Market Rent Controls Potential Gross Income Absent Atypical Concessions; Occupancy Adjustments Must Align With Fee‑Simple Valuation

Introduction

This Minnesota Supreme Court decision affirms a tax court valuation of a three‑story medical office building in Burnsville for the 2021 tax year. The property owner, Burnsville Medical Building, LLC (the taxpayer), challenged the County’s assessment and, after presenting an appraisal by its expert, obtained tax court review. Two core issues reached the Supreme Court:

• Whether, under the income capitalization approach, the tax court erred in estimating potential gross income using market rent rather than effective net rent (i.e., market rent reduced by tenant improvement allowances and free rent).
• Whether the tax court clearly erred in rejecting the taxpayer’s occupancy adjustment under the sales comparison approach, which the expert claimed was necessary due to a large tenant’s lease expiration nearly two years after the valuation date.

The Court affirms in full, holding that absent proof of atypical or excessive concessions, market rent is the proper basis for potential gross income, and that the tax court acted within its discretion in finding the occupancy adjustment methodologically unsound and not credible.

Summary of the Opinion

Following a bench trial, the tax court valued the property at $9,300,000—above Dakota County’s original assessment of $8,007,800. It weighted the income approach at 75% and the sales comparison approach at 25%. The taxpayer’s MAI/CCIM expert had used both approaches but (1) reduced potential gross income for tenant improvements and free rent to derive “effective net rent,” and (2) applied an occupancy adjustment that moved all comparables downward, regardless of whether they were more or less occupied than the subject, citing the risk of a large tenant vacancy 21 months after the valuation date.

The tax court rejected both moves: it adopted market rent to compute potential gross income because there was no proof of atypical/excessive concessions, and it declined the occupancy adjustment as internally inconsistent and misaligned with fee‑simple valuation. The Supreme Court affirmed, relying on its 2024 decision in Tamarack Village Shopping Center, LP v. County of Washington, to hold that typical tenant improvements and concessions are handled below the line—through the capitalization rate—rather than by reducing market rent, and endorsing the tax court’s credibility findings on the sales comparison adjustments.

Detailed Analysis

Precedents Cited and Their Influence

• Tamarack Village Shopping Center, LP v. County of Washington, 9 N.W.3d 820 (Minn. 2024)
  • Central authority. Reaffirmed here to hold that, in a fee‑simple valuation using the income approach, potential gross income is ordinarily based on market rent, not “effective rent,” unless the taxpayer proves tenant improvement allowances or rent concessions are atypical or excessive in the market.
  • Explained “above‑the‑line” (operating expenses) vs “below‑the‑line” (capitalized through the cap rate) treatment. Typical tenant improvements function as below‑the‑line costs reflected in capitalization rates; only atypical or excessive concessions justify reducing market rent to effective rent.
  • Rejected “double taxation” and “non‑existent improvements” arguments against using market rent because market rent already embeds market‑level concessions via investor expectations and cap rate selection.
• Eden Prairie Mall, LLC v. County of Hennepin, 797 N.W.2d 186 (Minn. 2011)
  • Supports using market rent and treating market‑level tenant improvements as below‑the‑line—captured in capitalization—rather than as a reduction to potential gross income.
  • Sets expectations for adequate explanation and evidentiary support of the tax court’s valuation.
• Archway Marketing Services v. County of Hennepin, 882 N.W.2d 890 (Minn. 2016)
  • Defines “market rent” as the rent obtainable in the open market, potentially distinct from in‑place contract rent, reinforcing the fee‑simple perspective.
• Bloomington Hotel Investors, LLC v. County of Hennepin, 993 N.W.2d 875 (Minn. 2023)
  • Articulates the income and sales comparison approaches and reinforcement of their doctrinal roles.
• Menard, Inc. v. County of Clay, 886 N.W.2d 804 (Minn. 2016)
  • Encourages use of multiple valuation approaches to cross‑check values and ensure reliability.
• Hansen v. County of Hennepin, 527 N.W.2d 89 (Minn. 1995); Montgomery Ward & Co. v. County of Hennepin, 482 N.W.2d 785 (Minn. 1992)
  • Appellate deference: A valuation within permissible limits, adequately explained, and supported by evidence must be sustained unless clearly erroneous.
• Southern Minnesota Beet Sugar Coop v. County of Renville, 737 N.W.2d 545 (Minn. 2007); Minn. Stat. §§ 271.06, subd. 6; 278.01
  • Assessor’s valuation is prima facie valid; taxpayer bears the burden to prove excessiveness. Here, the taxpayer overcame the presumption with an appraisal but ultimately did not prevail on key methodological points.
• Perham Hospital District v. County of Otter Tail, 969 N.W.2d 366 (Minn. 2022); Alliance Housing Inc. v. County of Hennepin, 4 N.W.3d 355 (Minn. 2024)
  • Standards of review: legal issues de novo; factual findings for clear error; appellate courts do not reweigh evidence or reassess credibility.
• Macy Retail Holdings, Inc. v. County of Hennepin, 899 N.W.2d 451 (Minn. 2017)
  • Forfeiture of arguments not raised below. Applied here to reject a new twist on occupancy adjustments within the income approach and lease‑up cost arguments absent record development.
• The Appraisal of Real Estate (Appraisal Institute, 15th ed. 2020)
  • Cited for the structure of the income approach, the definition of effective rent and rent concessions, and the role of lease‑up costs.

Legal Reasoning

1) Income capitalization approach: Market rent vs. effective net rent

The Court squarely rejects the taxpayer’s insistence on using “effective net rent” to compute potential gross income. Anchored in Tamarack Village, the Court holds that:

• Market rent is the baseline for potential gross income in fee‑simple valuations when rents are the primary income driver.
• Only when tenant improvement allowances or rent concessions (e.g., free rent, cash allowances) are atypical or excessive relative to market will reducing market rent to an “effective rent” be justified.
• Typical tenant improvements and concessions are “below‑the‑line”—reflected in investor expectations and captured in the capitalization rate—so using effective rent in addition would double‑count their effect.

On this record, the taxpayer’s own expert conceded there was no evidence that the property’s tenant improvement allowances or the limited free rent were atypical or excessive. Comparable leases in the report did not show free rent in the 2020 assessment year, and only one subject tenant had received a free‑rent period—and that occurred in 2018, pre‑valuation. Accordingly, the tax court properly used market rent to estimate potential gross income, and its factual determinations were not clearly erroneous.

2) Sales comparison approach: Occupancy adjustment and fee‑simple vs. leased fee

The taxpayer’s expert applied a single directional “occupancy adjustment” that reduced the value indications of all four multi‑tenant comparables—two that were more occupied than the subject (100% vs. 90%+) and two that were less occupied—rationalizing the uniform downward shift by pointing to a large tenant’s lease expiration 21 months after the valuation date. The tax court rejected this adjustment, and the Supreme Court affirmed, for three interlocking reasons:

• Internal inconsistency and credibility. A single, downward adjustment applied to comparables regardless of their relative occupancy to the subject is methodologically suspect. The tax court reasonably questioned credibility.
• Fee‑simple vs. leased fee mismatch. Tethering adjustments to a particular in‑place lease’s expiration shifts the analysis toward a leased fee perspective. Fee‑simple valuation seeks the unencumbered market value, not the value as affected by the specific subject lease profile (unless the jurisdiction directs otherwise). The tax court correctly flagged this misalignment.
• Speculative “destabilized occupancy.” The asserted “near‑term risk” was 21 months away, with no evidence that the tenant planned to vacate as of the valuation date. Speculative, post‑date events are not an evidentiary basis for a downward occupancy adjustment.

Because credibility determinations and weighing of appraiser adjustments are factual matters, the Court applied a deferential clear‑error standard, finding none.

Impact and Forward‑Looking Significance

• Statewide clarity on income approach inputs. The decision cements Tamarack Village as controlling across property types—including medical office buildings—that market rent, not effective rent, drives potential gross income unless the taxpayer proves atypical/excessive concessions with record evidence.
• Higher evidentiary bar for concessions. Taxpayers and appraisers must document—and quantify—market atypicality of tenant improvements and concessions to justify rent reductions. General market surveys or conclusory references to “free rent” will not suffice without comparables showing the same concession structure and magnitude.
• Occupancy adjustments disciplined. Appraisers must:
  • Align adjustments with fee‑simple valuation, avoiding bespoke leased‑fee considerations absent a legal mandate.
  • Apply adjustments symmetrically and transparently, with direction and magnitude tied to relative differences (e.g., higher vs. lower occupancy) and supported by data.
  • Avoid speculative “destabilization” theories; “near‑term” means truly imminent and evidenced, not merely a calendar date beyond the horizon.
• Reconciliation latitude preserved. The Court implicitly approves significant weighting of the income approach (75% here) for income‑producing properties, while reminding that both approaches serve as cross‑checks.
• Practical valuation effects. Expect fewer successful attempts to depress potential gross income via “effective rent” adjustments in the absence of strong market proof. Capitalization rate selection and support become even more critical to reflect typical concessions.

Complex Concepts Simplified

• Fee simple vs. leased fee:
  • Fee simple is the unencumbered ownership interest—valuation seeks market value assuming typical conditions, not tied to any specific lease.
  • Leased fee is the landlord’s interest subject to existing leases—valuation can be influenced by specific in‑place lease terms. Minnesota property tax valuations generally employ the fee‑simple perspective unless otherwise directed.
• Market rent vs. effective rent:
  • Market rent is the rent that would be achieved in an arm’s‑length market transaction for the space, reflecting typical market conditions.
  • Effective rent net‑outs concessions (e.g., free rent, atypical tenant improvement allowances) from nominal rent to show the “real” economic rent over the lease term.
• Tenant improvement (TI) allowances and concessions:
  • Funds or incentives landlords offer to fit out space or attract tenants. If they are typical for the market, their cost effect is captured below the line through the capitalization rate, not by reducing market rent.
  • If atypical or excessive compared to market norms, they can justify adjusting market rent downward to effective rent—but only with proof.
• Above‑the‑line vs. below‑the‑line:
  • Above‑the‑line expenses are operating expenses deducted to reach net operating income (NOI).
  • Below‑the‑line items are capital or non‑operating—reflected in the investor’s required return and capitalized via the cap rate. Market‑level TIs and ordinary concessions are typically below‑the‑line.
• Income approach steps (simplified):
  1. Estimate potential gross income (PGI) using market rent.
  2. Deduct vacancy and collection loss to get effective gross income (EGI).
  3. Deduct operating expenses to get NOI.
  4. Capitalize NOI (direct or yield capitalization) to derive value.
  5. If necessary, adjust for lease‑up costs when valuing a property that is not stabilized, with proper evidence.
• Occupancy adjustment (sales comparison):
  • Adjusts comparable sales to account for differences in economic occupancy relative to the subject. Direction and size must be supported by data and consistent with fee‑simple valuation.
• Standards of review:
  • De novo for legal questions (e.g., the correct standard for using market vs. effective rent).
  • Clear error for factual findings and credibility (e.g., whether concessions were atypical; whether an occupancy adjustment was supported).
• Prima facie validity:
  • Assessor’s value is presumed valid; the taxpayer bears the burden to overcome it with persuasive, methodologically sound evidence.

Practice Pointers

• For taxpayers and appraisers:
  • Do not reduce market rent to effective rent unless you can prove—with comparable market evidence—that the subject’s concessions are atypical or excessive. Identify the type, magnitude, and frequency of concessions in truly comparable leases.
  • Align all adjustments with fee‑simple valuation. Avoid adjustments that depend on idiosyncratic lease expirations or terms unless you establish a principled, market‑wide basis.
  • Ensure occupancy adjustments are directional and data‑driven. A blanket downward adjustment applied to both higher‑ and lower‑occupied comparables signals methodological inconsistency.
  • Document “destabilized occupancy” with evidence of imminence and likelihood. A lease expiring nearly two years after the valuation date, without more, is not “near‑term” risk.
  • If asserting lease‑up costs under the income approach’s Step 5, build a record: vacancy status, absorption timelines, TI/leasing commissions, and market‑supported durations and costs.
• For counties and assessors:
  • Maintain and present market evidence on typical concession patterns for the property type and submarket to defend market rent inputs and capitalization rates.
  • Challenge adjustments that mix fee‑simple and leased‑fee concepts or that lack internal consistency and data support.

What Would Have Changed the Outcome?

• Concrete, contemporaneous market evidence that the subject’s TI allowances or free‑rent concessions were atypical/excessive (e.g., multiple comparable leases with materially lower concessions; market surveys with granular concession data).
• Evidence that, as of the valuation date, the large tenant had communicated a decision to vacate or other credible indicators making vacancy imminent and reasonably certain (thus bearing on stabilization, lease‑up costs, or an occupancy adjustment grounded in fee‑simple market behavior).
• A methodologically consistent occupancy adjustment that varies with the direction of the occupancy difference, tied to market‑supported rent and cap rate impacts.

Conclusion

The Supreme Court’s decision reinforces a disciplined, market‑grounded framework for property tax valuation in Minnesota. It cements the principle—drawn from Tamarack Village—that potential gross income, in fee‑simple valuations, is anchored in market rent, with typical concessions captured through capitalization rather than rent reductions. It also underscores that sales comparison adjustments must be internally consistent, credibly supported, and aligned with fee‑simple valuation, not bespoke leased‑fee realities.

The ruling offers practical guidance to both taxpayers and assessors: evidentiary rigor on market concession norms is indispensable; speculative or asymmetrical adjustments will not carry the day; and credibility findings by the tax court, when adequately explained and record‑supported, will be sustained on appeal. In short, Burnsville Medical clarifies and extends the reach of Tamarack Village to medical office buildings, advancing predictability and methodological integrity in Minnesota property tax litigation.