Opinion
Page __
__ Cal.App.2d __ 333 P.2d 97 The TEXAS COMPANY, a corporation, Plaintiff and Appellant, v. The COUNTY OF LOS ANGELES, a body corporate and politic, and The City of Los Angeles, a municipal corporation, Defendants and Respondents. FORSTER SHIPBUILDING CO., Inc., a corporation, Wilmington Boat Works, Inc., a corporation, Fellows and Stewart, Incorporated, a corporation, Al Larson Boat Shop, a corporation, and Harbor Boat Building Co., a corporation, Plaintiffs and Appellants, v. COUNTY OF LOS ANGELES, a body corporate and politic, and City of Los Angeles, a municipal corporation, Defendants and Respondents. Civ. 23134, 23335. California Court of Appeals, Second District, Second Division Dec. 17, 1958Hearing Granted Feb. 11, 1959.
[333 P.2d 98] J. A. Tucker, C. L. Mead, Jr., R. K. Barrows, Los Angeles, for appellant The Texas Co.
Holbrook, Tarr & O'Neill, W. Sumner Holbrook, Jr., Francis H. O'Neill, Los Angeles, for appellants Forster Shipbuilding Co., Inc., and others.
J. Kerwin Rooney, Oakland, for amicus curiae on behalf of appellants.
Harold W. Kennedy, County Counsel, Los Angeles, Alfred Charles De Flon, Deputy County Counsel, Hollywood, for respondents.
ASHBURN, Justice.
The Problem
The problem common to these cases (heard together in this court) is a determination of the proper method of evaluating for taxation the lessee's interest under a tideland lease through application of the valuation method known as capitalization of income.
Summary of Conclusions
The fee being exempt from taxation, the only assessable interest in the land is the possessory right conferred by a leasehold (or occupancy permit) upon a private person or entity. As valuation through comparison with other sales is a practical impossibility, all parties agree that the capitalization of income is an acceptable method of valuation of such leaseholds. It is employed as a means of approximating the market value of such possessory interests, meaning the price which would be paid by a willing buyer to a willing seller, both parties being fully advised of all pertinent facts, neither of them acting under compulsion of any kind and a reasonable time being allowed for the production of a purchaser. It is the price which such a buyer would pay for an assignment of the leasehold interest. The authorities agree that the lessee's interest in a lease of unimproved land has market value only if the fair rental value exceeds the rent payable under the terms of the lease, thus giving it a 'bonus' value. No informed and sane purchaser will buy any leasehold of unimproved property where stipulated rents exceed the present rental value (the economic value) of the property. It is excess of rental value over agreed rent which alone gives value to the leasehold. The authorities also agree that income capitalization starts with net income and consists of projecting that income into the future over a given period, having due regard to risk of non-receipt and interest upon the use of invested capital, then discounting same at a given rate, with the result representing the present worth of the future net income plus interest for the use of the invested capital. This can succeed (under existing formulae such as Hoskold's or Inwood's tables) only if net income (e. g., the bonus value of a leasehold) is used as the basis of the computation. In the instant cases the county assessor undertook to capitalize the gross income to be derived by a purchaser of the leasehold from the use of the premises, without reference to the rents he will have to pay to the lessor; thereby having reached a satisfactory result, the assessor undertook to call it the fair market value of the lessee's possessory interest. The leasehold was valued as if it bestowed a rentfree occupancy on the tenant. This finds no support in any recognized authority cited or known to us. It seems to be derived from a manual for 'Appraisal of Possessory Interests and Equities Therein,' prepared by Mr. Oscar C. Brothers (formerly of the Los Angeles County Assessor's office) and issued by the State Board of Equalization. The county assessor, apparently adopting the ideas of Mr. Brothers, conceived the theory that the De Luz line of cases authorizes the severance of a leasehold into two parts, (1) a [333 P.2d 99] property interest, and (2) contractual obligations,--with the tax assessment limited to the property interest without regard to the condition attached to its very existence, i. e., payment of accruing rents. This is an unrealistic approach, is not consonant with precedents, is not sanctioned by the De Luz and companion cases, supra, and results in an unlawful assessment and tax.
The Facts
The Texas Company, plaintiff and appellant in No. 23134, held on the first Monday of March, 1956, three tideland leases or permits from the Board of Harbor Commissioners of the City of Los Angeles, covering certain tidelands and carrying fixed rental charges. The agreed rents then in effect were: For Lease No. 1: $7,681.83 per quarter plus $3,990.68 per annum for a pipe-line easement included in the leased property, plus wharfage charges. For Lease No. 2: $5,585.73 per quarter plus wharfage charges. For Lease No. 3: $2,331 per quarter. Each lease expires on July 23, 1967, and requires readjustment of the rent as of February 11, 1963. Each provides for termination upon default in payment of rent. The total annual rents (exclusive of wharfage) amount to $66,384.92; the accruals between the assessment date and the rental readjustment date of February 11, 1963, would aggregate about a half million dollars. Lease No. 1 was assessed at $93,730 upon which a tax of $6,703.85 was levied and collected; No. 2 was assessed at $84,300 and a tax of $6,038.57 paid; No. 3 was assessed at $21,890, a tax of $1,568.02 being paid thereon. All these payments were made under protest. The improvements were separately assessed and are not involved in this action. Appropriate proceedings before the County Board of Equalization having been unsuccessfully pursued, this action was brought for recovery of said taxes and was seasonably filed. A general demurrer to the complaint was sustained with leave to amend but plaintiff elected to stand upon the original complaint and has appealed from the judgment entered in favor of defendants. That complaint alleges, and the demurrer necessarily admits, that 'for and during each quarterly period between the assessment date and July 23, 1967, the amount of the rentals payable therein is and will be in excess of the cash value of the use and occupation of said land during such quarter. In other words, there was, on said assessment date, no excess of the cash value of the use of such land over and above the said rentals.'
Each of the plaintiffs in the case of Forster Shipbuilding Co., Inc., No. 23335, held on the first Monday of March, 1957, certain 'harbor orders' or 'revocable permits' leasing to it the right to occupancy of certain tidelands belonging to the City of Los Angeles.
The Forster lease specified a rental of $7,419.40 per year. For that tax year the assessor valued the 'possessory interest' in the land at $2,170 and the 'possessory interest' in the improvements at $8,530. An attempt to procure relief from the County Board of Equalization failed and the tax, $765.29, was paid under protest. Thereupon suit was brought against city and county to recover the amount paid as tax upon the possessory interest in the land, namely, $155.20. The complaint alleged that the assessor 'did value the alleged possessory interest as if no rent had been paid or was required to be paid under and pursuant to said contract for the use and occupancy of said property.' This the demurrer admits. The complaint is in five counts, the allegations of each being substantially the same except as to the applicable figures.
In Count 2 plaintiff Wilmington Boat Works, Inc. alleges that it held a like lease to tideland in March, 1957, with rental prescribed at $7,085.60 per year; that its possessory interest in the land was assessed at $13,910 for the said year 1957, and its possessory interest in the improvements at $25,780. The total tax, $2,843.07, was paid under protest and, after unsuccessful application for relief from the County Board of Equalization, suit was brought for recovery of $934.08, which amount represents the tax upon the possessory interest [333 P.2d 100] in the land. Like allegations are made as in the Forster Shipbuilding Company count as to method of assessment and invalidity of same.
In Count 3 Fellows and Stewart, Inc. sues for tax paid under protest in the sum of $6,543.84. Its rent was $18,840.63 per year and its complaint alleges illegality of assessment of its possessory interest in the land for the same reasons as its co-plaintiffs.
Count 4. Al Larson Boat Shop sues for $1,082.14 as tax paid upon its possessory interest in the land. Its prescribed rent is $5,038.20 per year.
Count 5. Harbor Boat Building Co. Rent, $15,481.56 per year. Sues for $1,529.87 as the amount of tax unlawfully levied upon its possessory interests in the land and improvements, paid under protest.
As in the Texas case a general demurrer was sustained, plaintiffs elected to stand upon their complaint and appealed from the judgment entered upon demurrer.
None of the claims asserted in these suits (except Harbor Boat Building Co.) relates to the assessment of the possessory interest in the improvements, only to the separately assessed interest in the real estate. There is no problem of amortization or payment upon a mortgage indebtedness present in either case. The validity of the assessments is to be determined exactly as would such impositions upon vacant land.
The Law
The basic principles governing this case are declared in De Luz Homes, Inc., v. County of San Diego, 45 Cal.2d 546, 290 P.2d 544, but, as later shown, that opinion has been misinterpreted by the assessor and counsel for respondents with respect to its application to the matter of rents payable by the hypothetical assignee of an uncomplicated lease such as those held by appellants. De Luz says, 45 Cal.2d at pages 561-566, 290 P.2d at page 554: 'The standard of valuation prescribed by the Legislature is that, '[A]ll taxable property shall be assessed at its full cash value.' Rev. & TaxCode,§ 401. 'Full cash value,' as defined in section 110 of the Revenue and Taxation Code, 'means the amount at which property would be taken in payment of a just debt from a solvent debtor.' It provides, in other words, for an assessment at the price that property would bring to its owner if it were offered for sale on an open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other. It is a measure of desirability translated into money amounts * * * and might be called the market value of property for use in its present condition. * * * [45 Cal.2d at page 561, 290 P.2d at page 554]
'Since nonexempt possessory interests in land and improvements, such as the leasehold estates involved in the present actions, are taxable property [citations], they too must be assessed at 'full cash value.' * * * [45 Cal.2d at page 562, 290 P.2d at page 554]
'Since the possessory interest must be assessed in accord with the standard of valuation applicable to all other property, its estimated value is the price it would bring if offered on an open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other, and this hypothetical market price is its value even though a sale of the property has not been made or contemplated. * * * [45 Cal.2d at page 563, 290 P.2d at page 555]
'In the present case, the assessor purported to value the leaseholds by the capitalization of income method, a generally accepted method of valuing property from which income may be or is derived. [citations.] According to this method, the value of property is the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt. (See, American Institute of Real Estate Appraisers, The Appraisal of Real Estate, ch. 17, 18; Babcock, The Valuation of Real Estate, pp. 39, 127-129; 1 Bonbright, The Valuation of Property, ch. XI.) '[I]t involves a capitalization or discounted valuation of the realized or prospective net monetary income derivable by continuous exploitation rather than by resale.' (1 Bonbright, op. cit. supra, p. 230.) The first step in the process is to [333 P.2d 101] determine prospective net income and this is done by estimating future gross income and deducting therefrom expected necessary expenses incident to maintenance and operation of the property. * * * [45 Cal.2d at page 564, 290 P.2d at page 555]
'Since it is generally accepted that a person who agrees to receive payment in the future is entitled to interest both for waiting and the risk of partial or no receipt, the second step is to discount each future installment of income by a rate of interest that takes into account the hazards of the investment and the accepted concepts of a 'fair return.' The sum of the discounted installments is the present value of the property. * * * [45 Cal.2d at page 565, 290 P.2d at page 556].
'In valuing property, the assessor must adhere to the statutory standard of 'full cash value', and must therefore estimate the price the property would bring on an open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other. The net earnings to be capitalized, therefore, are not those of the present owner of the property, but those that would be anticipated by a prospective purchaser. 'Anticipated future earning power is the sole matter of consequence, since reported earnings are already water under the mill.' (Bonbright, op. cit. supra, p. 229; see also Babcock, op. cit. supra, pp. 229-230.) * * * If a purchaser would buy a given property on an open market, the property has a value equal to the price such purchaser might be expected to pay.
'The standard of 'full cash value' applies equally to a leasehold interest. Accordingly, the assessor must estimate the price a leasehold would bring on an open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other. He must therefore capitalize, not the anticipated net earnings of the present lessee, but those of a prospective assignee.' 45 Cal.2d at page 566, 290 P.2d at page 556.
At this point the court turns to the special type of lease before it and the main contention of the taxpayer, namely, that amortization of cost of construction of improvements should be deducted from gross income to arrive at a proper basis for capitalization. To this matter we will return after considering the principles applicable to a simple possessory right to the land unrelated to any amortization of the existing lessee's improvements or mortgage payments.
A ground lease, considered apart from any improvements (as must be done here because of separate assessment of possessory interests in land and improvements), has no value to the lessee or a prospective assignee (a purchaser) unless the fair rental value exceeds the rent specified in the lease. If the reverse is true the leasehold has no value and of course no purchaser can be found for it. To value it by the capitalization method this difference, the bonus value where it exists, must be the basis of the computation. The rents payable by a purchaser-assignee cannot be divorced from the problem, for the right of possession is conditioned upon payment of the specified rents regardless of any contractual relation between the landlord and the one in possession. Upon default in payment the tenant's possession immediately becomes subject to termination, and this is true regardless of any default clause in the lease. 30 Cal.Jur.2d § 183, p. 329; § 280, p. 422; Tiffany on Real Property (3rd ed.), § 915, p. 586; 52 C.J.S. Landlord and Tenant § 718b, p. 583.
The capitalization process is thus described in Schmutz, on The Appraisal Process, page 87: '§ 1603. Income is not value. However, it is the yardstick by which value is measured. The connecting link between income and value is known as the capitalization rate. This is a discount rate; and, the capitalization process is a discounting process. § 1604. The capitalization of income, irrespective of the technique employed, is a simplified method of finding the sum of the present value (the value after discounting for loss of interest) of each future annual amount of the income expectancy. § 1605. By way of illustration, a net rental income of $1,000 collectible at the end of one year has a present day value of $1,000 less interest [333 P.2d 102] for one year; that due in 2-years has a present value of $1,000 less interest for 2-years; and so on. The sum of the discounted future amounts is called the capitalized value; and the interest rate at which the future amounts are interest rate at which the capitalization rate.' Page 88: '§ 1608. The income capitalization approach commences with the preparation of: (a) An estimate of the amount of the reasonably expectable future gross income, which may or may not be indicated by past and present incomes; (b) An estimate of the amount of the reasonably expectable future operating expense, taxes, insurance, etc.; and (c) By subtraction of the latter from the former to indicate the amount of the probable future net income. § 1609. The next steps in the process involve: (d) The estimation of the probable duration of the net income; (e) The estimation of the size of the capitalization (discount) rate; and (f) The selection of the technique by which the data is to be processed.'
It is axiomatic that the basic factor is future net income from the interest to be appraised. 'It is only in those cases where the net income from the property is in excess of the rent reserved that the tenant's interest becomes valuable.' (Taxation of Leasehold Interest, 21 Cal.Law Rev., 596, 603.)
'The lessee's interest, or the 'leasehold estate,' normally consists in the right of the use of the property in a stipulated manner and one the payment of agreed rentals. From the standpoint of value, the lessee's interest is to be found in any excess of annual benefits derived from the use of that property over the annual burdens or rents paid. * * *
'It should be noted that, whereas all realty has value, our problem when dealing with a possessory interest is to assign a portion of the total value of the realty to the possessory interest. It may be that the possessory interest has little or no value. When a municipality charges full rent for the use of its land by a private person, and no improvement has been erected on that land, no value exists for the lessee. Consequently, the possessory interest is valueless. Mathematically, the sum of (1) the present worth of all future rents, and (2) the reversionary value of that land, should equal the entire value of the land, thus leaving no value for the leasehold estate, when a fair rent is being paid and no improvement is on the land.
'It is only under two conditions that considerable value can accrue to the lessee and create a possessory interest. The first condition comes into existence when the lease was made at a rent under the present fair rental of the land. This could happen for a number of reasons. Usually, the lease was made a number of years ago during a period when the land had a lesser value than at present. Ofttimes, a favorable rent is offered as an inducement to private industry for locating in the community. The second condition under which a leasehold estate may attain value is created upon the construction of a sizeable improvement. Here, however, the lessee usually has a diminishing interest in the improvement until such time as the full present value of the improvement reverts to the lessor.' (Taxation of Possessory Interests, by Abram F. Goldman, 23 So.Cal.Law Rev., 169, 171-172.)
'It is entirely proper that the net income should be the basis of the capitalization process because while gross income, operating expenses, and certain fixed charges are considered in the income approach to value, it is net income productivity which creates value. Regardless of the gross income which may be produced, if the operating expenses and fixed charges are such that no net income remains after their payment, prudent capital would scarcely seek such an enterprise as an investment. * * * The net income before amortization or capital recapture provision is the proper amount to be multiplied by the factor because the recapture of capital is provided for in the factor. If the net income after capital recapture provision were used, the result would be erroneous because provision for that item would have been made twice.' (Capitalizing Income Into Value, by David L. Montonna. Reprinted in Selected Readings in Real Estate Appraisal, issued by [333 P.2d 103] American Institution of Real Estate Appraisers, at pp. 1072 and 1079.)
'On the other hand, the value of the property to the lessee will depend upon the amount of his net income, after all operating expenses and his obligation to the lessor have been paid.' (Contract v. Economic Rent, by Ivan A. Thorson. Reprinted in last cited 'Selected Readings,' at p. 1197.)
'Earning Expectancy Refers to Net Earnings.--Earning expectancy, in form for use in valuation, must be a prediction of future net incomes. This means net in the sense that it is the actual difference between the yearly 'puts' and 'takes.' It is the predicated net collections before allowances for depreciation, obsolescence, financial charges, and other allowances which are not actually items of paid expense. Net earnings therefore include both the interest returns on invested capital and installments representing a return of the invested capital. In other words earning expectancy includes only actual revenues or actual expense items such as rentals, gas bills, taxes, insurance premiums, and wages.' (Emphasis added.) (Babcock on Valuation of Real Estate, p. 229.) The same author, discussing the Valuation of Leasehold Estates, says at page 364: 'In the valuation process, the valuator usually commences with a valuation of the property in fee simple, assuming that there is no ground lease. He then proceeds to determine the return on the leasehold estate by deducting the ground rentals from the total real estate returns which he has predicted. This amount year by year is then divided between the teturn on the leasehold interest in the building and the return on the leasehold interest in the land.' (Emphasis added.)
Schmutz, The Appraisal Process, page 264: '§ 3515. The Lessee's interest, also known as the Leasehold, is the right of use and occupancy. The measure of the value of a Lessee's interest is: (a) The present worth of the difference between the fair value of the property, the economic rent, and the contract rent, if the latter is the lesser, which also is known as the 'bonus value' in a lease; (b) The present value (not cost) of the improvements constructed by the Lessee; and, (c) The present value of any adjustments in favor of the Lessee at the end of the lease term, for improvements constructed by Lessee and left for the Lessor, or otherwise. § 3516. In order that the Lessee have a valuable interest in leased property, it is essential that Lessee could sublet for a higher rent than Lessee is obligated to pay; and, or, that valuable improvements have been made by the Lessee. In brief, the market value of the interest of the Lessee is the amount Lessee can expect for an assignment of its lease. § 3517. By way of illustration, in the example mentioned in Paragraph 3511, a vacant lot, the value of the Lessee's interest is zero. It is assumed that the Lessee is paying the full amount of the fair ground rent, and therefore has no bonus value; and, it is further assumed that there are no improvements on the land, and thus no improvement value.'
A correct application of the capitalization process to lessee's interest is described in 21 California Law Review, at page 601, as follows: 'In the few instances in which the courts have given careful consideration to the method of evaluating the leasehold interest the usual procedure has been to determine the lessee's interest without having first computed the value of the lessor's estate. In such cases the lessee's interest is measured by the excess of net income the property may yield over the rent reserved. * * * In any event, the value of the lessee's interest at any time is the present worth of the difference between the rent reserved and the net income the property will yield during the term of the lease.' In 23 Southern California Law Review, at page 195: 'The correct procedure to be used is one that takes as its major factor, the excess of annual benefits over annual burdens.' Schmutz, The Appraisal Process, page 265: '§ 3518: However, in the modification of the problem, as stated in paragraph 3512, where it is assumed that the land value at the time of the appraisal is $150,000 and, as a consequence, the fair rental value is $9,000 per year (6% on [333 P.2d 104] $150,000), and the rental obligations of the Lessee is $6,000 per year, it follows that the Lessee has a rental saving of $3,000 per year (for 76 years). Further assuming that there are no improvements made by the Lessee, then the computation of the market value of the Lessee's interest is as follows:
'Present Worth of Net Gain,
Or saving in rent, or annual profit in the event of subletting the property:
The P. w. of $1 per annum for 76 years at 6% = 16.468
Then 16.468 X $3,000 = $49,404'
'The lessee's interest is sometimes called the leasehold. It is the market value of the lease. If the leased property is unimproved, the lessee's interest, if any, is simply the bonus value in the lease. * * *
Unless De Luz and companion cases, supra, hold otherwise, the result seems clear that the method of valuation employed by the assessor in the instant case is fundamentally unsound because it ignores rents to be paid by the prospective purchaser and hence the resulting assessment and tax are unlawful. Correctly interpreted, De Luz and related cases do not sanction the capitalization of prospective gross income without regard to rents necessary to be paid by the lessee in order to produce that gross income.
The De Luz cases deal with a unique situation which presented questions different from those inherent in the causes at bar. In each instance (De Luz Homes, Inc. v. County of San Diego, supra, 45 Cal.2d 546, 290 P.2d 544; Fairfield Gardens, Inc. v. County of Solano, 45 Cal.2d 575, 290 P.2d 562; Victor Valley Housing Corporation v. County of San Bernardino, 45 Cal.2d 580, 290 P.2d 565 and El Toro Development Co. v. County of Orange, 45 Cal.2d 586, 290 P.2d 569) the taxpayer was lessee of government-owned property which was devoted to a housing project for military and civilian personnel stationed at a military camp,--Camp Pendleton, Travis Air Force Base, George Air Force Base and El Toro Marine Air Base, respectively. The leases extended for 75 years, were in the same form and made pursuant to the Wherry Act (12 U.S.C.A. §§ 1748-1748h); each required the lessee to erect a housing project at its own cost; the Federal Housing Commissioner was authorized to insure mortgages on the property; the buildings and other improvements became the property of the United States as completed; ranges, refrigerators and similar items must remain on the premises and became the property of the United States after full payment of the mortgage debt. Construction of the Camp Pendleton project cost in excess of $4,516,000, and De Luz borrowed through mortgage of its leasehold $4,516,000 and furnished the lender a mortgage insurance policy issued by the Federal Housing Administration. Like procedure was followed in the other cases. Travis Air Force Base cost the lessee $8,295,500 and [333 P.2d 105] was mortgaged for the same amount. George Air Force Base cost $4,419,000; was mortgaged for said sum. El Toro Marine Air Base cost $4,543,000, and was mortgaged for the full amount. Each lease carried a nominal rental of $100 per year. The lessee was required, among other things, to accumulate a fund for replacing worn out improvements and equipment throughout the term of the lease. The basic contest in each case was over allowance or disallowance of amortization of the cost of the improvements; this seems to have also taken the form of a claim to deduction for payments upon the principal of the mortgage loan. If allowed, each leasehold would have had a value much less than that fixed by the assessor, who declined to make any deduction from the capitalization base on that account. The De Luz case, supra, also involved military bases known as Wire Mountain Homes Number 1 and Wire Mountain Homes Number 2, built and held under similar leases. The lessees contended that disbursements would exceed income until the mortgage was paid in full and the possessory interest should be valued at zero. Fairfield contended its leasehold was worth no more than $20. Victor Valley and El Toro made similar contentions.
The trial court found that none of the leaseholds involved in the De Luz case had taxable value at the time of assessment. The Supreme Court reversed. After announcing the general principles hereinbefore quoted, the opinion considers the claim of a right to amortization deductions in reaching a base for capitalization and incidentally a right to deduction of rents paid by the taxpayer (the theoretical assignor), rents so nominal that they were treated as de minimis in the Fairfield opinion, supra, at page 579. In this connection the court said, in De Luz, supra, 45 Cal.2d at page 566, 290 P.2d at page 556: 'The net earnings to be capitalized, therefore, are not those of the present owner of the property, but those that would be anticipated by a prospective purchaser. * * * The present owner may have invested well or poorly, may have contracted to pay very high or very low rent, and may have built expensive improvements or none at all. To value property by capitalizing his anticipated net earnings would make the value of property equal to the present value of his profits; since, however, the legislative standard of value is 'full cash value', it is clear that whatever may be the rationale of the property tax, it is not the profitableness of property to its present owner.' Also: 'To a prospective assignee, anticipated net earnings equal expected gross income less necessary expenditures for maintenance, operation, and taxes. No deduction is made for the cost of the lease to the present lessee, i. e., his charges for rent and amortization of improvements, for to a prospective assignee the value of a leasehold is measured solely by anticipated gross income less expected necessary expenditures.' (Emphasis added.) We deem it a fair interpretaion of the opinion to say that all rentals mentioned therein were those which had been paid by the existing lessee, not those to be paid in the future by an assignee of the lease. The context so indicates and the record shows that prior to the rendition of the opinion all counsel agreed upon the propriety of deduction of rents in finding a base for capitalization.
The case of Blinn Lumber Co. v. County of Los Angeles, 216 Cal. 474, 14 P.2d 512, 84 A.L.R. 1304, was disapproved (at pages 569-570 of 45 Cal.2d, at page 559 of 290 P.2d) so far as it recognized the propriety of deducting amortization items and rents in arriving at net income of the present lessee, the theoretical assignor of the lease. At page 567 of 45 Cal.2d, at page 557 of 290 P.2d it is said: 'The unamorized cost reflected on the balance sheet has no relation to the 'full cash value,' i. e., the price that a willing buyer would pay a willing seller. Furthermore, in determining the income to be capitalized to establish value for appraisal purposes, no deduction can be made for amortization.' Also: 'Rent paid for a leasehold interest, like the cost of improvements that revert to the lessor, is part of the cost or purchase price of the leasehold, and to include a deduction for it, is likewise [333 P.2d 106] to include an item of expense based on the answer, i. e., the value of the property. Thus, it would not only be anomalous to deduct any part of that value, the very answer sought, from the income that is to be capitalized to obtain that answer, it would be a duplication, for the interest rate applied in capitalizing net income provides for a return of capital value as well as interest. (American Institute of Real Estate Appraisers, The Appraisal of Real Estate, p. 321; ibid., p. 214; Babcock, op. cit. supra, p. 230; see example given below.)
'It is apparent, therefore, that in requiring the assessor to deduct the present lessee's charges for rent and amortization from estimated gross income the court in the Blinn case confused income for accounting purposes with income for appraisal purposes.'
At page 569 of 45 Cal.2d, at page 559 of 290 P.2d: 'Statements in the Blinn cases, 216 Cal. 474, 478-482, 14 P.2d 512, 84 A. L.R. 1304; Id., 216 Cal. 468, 472-473, 14 P.2d 516, requiring the assessing authorities to deduct the present lessee's charges to rent and amortization from expected [gross] income when valuing possessory interests by an analysis of anticipated earning power are therefore disapproved.' (Emphasis added.)
It is well to remember at this point that '[i]t is elementary that the language used in any opinion is to be understood in the light of the facts and the issue then before the court.' Porter v. Bakersfield & Kern Elec. Ry. Co., 36 Cal.2d 582, 590, 225 P.2d 223, 228. '[I]t is a familiar rule that expressions used in judicial opinions are always to be construed and limited by reference to the matters under consideration, and that they cannot be safely applied in their largest and most universal sense to dissimiliar cases.' City of Pasadena v. Stimson, 91 Cal. 238, 250, 27 P. 604, 606.
The court's reference in De Luz, supra, to page 230 of Babcock on Valuation of Real Estate, furnishes evidence of the restricted sense in which the language just quoted from De Luz, pages 567-568 of 45 Cal.2d, page 557 of 290 P.2d, was used. Babcock there says: 'In other words earning expectancy includes only actual revenues or actual expense items such as rentals, gas bills, taxes, insurance premiums, and wages.' (Emphasis added.) Elsewhere reference is made in De Luz to page 364 of Babcock which is quoted supra. At page 567 of 45 Cal.2d, at page 557 of 290 P.2d, in De Luz, Babcock is quoted as follows: "[I]n valuation, net earnings are net 'before depreciation,' i.e., net earnings are a combination of income and capital returns and are computed as the actual difference between the 'puts' and 'takes.' Appraising presupposes a purchaser, and the valuation is made at a figure which the net earnings can support including a return of capital equal to the successive losses of value expected in the depreciation of the property."
In the aggregate these passages rule out the though that future rentals are to be disregarded in the case of valuation of a mere lease of unimproved land.
While the Blinn treatment of amortization was disapproved in De Luz, the case of Hammond Lumber Co. v. County of Los Angeles, 104 Cal.App. 235, 285 P. 896, 899, was not overruled or expressly disapproved. It involved no question of amortization; the possessory interests in land and improvements were separately assessed, as in the present instance. 'The deputy assessor stated that in arriving at the value of the leasehold interest, the land itself was first taken at a valuation of $13,000 per acre, which corresponded with the value of surrounding property; then the annual average rent per acre, representing the income from the investment, was capitalized on the basis of an annual interest return of 6 per cent, and the difference between the value of the land and the capitalized rent charge or income represented the average value of the possessory interest per acre.' 104 Cal.App. at page 242, 285 P. at page 899. This was held to be proper, the court saying, at page 246, of 104 Cal.App., at page 901 of 285 P.: 'The board determined that the method pursued by the assessor was a [333 P.2d 107] correct method, and that his assessment was a fair and just valuation for purposes of taxation. The evidence before the trial court tends to confirm the judgment of the board, and supports the court's finding that plaintiff's interest was not assessed improperly, or in excess of its cash value, but only in proportion to the value of the possessory right.' Essentially this process is the one advocated by appellants at bar, for it takes cognizance of rents payable by the lessee. Footnote 10 of the De Luz opinion, 45 Cal.2d on page 570, 290 P.2d on page 559, says that 'the District Court of Appeal, in affirming a judgment denying recovery of taxes on a possessory interest, explained a method of valuation that deducted the lessee's rent from imputed gross income and that was presented in evidence to the county board of supervisors by the assessing authorities. 104 Cal.App. at page 244, 285 P. at page 900. That method did not control the decision of the court in the Hammond case, see especially, 104 Cal.App. at page 246, 285 P. at page 901, and it should not be inferred that it now controls assessing authorities.' It is not clear whether this footnote emphasizes use of 'imputed income' (rejected in De Luz, 45 Cal.2d at page 571, 290 P.2d at page 560) or deduction of rents. It does no more than throw a mantle of doubt upon the Hammond decision. It certainly does not overrule it or foreclose reexamination of the question.
It seems to be generally agreed throughout the United States that the basis for valuation of a leasehold in an eminent domain proceeding is its bonus value, the excess of fair rental value over agreed rents if any there be. Orgel, on Valuation Under Eminent Domain, § 126, p. 536: 'It is usually assumed that this market value is equal to the excess of the rental value over the rent reserved.' In an article entitled 'Some Legal and Appraisal Considerations in Leasehold Valuation under Eminent Domain', by John P. Horgan, 5 Hastings Law Journal 34, 36, it is said: 'It is apparent from the cases in California that this state follows the general rule as to the measure of the value of a condemned leasehold interest. That measure is the difference between theeconomic rent and the contract rent. Obviously, if the economic rent, which is the price which could be obtained on a sale of the lease in the open market, is equal to or less than the contract rent provided for in the lease, then the lease has no market value and the ousted tenant has no compensable claim for damages.
'In situations where the economic rent exceeds the contract rent, giving a market value to the lease, this excess is sometimes spoken of as the bonus value of the lease. More properly, however, it is the market value.' At page 38: 'The principles deducible from the cases of many jurisdictions and from the text writers support the conclusion that where the entire remaining interest of a tenant under a lease is taken the damages payable to the tenant are measured by the market or bonus value, if any, of the unexpired term.' To the same effect, see, 29 C.J.S. Eminent Domain § 143 b, p. 988; 3 A.L.R.2d 286, 291-294; 17 Cal.Jur.2d, § 36, p. 616; § 99, p. 666. In principle there is no perceivable distinction between eminent domain and taxation in this respect. If one whose property is taken in invitum can recover only the value computed upon his net income, it seems equally true as a matter of fairness and, indeed, due process of law that he should not be taxed upon a much higher valuation computed upon the basis of his gross income.
Finally, the interpretation placed upon De Luz and related opinions by respondents would lead to an illegal assessment and taxation of the fee which is exempt because of its tideland status. Calif.Const. Art. XIII, § 1. An intention to ignore this constitutional provision or to sanction a tax which in effect violates it cannot be attributed to our Supreme Court.
The interests of lessor and lessee constitute the totality of ownership in leased property; in sum they equal the value of the fee. The lessor's interest for valuation purposes represents the capitalized value of the rents to be received by it less necessary outlays; that of the lessee, the [333 P.2d 108] capitalized value of his estimated gross income less obligatory rentals and other necessary disbursements. 'Basically the valuation of a leasehold is a matter of dividing the value of the property free of the lease, into separate values imputable to the fee and leasehold interests. The sum of the values of the fee subject to the lease and leasehold interests should tend to be the same as the value of the property free and clear. However, under certain circumstances, the sum of these different interests may be worth more or less than the freehold. It could be more only if a financially capable lessee were liable for contract rent in excess of the present fair economic rent.' ('Factors Influencing Fee and Leasehold Interests.' Published by American Institute of Real Estate Appraisers in 'The Appraisal of Real Estate' at p. 419.) 'First and foremost it must be acknowledged that the combined interests of both lessor and lessee in any property cannot exceed the feehold value of such a property.' (Appraising Leasehold Estates, by Stanley L. McMichael. Published in 'Selected Readings in Real Estate Appraisal' by American Institute of Real Estate Appraisers, p. 1188.)
'The appraisal of the value of any interest in a leased property commences with the appraisal of the value of the Freehold, i. e., the combined value of all interests in the property, giving recognition to the existing leases and sub-leases. This combined value may be greater than the value which the property would have if it were not leased. If, however, the combined interests of all parties in a leased property sum-up to more than the value of the property on an unleased basis, then, and in such event, the freehold is composed of both tangible and intangible properties. This, the 'Two-property Concept' is described in Paragraphs 311-319 in this book.' (Schmutz, The Appraisal Process, § 3507 p. 262.)
'Taken together the sum of the lessor's and the lessee's interests represents the total value of the property. * * * That portion left to the lessor consists only of two parts, the right to receive the rents reserved and the estate of reversion; the residue of the property rights belongs to the lessee. The value of the lessor's estate, then, must always consist of (1) the present worth, at the time of the assessment, of the future series of rent payments reserved by the terms of the lease, and (2) the present worth, at the time of the assessment, of the reversion. If the lease remains in force he can receive nothing more than the sum of these two valuable interests. Whatever value the property may have at any period during the term of the lease in excess of the sum of these two items represents the value of the tenant's interest. The value of the lessee's estate, then, may be determined by subtracting the value of the lessor's interests from the total appraised value of the property.' (21 Cal.Law.Rev. 600.)
The problem under consideration is one of ad valorem taxation, nothing else. In the gross income used by the assessor in making the instant appraisements there is included an item payable to the lessor, rents, which must be the basis of capitalization when valuing the lessor's interest; that value is to be deducted from the value of the fee in order to reach a tax basis for the lessee's interest. When this step is omitted and the lessee is taxed upon a sum which includes the amount apportionable to the lessor (and subject to tax payable by him in the case of a private landlord), the impost is truly levied upon the exempt interest of the lessor. That the lessee does not own that interest is immaterial as is the further fact that the lessor does not have to pay any tax. See, United States v. County of Allegheny, 322 U.S. 174, 186, 189, 64 S.Ct. 908, 88 L.Ed. 1209. When the exempt interest is assessed and the tax imposed upon the lessee the rule of exemption has been violated and the lessee has been required to pay pro tanto a tax which nobody owes.
Parr-Richmond Industrial Corp. v. Boyd, 43 Cal.2d 157, 272 P.2d 16, is in point. Plaintiff had a possessory interest in certain government-owned property [333 P.2d 109] which had been offered for sale; it had made a bid which was accepted and which contemplated a merchantable title or no deal. While this was being worked out, and on the tax day, plaintiff was in possession by consent of the War Assets Administration. In the following June good title was made to plaintiff. The assessor imposed a tax upon all of said realty, asessed it to plaintiff in the same manner and with the same effect as if it owned the fee. Plaintiff conceded liability for a tax upon a possessory interest but, having paid under protest, sued to recover that part of the tax which was properly apportionable to the owner of the fee. It prevailed and the judgment was affirmed, the court saying, 43 Cal.2d at page 169, 272 P.2d at page 24: 'In determining the tax on plaintiff's possessory interest the trial court followed the formula similarly used in Kaiser Co. v. Reid, 30 Cal.2d 610, 184 P.2d 879, which was a valuation method theretofore judicially approved in cases presenting analogous considerations affecting possessory rights. Blinn Lumber Co. v. County of Los Angeles, 216 Cal. 474, 478-479, 14 P.2d 512, 84 A.L.R. 1304; Hammond Lumber Co. v. County of Los Angeles, supra, 104 Cal.App.2d 235, 244-245, 285 P. 896. The tax as so computed was then deducted from the amount of tax claimed by defendants, and the judgments herein were entered for the difference.' We perceive no difference in principle between that case and the situation at bar.
Also pertinent and persuasive is The California Company v. State of Mississippi, 221 Miss. 766, 74 So.2d 856, which involved a severance tax. Plaintiff was lessee of certain government-owned oil lands and the government was entitled to receive one-eighth of all oil produced. The statute required payment by the person in charge of production operations, who was authorized to deduct it proportionately from the persons owing the tax. In this instance the tax was measured by the entire production, including the government's one-eighth; it would not consent to a deduction of its proportionate share of the tax, plaintiff paid same in full and sued to recover one-eighth of the amount. From an adverse judgment it appealed and obtained a reversal, the Supreme Court holding that the tax was a direct levy upon oil belonging to the government. At pages 857 and 858, of 74 So.2d, the court said: 'Under the statutory formula, the United States is a 'producer', and as such the Mississippi oil severance tax is levied upon it to the extent of the one-eighth interest owned by the United States. Consequently, Chapter 134, Laws of 1944, is unconstitutional insofar as it attempts to impose a severance tax upon the United States of America. * * * The California Company was entitled to a credit for the amount of the tax which would ordinarily be charged to the holder of the royalty interest.' See, also, United States v. County of Allegheny, supra, 322 U.S. 174, 186, 189, 64 S.Ct. 908, 88 L.Ed. 1209; Gottstein v. Adams, 202 Cal. 581, 584, 262 P. 314.
Counsel for the Legislative Committee of California Association of Port Authorities, appearing as amicus curiae, stresses an argument that the county's application of the De Luz ruling to the situation before us effects a diversion of the economic impact of the tax to all Port Authorities, in that they are placed under the practical necessity of lowering their lease rentals to compete successfully with private owners of similar properties; that this is likewise true of municipally owned airports, warehouses and other facilities. Lessors of privately owned lands, according to long established custom, suffer an assessment of the fee without segregation of the lessee's interest, then pay the tax themselves, thus reducing the prescribed rentals indirectly to an extent of two per cent, or three or four per cent as the case may be. Owners of exempt lands can rent in competition with such private property by prescribing the same rents upon the theory that there will be no bonus value to the lease and hence no tax upon the possessory interest; the owner of the tax [333 P.2d 110] exempt fee thus has an advantage over the private owner of similar property. But when a tax is imposed upon the possessory interest so substantial as to make rent plus tax exceed rent paid to the private owner, the prospective lessee of public property is no longer interested, for his ultimate burden is substantially greater than that of the lessee of private land. Hence the public owners must reduce their rents to stay in business and the economic burden of the tax rests upon the public owner of the land. While no allegation to this effect appears in either complaint, the facts asserted by counsel seem to be self-evident and hence cognizable here. True, the shifting of economic burden probably would not alone invalidate the tax (De Luz, supra, 45 Cal.2d at page 570, 290 P.2d at page 559; Timm Aircraft Corp. v. Byram, 34 Cal.2d 632, 636, 213 P.2d 715), but it is not to be lightly assumed that the Supreme Court swept away from public property such as tidelands the economic benefit of the constitutional tax exemption without specifically considering and declaring that result.
It is our conclusion that the subject asessments and the taxes based thereon are illegal because of refusal of the assessor and the County Board of Equalization to take into consideration future rents payable by a purchaser of the lease in arriving at a base for valuation by capitalization of net income.
Counsel for appellants in the Forster case have presented other interesting questions. They contend that the De Luz line of cases should have prospective application only, this through application of the principles discussed in County of Los Angeles v. Faus, 48 Cal.2d 672, 312 P.2d 680 and Abbott v. City of Los Angeles, 50 Cal.2d 438, 236 P.2d 484. It is also argued that § 107.1, Revenue & Taxation Code, is curative in nature and hence should be given retroactive effect, thus applying its healing balm to leases under consideration here.
Rev. & Tax.Code, § 107.1: 'Possessory interest: What to consist of when arising out of lease of exempted property: As personal property: Cash value: Basis of assessment: Application of section. A possessory interest, when arising out of a lease of exempt property, consists of the lessee's interest under such lease and is hereby declared to be personal property within the meaning of Section 14 of Article XIII of the Constitution of the State of California.
As we see it, the Faus case, supra, does not apply because the Supreme Court in De Luz and related cases itself gave retroactive application to the doctrine therein declared, in that it applied the same to existing leases; that seems to leave no room for treating differently other leases in effect at the time of those decisions.
Section 107.1, Revenue & Taxation Code, has been held unconstitutional by the Attorney General (31 Ops.Cal.Atty. Gen. 17) but the Legislative Counsel (by letter of May 19, 1958, to Honorable Vincent [333 P.2d 111] Thomas) has ruled, after considering the Attorney General's opinion, that the statute is constitutional. If applicable to the situation presented at bar, the statute seems to proceed upon a misinterpretation of the De Luz opinion, and we do not feel obligated to pursue further the question of its validity or its effect if found valid.
Hence our decision does not rest upon the Faus doctrine or upon consideration of § 107.1, Revenue & Taxation Code. It rests upon the conclusion above stated, that the assessment was unlawful because it proceeded upon a faulty basis and a misinterpretation of the De Luz and related opinions.
Judgment in each case is reversed with instructions to overrule demurrer to complaint, with leave to defendants to answer within a reasonable time prescribed by the Superior Court.
FOX, P. J., and HERNDON, J., concur.
'For the purpose of illustration; let it be assumed that a vacant lot was (in the past) leased for a term of 50 years at a net ground rental of $6,000 per year, which at that time was 6 percent net on a land value of $100,000. However, at the time of appraisal (10 years later) the land has increased in value to $120,000 and the reasonable ground rental $7,200 per year.
'The lease has 40 years to run. The lessee's interest is the present worth of $1,200 per year ($7,200-$6,000) for 40 years. This is $1,200 X 15.046, factor for 40 years at 6 percent, or $18,055. This is the lessee's interest in the land. The lessor's interest (in the land) would be $120,000 less $18,055, or $101,945. * * *
'Not only is it possible for a lessee's interest in real estate to be composed of a bonus value, when the ground rental is less than it should be at the time of the appraisal, in addition to the value of the lessee's improvements, but it is also possible, and even common, for a lessee's interest to be less than the value of its improvement. This condition exists when the ground rent being paid by the lessee is excessive and, as a consequence, absorbs some of the property income that should be imputable to the structure.'
(Appraising Leasehold Estates, by Stanley L. McMichael. Reprinted in Selected Readings in Real Estate Appraisal, issued by American Institute of Real Estate Appraisers, at p. 1192.)
'The full cash value of such possessory interest is the excess, if any, of the value of the lease on the open market, as determined by the formula contained in the case of De Luz Homes, Inc. v. County of San Diego, 1955, 45 Cal.2d 546, [290 P.2d 544], over the present worth of the rentals under said lease for the unexpired term thereof.
'A possessory interest taxable under the provisions of this section shall be assessed to the lessee on the same basis or percentage of valuation employed as to other tangible property on the same roll.
'This section applies only to possessory interests created prior to the date on which the decision of the California Supreme Court in De Luz Homes, Inc. v. County of San Diego (1955), 45 Cal.2d 546, 290 P.2d 544, became final. It does not, however, apply to any of such interests created prior to that date that thereafter have been, or may hereafter be, extended or renewed, irrespective of whether the renewal or extension is provided for in the instrument creating the interest.
'This section does not apply to leasehold estates for the production of gas, petroleum and other hydrocarbon substances from beneath the surface of the earth, and other rights relating to such substances which constitute incorporeal hereditaments or profits a prendre.'