court
concluded that “[a]ll of the evidence regarding the actual
demands of the market in Corvallis, the location of the prop-
erty relative to major transportation facilities, the actual
condition of the property and other factors” undermined the
department’s position that a potential owner would convert
the non-core space into marketable rental property. Id. The
Tax Court found that the opinion offered by HP’s expert was
“consistent with the unrebutted testimony of witnesses for
taxpayer with knowledge of these improvements in partic-
ular and the market for space in Corvallis in general.” Id.
As a result, the Tax Court “accept[ed] the conclusion that
the costs of maintaining the excess space and converting
it to space that would be attractive to the market would
exceed the value to be produced by the potential rental of
that space.” Id. For those reasons, the Tax Court ultimately
concluded that the highest and best use of the property
was a continuation of its existing use as a single-purpose,
owner-occupied research and manufacturing facility where
a potential owner would use the core space for research and
manufacturing and leave the non-core space vacant.
	         After establishing the highest and best use of the
property, the Tax Court considered the conflicting valu-
ation opinions offered by the parties’ experts. HP’s expert
considered all three approaches to value—cost, income,
and sales comparison—but he concluded that the income
approach was not appropriate. Under the sales comparison
approach, HP’s expert considered the prices buyers recently
paid for similar single-purpose, owner-occupied research
and manufacturing properties, and concluded that HP’s
Cite as 357 Or 598 (2015)	607

improvements were worth $63 million on all three assess-
ment dates.
	        Under the cost approach, HP’s expert found the
cost to build a new and cost-effective single-purpose, owner-
occupied research and manufacturing property that pro-
vides the same utility as HP’s property. He then adjusted
that cost to reflect the property’s depreciation. One type of
depreciation is based on the negative value created by com-
ponents of the subject property that fail to cost-effectively
serve the property’s highest and best use. The value of the
loss, which is the target of the department’s appeal, is part
of that depreciation analysis and will be discussed further
below. Under the cost approach, HP’s expert concluded that
the improvements were worth $65 million in 2008, $68 mil-
lion in 2009, and $64 million in 2010.
	        HP’s expert then reconciled the results from the
cost approach and the sales comparison approach. His rec-
onciliation produced a final valuation of the improvements
that matched his results from the cost approach. As a result,
HP’s expert offered his final opinion that the real mar-
ket value of HP’s improvements was $65 million in 2008,
$68 million in 2009, and $64 million in 2010.
	        The department’s expert reached final opinions
of the real market value that were substantially higher:
$210 million for 2008, $217 million for 2009, and $179 mil-
lion for 2010. However, the department’s expert reached
those final valuation opinions by valuing the improvements
according to a highest and best use that the Tax Court ulti-
mately rejected—namely, that the property would be used
entirely or partially to generate rental income. Additionally,
the department, both through its expert and in its post-
trial briefing, attempted to rebut the methodology that HP’s
expert used.
	        Because the real market value is based on the high-
est and best use of the property, the Tax Court rejected the
valuation opinions of the department’s expert and accepted
the testimony of HP’s expert on the value of the property
at its highest and best use. Id. at 196 (“[T]he real market
values for the subject property as found by the appraiser
for taxpayer are accepted by the court as the real market
608	              Hewlett-Packard Co. v. Benton County Assessor

values for the subject properties as of the respective assess-
ment dates.”). As a result, the Tax Court found that, for the
purposes of assessing property taxes, the real market value
of HP’s improvements was $65 million in 2008, $68 million
in 2009, and $64 million in 2010.
	        The department appeals the Tax Court’s decision on
the real market value. We review final decisions and orders
of the Tax Court for “errors or questions of law or lack of sub-
stantial evidence in the record to support the tax court’s deci-
sion or order.” ORS 305.445. The department does not argue
that the Tax Court erred when it adopted the factual con-
clusions or the highest and best use analysis of HP’s expert.
Instead, the department contends that, even if the Tax Court
correctly decided the facts and the highest and best use of the
property, the Tax Court nevertheless erred when it adopted
the final valuation opinion offered by HP’s expert.
	         According to the department, HP’s expert deter-
mined the real market value using a methodology that
failed to comply with the department’s administrative rules.
Specifically, the department contends that HP’s expert, and
therefore the Tax Court, misapplied the department’s rule
defining value of the loss, which is a step in the process for
calculating depreciation under the cost approach. See OAR
150-308.205-(F)(3)(k) (defining value of the loss).5 Value of
the loss is generally the excess operating costs that an owner
will incur as the result of inefficiencies in the property that
prevent the property from cost-effectively serving its high-
est and best use. Id. The department argues that, as a mat-
ter of law, HP’s expert misapplied the department’s rule on
the value of the loss and, therefore, that the Tax Court erred

	5
      The department’s definition of value of the loss includes technical terms
that will be explained further below. That definition states,
  	 “The value of the loss equals the present value of the after-tax loss in
  anticipated income from the continuing operation of the property with a defi-
  ciency or superadequacy compared to the projected operation of the replace-
  ment property. For industrial plants, this loss in income is often the result of
  excess operating costs due to inefficiencies in the subject plant compared to
  the subject property when cured of the functional obsolescence. The present
  value includes factors for the time period that the plant will continue to incur
  the loss in income and an appropriate discount rate. See OAR 150-308.205-
  (C) for the appropriate method of calculating the discount rate.”
OAR 150-308.205-(F)(3)(k).
Cite as 357 Or 598 (2015)	609

as a matter of law by adopting the misapplication of the rule
by HP’s expert.
	        As an initial matter, HP argues that a Tax Court
determination of the real market value of property is a fact
issue and not a legal issue. In support, HP cites Reynolds
Metals Co. v. Dept. of Rev., 299 Or 592, 705 P2d 712 (1985),
on recons, 300 Or 250, 709 P2d 710 (1985), in which we iden-
tified the fact issues in that case as including the dollar value
of a property’s depreciation. Id. at 594 (“The major issues of
fact are the dollar value of physical depreciation and the dol-
lar value of functional obsolescence in the plant.”).
	        HP, however, misreads Reynolds Metals. Although
the valuation issues in Reynolds Metals were fact issues,
nothing in that decision states that valuation issues are
always and entirely fact issues. To be sure, the valuation
process—including the highest and best use analysis and
the approaches to value—is fact intensive. The process fre-
quently requires an appraiser to collect data on the phys-
ical property, the real estate market, and larger economic
trends. And an appraiser may exercise professional judg-
ment while both collecting that data and weighing its rel-
evance. Further, the final opinion of value offered by an
expert appraiser is just that—an expert opinion. To decide
a property’s real market value, the Tax Court often resolves
fact issues relating to the competing testimony of appraisal
experts, including the credibility and persuasiveness of
those experts.
	        Despite the fact-intensive nature of the valua-
tion process, the relevant statutes and department rules
may impose legal constraints on that process. And inter-
pretations of those statutes and rules remain legal issues.
See Hopkins v. SAIF, 349 Or 348, 355, 245 P3d 90 (2010)
(“Whether one expert is more persuasive than another in
a particular case can be important in resolving a factual
question; it cannot, however, determine the legal meaning
of a statutory term.”). The statutes and rules governing the
valuation process leave room for opposing appraisal experts
to comply with the governing statutes and rules while still
reaching different results. Nevertheless, determining the
meaning and scope of the statutes and rules is a question of
610	          Hewlett-Packard Co. v. Benton County Assessor

law. Whether an appeal challenging a valuation judgment
raises a factual issue or a legal issue depends on the ques-
tion presented.
	        The question that the department presents here
relates to the interpretation of the department’s rule defin-
ing the value of the loss, OAR 150-308.205-(F)(3)(k). That is
a legal issue. The department stated repeatedly in its brief-
ing and at oral argument that it was not asking this court
to reconsider the Tax Court’s factual findings. As a result,
we consider only the narrow legal issue that the department
raises: whether the rule defining value of the loss required
the Tax Court to calculate the value of the loss differently
than it did.
	        Because the department is the source of the rule
defining value of the loss, OAR 150-308.205-(F)(3)(k), the
department’s interpretation of that rule is entitled to def-
erence “as long as its interpretation is a plausible one and
not inconsistent with the rule, its context, or any other
source of law.” Powerex Corp. v. Dept. of Rev., 357 Or 40,
54, 346 P3d 476 (2015) (quotation omitted). Context plays
an important role in this case, both because the rule at
issue refers to technical terms used in other rules and
because the rule itself is part of a larger scheme of rules
governing the valuation process. We therefore consider
that context before assessing the rule defining value of
the loss and the plausibility of the department’s interpre-
tation of that rule.
	        As noted above, the value of the loss is a compo-
nent of the depreciation analysis within the cost approach
to value. “The cost approach to value is based upon the
principle of substitution, that is, it assumes that property
is worth its cost or the cost of a satisfactory substitute with
equal utility.” Delta Air Lines, Inc. v. Dept. of Rev., 328 Or
596, 605, 984 P2d 836 (1999). At its most basic level, the
cost approach requires an appraiser to calculate the cost to
construct a substitute property and then deduct value from
that cost to account for the subject property’s depreciation—
namely, attributes of the subject property that detract from
its market value.
Cite as 357 Or 598 (2015)	611

	        In this case, HP’s expert used the replacement cost
approach, which starts by calculating the cost to build “a
property having equivalent utility to the subject property
but built with the most cost-effective materials, design,
and layout.” OAR 150-308.205-(F)(3)(b); see also Hewlett-
Packard, 21 OTR at 195 (stating that the parties both
applied the replacement cost approach).6 The department’s
rules define “[t]he most cost-effective materials, design, and
layout” as the “combination of investment (cash out-flows)
and the present value of anticipated after tax net income
(cash in-flows) that produces the highest net present value.”
OAR 150-308.205-(F)(3)(b).
	         Because the replacement cost approach focuses on
the cost of constructing improvements with “equivalent util-
ity to the subject property,” HP’s appraiser first found the
utility of the subject property. He determined that only the
core space provided utility to a potential owner of the prop-
erty. He then divided up the square footage in the core space
according to the functions that the space could support, such
as office, manufacturing, and warehouse. He then multiplied
the square footage for each category by the cost per square
foot to construct new, cost-effective buildings that serve
those same functions: new office space, new manufacturing
space, and new warehouse space. The result was the cost of
constructing a new 1.2 million square foot facility that could
support manufacturing and research and development oper-
ations. For the 2008 assessment, HP’s expert estimated that
the cost of constructing a new, cost-effective version of the
core space would be $192 million.7
	        HP’s expert then deducted value from that replace-
ment cost to account for the subject property’s depreciation.
The department’s rules identify three types of deprecia-
tion: physical depreciation (age and deterioration), external
	6
      The replacement cost approach is in contrast to the reproduction cost
approach, which starts by calculating the cost to build “a new replica of the sub-
ject property * * * using the same materials, design, layout, [and] quality of work-
manship.” OAR 150-308.205-(F)(3)(a)(A).
	7
       Throughout the remainder of the opinion, we use the values for the 2008
assessment to illustrate the facts and concepts relevant to the department’s chal-
lenge. Although the values are slightly different for the 2009 and 2010 assess-
ments, the analysis is the same.
612	          Hewlett-Packard Co. v. Benton County Assessor

obsolescence (economic and locational factors), and func-
tional obsolescence (construction and design inefficiencies).
See, e.g., OAR 150-308.205-(F)(2)(b) (referring to physical
depreciation, functional obsolescence, and external obsoles-
cence). HP’s expert found no external obsolescence to deduct
from the $192 million replacement cost, but he deducted
$89 million for the physical depreciation of the core space and
$38 million for its functional obsolescence. Based on those
values, HP’s expert concluded that, for the 2008 assessment,
the cost approach indicated that the subject property was
worth about $65 million.
	        The department does not challenge the values HP’s
expert used for the replacement cost, the physical depreci-
ation, or the external obsolescence. Instead, of all the steps
in the process HP’s expert used in the cost approach, the
department challenges only the value HP’s expert used for
the property’s functional obsolescence. The department’s
rules for finding a property’s functional obsolescence include
the calculation for the value of the loss.
	        The department’s rules define functional obsoles-
cence as
   “a loss in market value of a subject property when there is
   a reasonable feasibility of a typical prospective purchaser
   acquiring, without undue delay, a replacement property
   possessing an equivalent utility but is more cost-effective
   in terms of design, materials, or equipment.”
OAR 150-308.205-(F)(3)(c). An appraiser identifies func-
tionally obsolete components of the subject property by com-
paring the subject property to the replacement property,
which represents the improvements that would most cost-
effectively achieve the same utility as the subject property.
Id. (“Functional obsolescence exists only by a comparison
between the subject and the replacement property.”).
	        A functionally obsolete component can be either
deficient or superadequate. A property has a deficiency if it is
missing a component needed to operate more cost-effectively
or if it has a substandard version of that component. See
OAR 150-308.205-(F)(3)(c)(A) - (B) (describing deficiencies).
And a property has a superadequacy if it has a component
exceeding market norms or the requirements needed to
Cite as 357 Or 598 (2015)	613

operate cost-effectively. See OAR 150-308.205-(F)(3)(c)(C)
(describing superadequacies). Specifically, a superadequacy
is “an asset present in the subject property that is not pres-
ent in the replacement property and does not contribute to
value an amount equal to its cost.” Id.
	       In this case, HP’s expert determined that HP’s
property had a superadequacy—namely, the non-core space.
According to the analysis by HP’s expert, which the Tax
Court adopted, only 1.2 million square feet of the property
provided utility to a potential owner. But the subject prop-
erty was 2 million square feet. As a result, the subject prop-
erty had 800,000 square feet of superadequate space, which
corresponded to the non-core space. The department does
not challenge that determination.
	        The indication of value that results from the cost
approach must account for the presence of functionally obso-
lete components, such as the superadequate space on the
subject property. To do so, an appraiser determines the mar-
ket loss resulting from the presence of functionally obsolete
components and then deducts that amount from the repro-
duction or replacement cost. Because HP’s expert started
with the replacement cost, the department’s rules required
a deduction using one of two potential methods for calculat-
ing the market loss: “the cost to cure or the value of the loss.”
OAR 150-308.205-(F)(2).
	        The cost to cure is the cost needed to alter the sub-
ject property so that it can operate as cost-effectively as
the replacement property. See OAR 150-308.205-(F)(3)(h)
(defining cost to cure as “the net cash out-flow anticipated to
be necessary to eliminate the deficiency or superadequacy”).
In this case, the cost to cure would be the cost to eliminate
the non-core space and allow the property to operate in the
same manner as the replacement property, consisting solely
of the core space.
	        The value of the loss, as previously noted, is gen-
erally the additional operating costs that will result from
failing to alter the subject property to match the cost-
effectiveness of the replacement property. OAR 150-308.205-
(F)(3)(k). The department’s rules define the value of the
loss as “the present value of the after-tax loss in anticipated
614	              Hewlett-Packard Co. v. Benton County Assessor

income from the continuing operation of the property with
a deficiency or superadequacy compared to the projected
operation of the replacement property.” Id. That rule states
that, “[f]or industrial plants, this loss in income is often the
result of excess operating costs due to inefficiencies in the
subject plant compared to the subject property when cured
of the functional obsolescence.” Id.
	         Between those two methods—the cost to cure and
the value of the loss—an appraiser uses whichever method
results in the smaller deduction. OAR 150-308.205-(F)(2).
If the cost to cure is less, then the functional obsolescence is
“curable.” OAR 150-308.205-(F)(3)(g). If the value of the loss
is less, then the functional obsolescence is “incurable.” OAR
150-308.205-(F)(3)(f).
	        The department concedes that in this case the
value of the loss is less than the cost to cure, even if we
affirm the analysis that the Tax Court adopted.8 Therefore,
the non-core space is an incurable superadequacy. The mar-
ket loss resulting from the presence of the non-core space
is determined according to the value of the loss, and the
value of the loss is deducted from the cost of the replace-
ment property.
	        HP’s expert determined the value of the loss, and
thus the functional obsolescence, by comparing the antici-
pated income from operating the 2 million square foot sub-
ject property to the anticipated income from operating the
1.2 million square foot replacement property. According to
HP’s expert, an owner of the subject property would annu-
ally incur $4.6 million in additional operating expenses,
as compared to the replacement property, until the prop-
erty is redeveloped. After factoring in taxes and by apply-
ing a discount rate to the additional operating expenses
incurred over the remaining economic life of the non-core
space, HP’s expert determined the value of the loss to be
$38 million.

	8
       The department assigned as error the manner in which HP’s expert had
calculated the cost to cure as well as the value of the loss. At oral argument, how-
ever, the department waived any challenge related to the cost to cure and stated
that it was challenging only the value of the loss. As a result, we do not consider
whether HP’s expert properly calculated the cost to cure.
Cite as 357 Or 598 (2015)	615

	        The department does not challenge the manner in
which HP’s expert calculated the taxes, the discount rate, or
the remaining economic life of the non-core space. Instead,
the department contends only that HP’s expert erred when
he calculated the “loss in anticipated income from continu-
ing operation of the [subject] property with a deficiency or
superadequacy.” OAR 150-308.205-(F)(3)(k). According
to the department, the value of the loss should have been
$13 million instead of the $38 million used by HP’s expert.
The department reaches that number by relying on the
highest and best use analysis performed by HP’s expert. As
part of that analysis and as described above, HP’s expert
considered whether converting the non-core space was
a financially feasible use. He concluded that conversion
was not financially feasible because an owner would lose
$13 million by converting and maintaining the non-core
space. The department contends that a potential owner
would rather lose $13 million by converting the non-core
space than lose $38 million by leaving the non-core space
vacant. Recalculating the value of the loss as $13 million
instead of $38 million would increase the cost approach val-
uation by $25 million, resulting in a $90 million indication
of value rather than the $65 million reached by HP’s expert
and the Tax Court.
	        The difficulty with the department’s analysis is fit-
ting it within the narrow legal argument that it makes—
namely, that the Tax Court misinterpreted or misapplied the
rule defining the value of the loss. The department’s under-
standing of the value of the loss is inconsistent with the val-
uation scheme otherwise set out in the department’s rules.
The value of the loss is used to measure the functional obso-
lescence of the subject property. OAR 150-308.205-(F)(2).
And functional obsolescence is the negative value of any
deficiency or superadequacy in the subject property as
compared to the replacement property. OAR 150-308.205-
(F)(3)(c). The replacement property provides the same util-
ity as the subject property but uses the most cost-effective
materials, design, and layout. OAR 150-308.205-(F)(2). As
a result, for the purposes of determining functional obso-
lescence, the only difference between the subject property
and the replacement property is the materials, design, and
layout of the two properties.
616	          Hewlett-Packard Co. v. Benton County Assessor

	         But the department’s interpretation distorts the
comparison between the subject property and the replace-
ment property. The department would allow an appraiser to
consider changes to the utility of the subject property as part
of his or her value of the loss calculation. In this case, under
the department’s interpretation, the subject property would
provide 2 million square feet of utility that includes market-
able rental space as well as an owner-occupied research and
manufacturing facility. The replacement property, on the
other hand, would provide only 1.2 million square feet used
as an owner-occupied research and manufacturing facility.
The department contends that a potential owner would use
all 2 million square feet because that would generate the
most value.
	        But it is not appropriate to measure functional obso-
lescence by comparing the value of a 2 million square foot
property that includes marketable rental space as well as an
owner-occupied research and manufacturing facility to the
value of a 1.2 million square foot property used only as an
owner-occupied research and manufacturing facility. That
comparison occurs at the stage of determining the high-
est and best use. By the time an appraiser calculates the
value of the loss as part of the final valuation opinion, the
appraiser has already figured out the use that a potential
owner would make of the property to produce the highest
value or maximum productivity: that use is the property’s
highest and best use. See OAR 150-308.205-(D)(1)(c) (defin-
ing highest and best use as, among other things, the use
that “results in the highest value”).
	         Here, the Tax Court found that the highest and best
use of the property was as a single-purpose, owner-occupied
manufacturing and research facility. HP’s expert found that
the non-core space provided no utility as part of a single-
purpose, owner-occupied manufacturing and research
facility. The Tax Court expressly adopted that finding and
valued the property as though it provided only 1.2 million
square feet of utility. As a result, the non-core space was not
included in the replacement property. And the value of the
loss was calculated as the increased operating expenses that
an owner would incur as a result of operating the subject
property as compared to the replacement property. That is
Cite as 357 Or 598 (2015)	617

entirely consistent with the department’s rule, which states
that the value of the loss “is often the result of excess operat-
ing costs due to inefficiencies in the subject plant compared
to the subject property when cured of the functional obsoles-
cence.” OAR 150-308.205-(F)(3)(k).
	        HP’s expert calculated those additional operating
expenses as $4.6 million per year, which, when spread out
over the remaining economic life of the improvements, leads
to a present value of $38 million. The department calcu-
lates the operating expenses differently only because the
department contends that the property should be operated
to serve a different use. If the department were correct, and
converting the non-core space into marketable rental prop-
erty would increase the value of the property by $25 million,
then the highest and best use of the property would be the
mixed-use manufacturing/rental property that the depart-
ment urged the Tax Court to accept. In that case, using the
non-core space as marketable rental property would contrib-
ute $25 million in incremental value to the subject prop-
erty over leaving the non-core space vacant, even if the non-
core space continued generating operating losses after the
conversion. In other words, if using the property solely as
a research and manufacturing facility makes the property
worth $65 million and using the property as a rental prop-
erty as well as a research and manufacturing facility makes
the property worth $90 million, then using the property as
a rental property contributes $25 million in value.9
	       To the extent the department accurately represents
the conversion costs and projected rental income used by
HP’s expert and the Tax Court, then the department would
have identified a potential error in the highest and best use

	9
       That is not to suggest that, even if the highest and best use was the mixed-
use manufacturing/rental property that the department urged, the final valu-
ation would increase by $25 million. Changing the highest and best use would
require changing numerous other components of the cost approach, including
the utility provided by the property, the scope of the replacement property, the
calculation for physical depreciation, and the existence of external obsolescence.
Further, changing the highest and best use would also require changes to the
sales comparison approach as well as the reconciliation leading to the final val-
uation opinion. The wide-ranging effects of the department’s argument on the
valuation process highlight the impropriety of attempting to contain this issue
entirely within the value of the loss.
618	          Hewlett-Packard Co. v. Benton County Assessor

analysis—specifically, calling into question the analysis of
financial feasibility and the use that creates the highest
value.. But the department has not asked us to consider the
proper interpretation of those criteria or the Tax Court’s
findings on those issues. Nor has the department asked us
to review the Tax Court’s conclusion that there were signifi-
cant questions regarding the legal permissibility of convert-
ing the non-core space into marketable rental space. Those
questions create market risk and decrease the present value
of the proposed use.
	        It is unclear whether the financial feasibility analy-
sis performed by HP’s expert is the correct test for the finan-
cial feasibility of improved property. If converting the non-
core space is not financially feasible because it leads to a
loss of $13 million, then it is not immediately apparent how
leaving the non-core space vacant could be financially fea-
sible, given the conclusion of HP’s expert that leaving the
non-core space vacant creates a loss of $38 million. Even the
Tax Court stated that HP’s expert’s analysis of the highest
and best use was “perhaps not free from criticism.” Hewlett-
Packard, 21 OTR at 191.
	        Nevertheless, by concluding that the highest and
best use of the property was as a single-purpose, owner-
occupied manufacturing and research facility, the Tax Court
held that a single-purpose, owner-occupied manufacturing
and research facility was the physically possible, legally
permissible, and financially feasible use that resulted in
the highest value. The department does not challenge the
factual or legal basis for ruling. Instead, the department
maintains that we can rule in its favor without reversing
the Tax Court’s ruling on highest and best use. But without
disturbing that ruling, we cannot accept the department’s
argument that a potential owner of the property would use
it as a mixed-use manufacturing/rental property. Therefore,
on the record before us, the Tax Court properly calculated
the value of the loss.
	       The judgment of the Tax Court is affirmed.
