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A taxing question: How much is the Sears Tower worth?



From the start, it was a Chicago version of David versus Goliath: a middle-class taxpayer, represented by one rather disheveled public-interest attorney, up against a giant corporation, with its money, clout, and legions of lawyers.

The showdown took place at a meeting last month of the Cook County Board of Appeals--the two-person body that hears complaints that property has been under- or overassessed. The setting: a stuffy, fluorescent-lit hearing room on the sixth floor of City Hall.

In this case, James Duffy, a home owner from the northwest side, had charged that the Sears Tower was underassessed. His case seemed strong. The Sears Tower is up for sale with an asking price of about $1.1 billion, but in 1987 Cook County assessor Thomas Hynes set its fair market value at $329 million. That means Sears, Roebuck and Company paid only $23.5 million in property taxes--less than a third of what it would have paid if the building had been accurately assessed, Duffy charges.

"If Sears is not properly valued, units of government are shortchanged on their property-tax revenue," says Patrick Quinn, the public-interest lawyer who took Duffy's case. "If the Sears Tower were properly valued at $1.1 billion, it would generate about $78 million in property taxes. That's about 23 more million for the school board, 15 more million for the city, and 17 more million for other units of local government. Sears has been underassessed and paying less than their fair share of property taxes for this whole decade. For that matter, most downtown real estate is in that category."

Of course, Sears disputes that the property is underassessed. To plead their case before the board they hired Kevin O'Keefe, a feisty and well-connected Loop lawyer. By the time O'Keefe had finished ridiculing Quinn and his argument, the board had dismissed Duffy's case.

"Justice was served," O'Keefe told reporters after the hearing. "[Quinn's] evidence wasn't there."

But how can you justify a reported asking price of $1.1 billion and an assessment of $329 million? asked TV reporter Terry Savage.

O'Keefe paused; he eventually replied "No comment."

The Sears Tower illustrates how convoluted economic theories with little practical relevance dictate different values for downtown properties. As always, the issue is muddied by the county's confusing system of setting and collecting property taxes. Hynes determines fair market value by approximating the price a piece of property would fetch if it were for sale. The assessed value is that portion of fair market value on which property is taxed. The Sears Tower, like other commercial buildings, is taxed on 38.5 percent of its value; in contrast, single-family homes are taxed on 16 percent of their fair market value.

It's not unusual for assessors to underassess fair market value. They're politicians; they have to run for reelection every four years. The higher assessments are, the more property taxes voters will have to pay. Most voters already feel they pay too much in taxes.

Aside from politics, assessors must consider the theoretical distinction made by academics and appraisers between "fair market value" and "investment value."

"One thing you learn the first day in Appraisal 101 is that sales price does not automatically equal market value," says Dick Vanecko, Hynes's chief spokesman. "There are extraneous circumstances that might drive up the sales price for real estate that have nothing to do with its real value. We are looking at the value of real estate and not what's added on."

For example, the average vacant acre of land next to a factory may go for $100,000. But if the factory owner wants to expand, he would desperately need that nearby vacant acre. Thus, he might buy it for as much as $200,000.

"Our imaginary factory owner might find a cheaper acre of land elsewhere, but he has to consider moving expenses," says Arthur Lyons, president of the Center for Economic Policy Analysis, a not-for-profit research group. "If it's going to cost him more than $200,000 to move, he's better off paying a high price for the land next to his factory. In this case, the investment value is worth more than the fair market value."

Conversely, sometimes the sales price is driven down because of the seller's needs. There is, for instance, an urgency to Sears's efforts to sell its tower. According to press reports, Sears wants to raise capital to stave off a threatened buy-out. Thus, their estimated $1.1 billion asking price might be higher if they had more time to shop for buyers.

"Investment value is the monetary value of a property to a particular investor," reads a passage from a manual published by the International Association of Assessing Officers. "Investment value reflects the goals, financial position, tax status, and required rate of return of individual investors. Thus a property may have many investment values although it possesses only one market value. In other words, investment value reflects the worth of a property to a particular investor, whereas market value reflects the consensus of typical buyers and investors."

This was the thrust of the argument advanced last year by Sears when they petitioned the Board of Appeals for a reduction in the tower's fair market assessment. In that case, Sears argued that the fair market value of Loop real estate was inflated by investors who purchased property as a hedge against income taxes.

"There are different tax advantages in real estate," Lyons explains. "You can depreciate the value of that building on your taxes. Let's say it's a 40-year depreciation on a $1 billion building. That means you can write off one 40th, or 2.5 percent, of $1 billion from your taxes. Say your income for the year is $30 million. If you bought or built a $1 billion building, you would only have to pay taxes as though your income were $5 million. To carry the argument to the Sears Tower, Sears would argue that the fair market value is less than the investment value, which is inflated by developers looking for a tax break."

In time, however, such theoretical distinctions lose relevance. After all, the only investors interested in buying the Sears Tower are those rich enough to exploit its value as a tax dodge. It's misleading to talk about a fair market value of $329 million--that market does not exist. Sears would not sell their tower that cheaply.

"They want it two ways," says Quinn. "They want to sell the tower for $1 billion, while telling the assessor it's really only worth $329 million. Would Sears ever think of insuring that building for the pittance they say it is worth, $329 million? Obviously not. If they were ever borrowing money using the building as collateral they would use the $1 billion figure. Whoever buys the Sears Tower won't tell the IRS the building's value is $329 million. But they'll make that claim to the assessor. This Alice-in-Wonderland world, where a $1 billion building is worth $329 million, is at the board of appeals."

"Some of these guys have unbelievable chutzpah," Lyons adds. "The ultimate example is what happened a few years ago with the Chicago Theatre. Lawyers for the owners were in court arguing that the city should pay them $27 million for the property, while different lawyers for the owners were telling the board of appeals that the county's $3 million assessment was too high."

In the case of Sears, it's difficult to figure exactly what the tower is worth because Sears isn't telling. At least, they're not telling the public. They have allowed an elite group of potential buyers to review a detailed prospectus of the building's annual income, provided the buyers sign a confidentiality agreement. Portions of the prospectus were leaked when Peter Waldstein, a reporter for Crain's Chicago Business, managed to review a copy.

"According to the prospectus, projected gross revenues for the tower--including 3.4 million net rentable square feet of office space; 114,298 square feet of retail space; the 20,938-square-foot Skydeck, and 13,298 square feet of storage space--begin next year at $126.8 million," Waldstein wrote in his April 3 article "Tower's secrets: Prospectus tells all."

"Projected revenues climb steadily past the $200 million mark in 1998 at $205.5 million, and top out in 2005 at $310.9 million. . . . Real estate sources say that given those numbers, Sears likely hopes to sell the tower for $1 billion plus. It is the unanimous opinion of several real estate sources interviewed for this article that Sears will have a very difficult time unloading the building in that price range."

Armed with Waldstein's article, Quinn asked the board of appeals--whose members are Democratic Party stalwarts Wilson Frost and Joseph Berrios--to reassess the building at a higher fair market value.

O'Keefe objected, arguing that the Waldstein article was "hearsay."

Frost, the board's chairman, sustained O'Keefe's objection. So Quinn called on Lyons to testify that there is no real distinction between fair market and investment value. But Frost ruled that Lyons couldn't testify on that subject because he was an economist, not an appraiser, and therefore not an expert witness.

"That was ironic," Lyons later noted. "When Sears raised the issue of fair market and investment value two years ago, their main witness was an economist named John McDonald."

Quinn then requested that the board ask Sears to provide a copy of its prospectus. The board has no such authority, Frost ruled, and wouldn't use it if it did.

"For you to continue talking about something you admit you did not have firsthand account of is beyond the bounds of reasonableness," Frost eventually told Quinn. "I'm going to rule that any reference to the prospectus is out of order."

Finally, Quinn attempted to "reconstruct" the income Sears derived from the tower based on newspaper reports of rents in similar buildings. But Frost dismissed these accounts as "hearsay."

"In all deference to the media, if you read different stories they give different impressions," said Frost.

And so it went. With each favorable ruling, O'Keefe's boldness grew. He openly mocked Quinn, exchanging winks and stifled guffaws with partners who sat in the hearing room. When Quinn repeated a favorite phrase--"This is the heart of the case"--O'Keefe's partner turned to an associate and in a loud stage whisper chuckled: "How many hearts does this case have?"

"Can you recall any evidence turned up by Mr. Quinn other than self-serving statements?" O'Keefe asked in closing. "All Mr. Quinn is talking about--all he can talk about--is what he reads in the newspapers."

After ten minutes of deliberation the board agreed.

"The board finds that the [complainant] has failed to meet the burden of proof," Frost declared.

Ironically, the next day's papers featured articles on incentives offered by city and state officials to keep Sears from moving its 6,000-employee Merchandise Group from the area after the tower is sold.

"The latest offer I saw in the paper was 80 acres of virtually free land out by O'Hare and $10 million in tax breaks, a total package worth about $104 million," says Quinn. "It's just more corporate socialism. Let's call it for what it is."

Art accompanying story in printed newspaper (not available in this archive): photo/Jon Randolph.

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