Adjustment of the Neeta City sale
53 The appellant said, in the words of the ground of appeal -
"The primary judge erred as a matter of valuation principle in failing to separately account for the value of existing leases and rental guarantees when seeking to identify the underlying value of the fee simple in "comparable" improved (ie, fully let and ongoing) retail sales, and thereby necessarily overstated the underlying value of that fee simple for the purposes of the purported comparable sales analysis that was undertaken."
54 This concerned the Neeta City sale. The sale price was $90,000,000. It was necessary to subtract the added value of the improvements, a well-recognised valuation exercise. Mr Watt subtracted $71,400,000, being the replacement cost of the improvements depreciated by 30 per cent, arriving at an unimproved value of $18,600,000 representing $837 per square metre, which he further adjusted for Neeta City's superior site and otherwise to $556 per square metre. He did not directly apply that figure to the land, but the trial judge observed at [22] that his land value was "informed by the Neeta City sale". Application to the land's 4,282 square metres would bring a value of $23,807,920.
55 Mr Jackson said in the first joint report that there should also have been subtraction of "a component of value attributed to the existing leases and a rental guarantee within the sale price". He said that the leases gave a gross income of $8,807,346 per annum, and included 17 years remaining of a lease to Big W and nine years remaining of a lease to Woolworths, and that a 12 month rental guarantee was given by the vendor to the purchaser. He would have subtracted an additional $8,682,589, described as representing the present value of the income of a notional 12 month leasing up period and as an allowance "reflect[ing] the circumstance that the purchaser acquire the property fully leased and therefore with the advantage associated of all leases being in place". The unimproved value of the Neeta City site would have represented $484 per square metre, after further adjustment by Mr Jackson becoming $315 per square metre.
56 Mr Jackson further explained his opinion in his oral evidence. He said that the sale of an investment property comprised the land, the buildings and the leases, and that in order to arrive at the land value it was necessary to "strip out" not only the buildings component but also the leases component. The existing leases were worth something to the purchaser, who would pay more for a fully let shopping centre, and that added value had to be subtracted. To ignore the leases, he said, assumed that a purchaser would pay the same price for a vacant shopping centre as for a fully tenanted shopping centre, which was incorrect.
57 Mr Jackson's reasoning could be thought to have required deduction of a capitalised income stream for the lifetime of the existing leases. It is important that in the result his deduction was confined to a capitalised income stream for a notional letting-up period.
58 Mr Watt regarded subtraction of the value of the leases as a novel concept in valuation practice. In the second joint report he understood Mr Jackson to advocate deduction of the present value of the letting up of all the leased areas at the time of sale, which as I have said Mr Jackson's reasoning could be thought to have required. He responded that the sale price of an investment property included the market's perception of the value of the lease income, that the yield return was the intrinsic value of the land and improvements, and that the value of the leases was "embedded in the land and improvements, as neither can exist without the other". He considered that Mr Jackson obtained his concept from the practice of developers including letting-up allowances in their developmental cash-flow analysis, by which he meant an allowance for lease incentives and/or rent free periods, which he distinguished from the present value of the leases. In his opinion, the income benefits and risks of the existing leases were "incorporated in the effective yield paid for the property", and there was "no additional or separate element of value as described by Mr Jackson"; although he appeared to accept some adjustment for the present value of letting up of leased areas associated with local retailers because there was "some risk with the leasing of specialties", but not for the value of letting to major tenants such as Coles and Woolworths because "there is little or no risk associated with the leasing up of major tenancies within a shopping centre".
59 Mr Watt said in the report that in any event "the generous elemental costings and the loading that I have included within each replacement cost schedule more than adequately accounts for any such adjustment that Mr Jackson might suggest is required."
60 Mr Watt also gave oral evidence on the matter. He said expressly that the loading he used was "sufficient to allow for any letting-up incentives that might be considered for a property of that nature". There was an exchange between Mr Jackson and Mr Watt about the rental guarantee, which appears to have moulded Mr Watt's response to an invitation to speak of "the 8% discount", that is, the capitalised income for a notional 12 month letting-up period. In his response he reiterated difficulty with Mr Jackson's concept as expressed in the first joint report, but repeated that "there are letting up allowances embedded within my new costs schedule in any event"; he appears to have seen the rental guarantee as an indication of a degree of difficulty in letting the Neeta City site. He questioned the basis for taking a notional letting-up period of 12 months rather than some other period, saying in effect that difficulty in letting was reflected in the purchase price and repeating his disagreement with a value of the leases as a separate deduction.
61 The trial judge favoured Mr Watt's approach; for convenience, [20] and [21] of the reasons are repeated -
"20 The applicant offered no sales evidence that the court considers to be relevant, although Mr Jackson was critical of the analysis by Mr Watt of the Neeta City sale. In particular, Mr Jackson questioned Mr Watt's capitalisation approach, although his own approach appears, at least to this bench, to be novel. The capitalisation approach adopted by Mr Watt enables the earning capacity of an investment property such as Neeta City to be used directly in assessing the capitalised worth of the income stream. This resultant capital value, using an appropriate capitalisation rate, accounts for such matters as demographic movement, local economic circumstances and in particular broader economic issues such as interest rates. This is particularly so in the case of the Neeta City sale, since the demographic characteristics and economic circumstances are identical to those for the subject land.