Running to the Mall? Property Tax Valuation During a Pandemic

The pervasive nature of the COVID-19 pandemic made it obvious to many that litigation addressing challenges to the real property valuation of commercial centers would not take long to commence, given that people are not “running to the mall” with the frequency that they had in the past. A recent decision by a trial-level court in New York, Crystal Run Galleria,¹ emphasizes how the pandemic will provide abundant opportunities for affected businesses to challenge real estate assessments for the 2020 tax year and beyond.

I. The Large Mall/Small Town Dynamic

At the crossroads of Interstate 84 and Route 17, an area that many in the five boroughs of the Big Apple would consider (with perhaps an air of derision) to be “upstate New York,” the Galleria at Crystal Run is a large mall located in the town of Wallkill. Only about an hour north of midtown Manhattan on a good traffic day, the mall boasts a movie theater multiplex, restaurants, over 100 retail establishments, and an “Urban Air Trampoline and Adventure Park” that seems thrilling for people who don’t lose their equilibrium when they jump and bounce uncontrollably on a flimsy net.

Being a large mall in a relatively small town means that the amount of property tax it generates is material to the town’s survival and prosperity. Small towns plan their budgets around these expected tax revenues. Likewise, the amount of property tax paid by the owner of such a mall can be a meaningful operating cost for that location. Given the somewhat symbiotic relationship between a small town and a large commercial center, a level of tax certainty is appreciated by both parties to the arrangement. And this is especially true in New York, where taxpayers can and do freely challenge real property assessments from municipalities in tax certiorari proceedings.

II. Consent Orders and the Pursuit of Tax Certainty

Given the prevalence of tax certiorari litigation, how can some level of property tax certainty be obtained? One way to achieve it is through a settlement agreement in the form of a consent order that essentially requires the property tax assessment level to remain the same for several years (three years, if the statutory term is followed), without the ability for the town or taxpayers to disturb the amount. That is, unless an exception occurs. An exception is an extenuating circumstance on a statutorily enumerated list of events, or as adjusted by the parties’ agreement.

The statutory list of exceptions that generally applies is in N.Y. Real Prop. Tax Law section 727. The list includes exceptions for the following events:

• a revaluation or update of all real property on the assessment roll, or in a special assessing unit of all real property of the same class;

• a physical change (improvement) to, or change in the zoning of, the property;

• an alteration of the property by fire, demolition, destruction, or similar catastrophe;

• an action taken by any federal, state, or local government office that caused a discernible change in the general area where the property is located directly affecting property values;

• a change of 25 percent or more in the occupancy rate of a building located on a property not eligible for small claims assessment review;

• the property owner becomes eligible or ineligible to receive a real property tax exemption; or

• a change in the use or classification of the property.²

As noted, however, the parties to a consent order can agree to change the list of exceptions that would trigger a change in the assessment level. In this matter, the Galleria had challenged its 2017 tax year assessment and then settled with the town of Wallkill via a consent order and judgment. In the consent order, the parties agreed to fix the full market value of the property for Galleria’s 2018-2021 tax years at $132,738,000 but chose to waive the statutory list of exceptions and instead specify their own list of exceptions. The parties agreed that specific upgrades to the mall, revaluation/assessment updates, most occupancy rate changes, and sale of the property would not disturb the full market value fixed by the consent order. The exceptions that were agreed upon and could result in a change to the value included the addition of the mall’s gross leasable area, fire, demolition or destruction, a lender-related sale, a significant decline in the average occupancy rate, and the town’s adoption of a homestead/non-homestead real property tax rate structure.

Following execution of the consent order, the Galleria claimed that business at the mall declined for a variety of reasons in 2018 and 2019, in part because of growing competition from e-commerce business, resulting in financial problems for many of its tenants. Then the pandemic hit, and to make matters even worse, the Galleria had the unfortunate distinction of being relatively close to the first pandemic hotspots in New York. The taxpayer argued that one of the consent order exceptions had been triggered by the pandemic, in that the property was “altered by fire, destruction, related demolition, or similar catastrophe.” In addition to the substantive claim that the consent order exception had been triggered, the taxpayer argued equity and constitutionality — in essence, the pandemic frustrated the purpose of the consent order, and enforcement of the consent order would violate the New York Constitution.

III. Examination of ‘Similar Catastrophe’ Exception

The trial court began its analysis by addressing the “similar catastrophe” exception language in the consent order. The court first examined the purpose of the consent order, and it concluded that both parties were indeed looking for certainty. Wallkill wanted to ensure the amount of real property tax revenue that it would receive, and likewise, the taxpayer wanted to make sure that its taxes would not increase over the next few years. The parties were so focused on certainty that the specific exception raised by the taxpayer actually had been slightly adjusted from the statutorily enumerated exception.³

Given the parties’ desire for precise certainty, the court then looked to construe the exception as part of the whole consent order. In doing so, the court concluded that the exception could be triggered only if the property itself was altered through material or substantial physical damage, and that a change in the value, use, or function of the property did not qualify under the exception without any physical alteration to the property. The court rejected the taxpayer’s contention that the pandemic is a catastrophe under the order — while it certainly is a catastrophe, it was not considered as the type of catastrophe intended to be covered under the exception to the consent order. Likewise, the court did not accept the taxpayer’s argument that any type of alteration to the property caused by the pandemic was enough to trigger the exception. Finally, the taxpayer could not show that the presence of a contaminant (in the form of the COVID-19 virus) caused a physical loss that would qualify as an alteration of property as intended by the consent order.

The court then looked to the principle of ejusdem generis, in which the meaning of a word in a larger series of words is determined by looking at the surrounding words. Under this principle, general words that follow specifically delineated words apply to the specifically listed items only. As such, the court interpreted the phrase “altered by fire, destruction, related demolition, or similar catastrophe” to mean that a similar catastrophe had to embrace events described in the prior words in the phrase. A similar catastrophe thus had to relate to a destructive act causing material or substantial physical damage. The pandemic did not cause the same type of physical destruction that would allow the taxpayer to claim the “catastrophe” exception to the consent order.

IV. Analysis of Equitable and Constitutional Arguments

Having parried the substantive attacks on the consent order, the court then considered the taxpayer’s equitable and constitutional arguments. Regarding equity, the taxpayer looked to the doctrine of “frustration of purpose” to try to defeat the operation of the consent order. A contract may be subject to rescission under the concept of frustration of purpose if a contingency has occurred; the risk of that contingency has not been allocated by agreement or in another manner; and while both parties can perform the contract, the contingency frustrated the purpose of the contract. In this case, the taxpayer viewed the contingency to be the pandemic, the risk of the pandemic was not allocated by the consent order, and the pandemic frustrated the purpose of the consent order because it caused the property’s actual value to diminish rapidly. The court noted that while the pandemic was unforeseeable, the risk of an event that would substantially increase or decrease the value of the property could be foreseen, and was in fact addressed in the consent order: The parties agreed that the property tax valuation could be changed if the average occupancy rate of the Galleria was below 60 percent for a continuous 12-month period.

The taxpayer fared no better on the state constitutional front. The New York Constitution provides that a property assessment “shall in no case exceed full value.”⁴ Based on that provision, the taxpayer claimed that the consent order prohibiting a tax certiorari proceeding could be overturned on the basis that the agreed-upon value in the consent order now exceeded the property’s full value. The court said the taxpayer waived the ability to invoke the constitutional provision by entering into the consent order agreement.

V. Taxable Status Date Versus Valuation Date

The court concluded its analysis by addressing the date on which the property was to be valued for the 2020 tax year. Two relevant provisions in the New York Real Property Tax Law were compared. The first concludes that all real property subject to tax and assessed as of a March 1 taxable status date is valued as of July 1 of the prior year.⁵ The second requires that the taxable status date of real property be determined annually, according to its condition and ownership as of March 1, and such valuation determined as of the applicable valuation date.⁶ Accordingly, had no consent order been in place, the taxable status of the Galleria would have been determined as of March 1, 2020, while the property would have been valued as of July 1, 2019.

The taxpayer argued that as of March 1, 2020, the pandemic had adversely affected the condition of the mall. While the property may have been financially affected by that date, the condition of the mall had not been affected — the mall was still open for those who wanted to enter. And as the pandemic did not exist on the valuation date of July 1, 2019, the financial impact of the pandemic could not be relevant to determining the mall’s assessed value on the 2020 tax year assessment roll.

VI. What Can Malls Argue in Light of the Galleria’s Experience?

Following a year of pandemic-related declines from an economic perspective, many owners of commercial centers likely are wondering what they can do to reduce their real property tax valuation. Can they make colorable arguments that the pandemic has resulted in a permanent reduction in the valuation of their properties, and when will the relief come?

A good place to start is to consider what could have been done differently by the Galleria, and the powers that the Galleria did have under the consent order. Had the Galleria and Wallkill kept the section 727 statutory provisions when negotiating the consent order, the Galleria might not have been stuck arguing that the pandemic was a catastrophe as intended to be defined under the exception in the consent order. Instead, the taxpayer might have tried to claim that pandemic-related actions taken by the government (a section 727 exception) caused a change in the area of the mall, directly affecting the property value of the mall. One problem with that argument is that many of the governmental actions taken to prevent the spread of the coronavirus, even in places close to the early hot spots, took place after March 1, 2020, and as such, this argument might only have been workable for the 2021 tax year assessment roll, not 2020. Further, a “change in the area” of the mall does not incorporate policies that only tend to reduce congregations of people — rather, the government order had to completely close the mall to activate the exception. Alternatively, the Galleria conceivably could claim under the consent order that its average occupancy rate went below 60 percent for a continuous 12-month period, allowing the Galleria to elect to terminate the consent order at that time. It likely would have taken several months into 2020 at the earliest before that threshold could have been met.

So for commercial center taxpayers that want to enter into a consent order with a jurisdiction in the pursuit of tax certainty, the lesson is clear: A lot can happen in three or four years. Neither the Galleria nor the town for that matter knew that a pandemic would strike during the period of the agreement and decimate the foot traffic in the mall. Therefore, protecting against a completely locked assessment value through rigorous review of the exceptions to be placed in a consent order, and considering “disaster scenarios,” is essential.

Of course, for other taxpayers that do not have a consent order in place, or are governed by section 727, the Galleria decision can easily be distinguished because it interprets only the specific consent order entered into between the parties, not the general provisions of section 727. At the same time, businesses claiming that the pandemic immediately caused an adverse impact on their property values may still have to prove more than just a diminution of foot traffic. Rather, they may have to show that the business was forced to shut down entirely. As most real property valuations take place on that March 1 date, and the United States did not take steps to lock down many sectors of the economy until a couple weeks after that date, assessments based on the March 1, 2020, status date may be difficult to challenge based on a purely pandemic-related argument. It’s likely a different story for 2021, when a valuation as of July 1, 2020, certainly would capture the effect of the pandemic.

Finally, the decision highlights the important distinctions between the date on which the property value is determined for a tax year and the tax status date that locks in treatment. Interestingly, these dates can be vastly different in different municipalities in the same state. For example, in Orange County, New York, the location of the Galleria, the status date for the 2020-2021 tax year is March 1, 2020, with value determined on July 1, 2019. In contrast, in Nassau County, New York, the status date and value date is finalized on January 2 of each year for the subsequent tax year. Practically, what that means is that the effects of the pandemic on real property assessment values will not be felt in Nassau County until the 2022-2023 tax year, since the status and value date for that tax year was recently locked in on January 2, 2021.

We hopefully will move from pandemic-tainted times to a more positive future — one in which we can feel more comfortable freely consorting with family, friends, and acquaintances in a food court, favorite retail shop, and entertainment venue in the span of minutes. While our biggest worry could be where to find a decent parking spot in the new normal mall experience, the mall owners will be dealing with volatile property tax valuations that could affect the viability of those properties for some time to come. Likewise, the municipalities will be concerned about the long-term threat posed by taxpayers challenging assessments derived from ironclad agreements that are designed to promote revenue stability. Along with the continuing pressures of e-commerce, if left unchecked, valuation volatility could disturb the large mall/small town dynamic that still drives commerce across the United States.