Travis Central Appraisal District v. FM Properties Operating Company

TEXAS COURT OF APPEALS, THIRD DISTRICT, AT AUSTIN

NO. 03-96-00043-CV

Travis Central Appraisal District, Appellant

v.

FM Properties Operating Company, Appellee

FROM THE DISTRICT COURT OF TRAVIS COUNTY, 353RD JUDICIAL DISTRICT

NO. 93-11165, HONORABLE PAUL R. DAVIS, JUDGE PRESIDING

FM Properties Operating Company ("FM"), appellee, sued the Travis Central Appraisal

District ("the District"), appellant, challenging an order of the District's Appraisal Review Board that

appraised, for ad valorem taxation purposes, the value of real estate owned by FM. Relying on section

23.12(a) of the Texas Tax Code, which requires that real estate inventory be valued as a unit, FM claimed

the District's assessment based on individual lot values was excessive. See Tex. Tax Code Ann. §

23.12 (a) (West Supp. 1997) (hereinafter "Code"). The District answered by (1) challenging the trial

court's jurisdiction to entertain the suit because FM had not paid the disputed taxes before filing suit, as

required by section 42.08 of the Code; and (2) counterclaiming for a declaratory judgment that section

23.12(a) is unconstitutional. FM responded by seeking a declaratory judgment that section 42.08 is

unconstitutional. After a trial to the court, the trial court rendered judgment for FM, ruling that section

23.12(a) is constitutional and that section 42.08 is unconstitutional. The District perfected this appeal. We

will affirm.

FACTUAL BACKGROUND

FM is in the business of purchasing raw land or developed lots to sell to builders, who then

build homes on the land as part of the development of a subdivision. On January 1, 1993, FM owned a

total of 210 residential lots in four subdivisions; on January 1, 1994, FM owned a total of 153 residential

lots in three subdivisions. All of the lots were held by FM for sale in the ordinary course of its business,

had not been occupied, leased, or rented, and produced no income during FM's ownership. The parties

stipulated that (1) if section 23.12(a) of the Code is constitutional, an appraisal of FM's properties as a unit

pursuant to that statute would yield market values of $9,933,326 for the tax year 1993 and $6,670,193

for the tax year 1994; and (2) if section 23.12(a) is unconstitutional, the sum of the individual lot values of

FM's parcels would yield total market values of $13,932,875 for the tax year 1993 and $10,755,881 for

the tax year 1994.

DISCUSSION

In point of error two, the District contends the trial court erred in declaring unconstitutional

section 42.08 of the Code, which requires that a taxpayer pay the previous year's real property assessment

as a condition for obtaining judicial review. The Texas Supreme Court's recent decision in Central

Appraisal District v. Lall , 924 S.W.2d 686 (Tex. 1996), holding section 42.08 unconstitutional, is

dispositive on this issue. We overrule point of error two.

In point of error one, the District asserts that section 23.12(a) violates the Texas

Constitution. The relevant portion of section 23.12(a) provides:

[T]he market value of an inventory is the price for which it would sell as a unit to a

purchaser who would continue the business. An inventory shall include residential real

property which has never been occupied as a residence and is held for sale in the ordinary

course of a trade or business, provided that the residential real property remains

unoccupied, is not leased or rented, and produces no income.

Code § 23.12(a). (1) The District contends section 23.12(a) violates article VIII, sections 1 and 2 of the

Texas Constitution, which provide:

§ 1. Equality and uniformity; tax in proportion to value; income tax; exemption of

certain tangible personal property from ad valorem taxation

Sec. 1. (a) Taxation shall be equal and uniform.

(b) All real property and tangible personal property in this State, unless exempt as

required or permitted by this Constitution, whether owned by natural persons or

corporations, other than municipal, shall be taxed in proportion to its value, which shall be

ascertained as may be provided by law.

* * *

§ 2. Occupation taxes; equality and uniformity; exemptions from taxation

Sec. 2. (a) . . . [T]he legislature may, by general laws, exempt from taxation [various types

of property specifically described in this section]; and all laws exempting property from

taxation other than the property mentioned in this Section shall be null and void.

Tex. Const. art. VIII, §§ 1, 2. The District asserts that section 23.12(a) violates the "equal and uniform"

and "in proportion to its value" requirements contained in section 1 and constitutes an unauthorized

exemption from taxation under section 2.

In two recent opinions, the Texas Supreme Court summarized the rules for determining the

constitutionality of a taxation statute:

In determining the constitutionality of a statute, we begin with a presumption that

it is constitutional. Courts presume that the Legislature "understands and correctly

appreciates the needs of its own people, that its laws are directed to problems made

manifest by experience, and that its discriminations are based upon adequate grounds."

The wisdom or expediency of a law is for the Legislature to determine, not this court.

Furthermore, the party challenging the constitutionality of a statute bears the burden of

demonstrating that the enactment fails to meet constitutional requirements.

Enron Corp. v. Spring Indep. Sch. Dist. , 922 S.W.2d 931, 934 (Tex. 1996) (citations omitted) (quoting

Smith v. Davis , 426 S.W.2d 827, 831 (Tex. 1968)).

We presume that a statute passed by the Legislature is constitutional.

Furthermore, this Court must liberally construe any constitutional provision that directs the

Legislature to act for a particular purpose, and we must, if possible, construe statutes to

avoid constitutional infirmities. Finally, we must reject interpretations of a statute that

defeat the purpose of the legislation so long as another reasonable interpretation exists.

Nootsie, Ltd. v. Williamson County Appraisal Dist. , 925 S.W.2d 659, 662 (Tex. 1996) (citations

omitted).

In Enron , the supreme court addressed an identical constitutional challenge to a taxation

statute that is closely related to the one at issue here. Section 23.12(f) of the Code permits "[t]he owner

of an inventory" to elect to have its inventory "appraised at its market value as of September 1 of the year

preceding the tax year to which the appraisal applies" instead of January 1 of the tax year, the date when

all other property must be appraised for ad valorem tax purposes. In upholding the constitutionality of the

statute, the court held that "the Legislature may constitutionally draw distinctions in the manner in which

market value of property is determined for ad valorem tax purposes, as long as the classifications are not

unreasonable, arbitrary, or capricious." 922 S.W.2d at 936 . In the present case, therefore, the touchstone

for the District's constitutional challenge is whether section 23.12(a) creates a valuation method for

inventory that is unreasonable, arbitrary, or capricious.

For ad valorem tax purposes, "value" must be based on "reasonable market value."

Nootsie , 925 S.W.2d at 661 ; Enron , 922 S.W.2d at 935 . The Code defines "market value" as:

the price at which a property would transfer for cash or its equivalent under prevailing

market conditions if:

(A) exposed for sale in the open market with a reasonable time for the seller to find a

purchaser;

(B) both the seller and the purchaser know of all the uses and purposes to which the

property is adapted and for which it is capable of being used and of the enforceable

restrictions on its use; and

(C) both the seller and purchaser seek to maximize their gains and neither is in a

position to take advantage of the exigencies of the other.

Code § 1.04(7) (West 1992). This statutory definition, first enacted in 1979, accords with the traditional

definition applied by Texas courts that market value means the price property would bring when offered

for sale by one who desires, but is not obliged to sell, and is bought by one who is under no necessity of

buying it. See State v. Windham, 837 S.W.2d 73, 77 (Tex. 1992); Polk County v. Tenneco, Inc. , 554

S.W.2d 918, 921 (Tex. 1977); City of Pearland v. Alexander , 483 S.W.2d 244, 247 (Tex. 1972);

Humes v. Hallmark , 895 S.W.2d 475, 480 (Tex. App.--Austin 1995, no writ). See generally Gary A.

Goff, Comment, Fair Market Value: A Primer for Texas Legal Practice , 15 Tex. Tech L. Rev. 637 ,

639-43 (1984).

The Code also provides:

The market value of property shall be determined by the application of generally

accepted appraisal techniques, and the same or similar appraisal techniques shall be used

in appraising the same or similar kinds of property. However, each property shall be

appraised based upon the individual characteristics that affect the property's market value.

Code § 23.01(b) (West 1992).

The District complains that section 23.12(a): (1) violates the "equal and uniform"

requirement of article VIII, § 1(a) of the constitution by treating some owners of real property (those whose

property comes within the statutory description of "inventory") differently from other owners of real

property; (2) violates the "in proportion to its value" requirement of article VIII, § 1(b) by imposing a

valuation methodology that does not yield market value; and (3) violates the exemption provision of article

VIII, § 2(a) by exempting from taxation certain real property that is not mentioned in that section. We will

address the District's arguments in that order.

I. Equal and Uniform

The District's primary complaint about section 23.12(a) is that it discriminates against the

owners of real estate whose property does not satisfy the prerequisites of "inventory" set out in the statute.

The District argues that, by treating owners of real estate inventory differently from owners of other real

property, the statute violates the constitutional requirement that taxation be "equal and uniform." On

essentially the same basis, the District argues that section 23.12(a) is arbitrary and capricious.

To the extent the District is arguing that section 23.12(a) is per se unconstitutional merely

by virtue of creating a classification scheme wherein owners of real estate inventory are treated differently

from owners of other real property, this argument has been foreclosed by Enron . The foundational holding

of Enron was that "the Legislature has the authority to establish a method of determining the market value

of inventory that differs from the method of valuing other property for ad valorem tax purposes . . . ." 922

S.W.2d at 941 . As to the present complaint, therefore, the District can prevail only by showing that the

particular method of determining the market value of inventory mandated by section 23.12(a) is

unreasonable, arbitrary, or capricious. Accordingly, the features of that method must be examined.

The first sentence of section 23.12(a) requires that the market value of any inventory

--whether real or personal property--be determined by the price for which the property would sell "as

a unit to a purchaser who would continue the business," i.e., the business of selling whatever goods make

up the inventory. The term "inventory" is not defined in the Code, but it is clear from the context that the

legislature meant the stock of goods on hand being held for sale in the regular course of a business. Cf.

Tex. Bus. & Com. Code Ann. § 9.109 (West 1991). The second sentence of section 23.12(a) establishes

the prerequisites for including real property in the category of "inventory": (1) residential real property that

(2) has never been occupied as a residence, (3) is held for sale in the ordinary course of a trade or

business, (4) remains unoccupied, (5) is not leased or rented, and (6) produces no income. To the extent

the first sentence of section 23.12(a) relates to personal property, the District makes no complaint.

Indeed, the District concedes that "it may be reasonable to classify personalty held in inventory as

'inventory' and allow bulk appraisal of such property for tax purposes." Nor does the District complain

about the criteria in the second sentence by which it is determined whether specific real property constitutes

inventory. Rather, the District argues generally that a separate classification for inventory, whereby

inventory is appraised as a unit, cannot be applied to real property at all. The District asserts that the

market value of the whole property can be determined only by finding the market value of each individual

lot and then adding those values together. We reject the District's argument.

The "unit" method of valuation imposed by section 23.12(a) is supported by generally

accepted appraisal techniques that have been approved by numerous courts and commentators.

Professional appraisers typically value multiple unimproved lots in a subdivision--or potential

subdivision--as a unit, utilizing the so-called "development approach." (2) See J. D. Eaton, Real Estate

Valuation in Litigation 201-25 (Amer. Inst. Of Real Estate Appraisers 1982); Stephen Leroy Angell,

Appraisal of Subdivisions , in Encyclopedia of Real Estate Appraising 483-509 (Edith J. Friedman ed.

1959); see also The Appraisal of Real Estate 49-50 (Amer. Inst. of Real Estate Appraisers, 8th ed.

1983); Real Estate Appraisal Terminology 11-12 (Amer. Inst. of Real Estate Appraisers & Soc'y of

Real Estate Appraisers, Byrl N. Boyce ed. 1975) (defining "anticipated use method"). In applying the

development approach to raw land that is not yet fully subdivided, the procedural steps generally used by

appraisers are as follows:

1. Prepare subdivision layout to determine number, size, and shape of typical lots.

2. Estimate retail value of lots.

3. Estimate direct development costs.

4. Estimate indirect development costs.

5. Compute income residual to developer's profit and land (Step 2 minus Steps 3 and 4).

6. Deduct developer's profits from Step 5.

7. Estimate the amount of time required to develop and sell out the subdivision.

8. Discount anticipated income stream into a current indicated raw land value.

Eaton, supra , at 223. Although the development approach is often utilized to determine market value for

raw land that is not yet subdivided, as for example where it is shown that residential subdivision is a tract's

highest and best use, it is even better suited for a tract of land that is already fully subdivided, because the

existence of an actual subdivision layout makes step 1 unnecessary and makes the figures obtained from

steps 2, 3, 4, and 7 more reliable.

[For land that has been fully subdivided,] [t]he problems involved in the partially developed

subdivision have evaporated. The costs to the developer are no longer speculative, the

value of the individual lots in the market may be ascertained with as much certainty as in

any other condemnation proceeding, and the possibility of such a use is no longer remote.

Eaton, supra , at 212 (quoting 4 Nichols on Eminent Domain , § 12.3142[1][d] (rev. 3d ed. 1979, Julius

L. Sackman, co-author)).

For purposes of the present case, the significance of the development approach is that it

acknowledges the propriety of valuing a subdivided tract as a unit, so that the retail price at which individual

lots will be sold is only one of several factors to be considered. Professional appraisers recognize that,

although the retail price of individual lots should be considered, direct and indirect development and

marketing costs must also be considered in order to find true market value:

Another terminology problem involves use of the terms retail value and gross

sellout value . These terms do not identify value estimates; they represent the total gross

receipts expected to be produced by the project. Value is a point-in-time estimate, based

in part on the theory that the value of any good or service is the present value of the future

benefits to be derived from its ownership. Since arriving at a gross sellout value does not

involve consideration of the expenses of disposition or holding or the calculation of present

worth, gross sellout value is not a value estimate. Labeling expected gross receipts as any

kind of value estimate is highly misleading and should be avoided.

Douglas D. Lovell and Robert S. Martin, Subdivision Analysis 61 (Appraisal Inst. 1993). A paramount

concept to be gleaned from this passage is that value is a point-in-time estimate. The notion of market

value, therefore, necessarily refers to what a purchaser would pay for property at the present time in a

single transaction, not what might be paid by dozens or even hundreds of purchasers if the property were

sold in pieces over an extended period of time.

Courts and commentators have also recognized and approved the development approach

for appraising the value of a tract of land that has been--or is expected to be--subdivided into smaller

parcels. Questions of valuation of land often arise in eminent domain cases, in which the respective

positions of the landowner and the government are opposite from tax cases. In eminent domain cases, the

landowner rather than the taxing authority attempts to show the highest value possible. In such cases,

courts permit the landowner to present evidence of individual lot values only in conjunction with evidence

of development and marketing costs:

[T]he better view . . . is that a lot method appraisal can be admitted in appropriate cases

if the proponent offers credible evidence of the costs of subdivision-- e.g. , the expense of

clearing and improving the land, surveying and dividing it into lots, advertising and selling,

holding it, and paying taxes and interest until all lots are sold.

United States v. 47.3096 Acres, Etc., in Oxford Township , 583 F.2d 270, 272 (6th Cir. 1978); see

also United States v. 99.66 Acres of Land , 970 F.2d 651, 655 (9th Cir. 1992); United States v. 100

Acres of Land, More or Less, in Marin County , 468 F.2d 1261, 1266-67 (9th Cir. 1972); United

States v. 147.47 Acres of Land in Monroe County , 352 F.Supp. 1055, 1060-61 (M. D. Penn. 1972);

Dash v. State , 491 P.2d 1069, 1071-75 (Alaska 1971); Commonwealth v. McCready , 371 S.W.2d

485, 487 (Ky. Ct. App. 1963); Clifford v. Algonquin Gas Transmission Co. , 604 N.E.2d 697, 702-03

(Mass. 1992); Ramsey County v. Miller , 316 N.W.2d 917, 919-21 (Minn. 1982); Robinson v. Town

of Westport , 610 A.2d 611, 616 (Conn. 1992). (3) At least one noted commentator has expressly approved

the development approach: "In the case of land that has actually been fully subdivided, or nearly so, the

courts are in agreement that the 'lot method' or 'developer's residual approach' to valuation is proper."

4 Nichols on Eminent Domain , § 12B.14[1][d], at 12B-180 (rev. 3d ed. 1997, Julius L. Sackman, co-author). In the present case, FM's appraisal expert testified that the development approach is a generally

accepted appraisal technique and that he used that approach in appraising the value of the property at issue

here.

Texas courts have recognized three general approaches to determining market value: (1)

the market data (or comparable sales) approach; (2) the cost approach; and (3) the income (or income-capitalization) approach. See Religious of the Sacred Heart v. City of Houston , 836 S.W.2d 606, 615-16 (Tex. 1992); Polk County v. Tenneco, Inc. , 554 S.W.2d 918, 921 (Tex. 1977). In addition, when

circumstances dictate, the Texas Supreme Court has not hesitated to recognize alternative methods of

valuation. See Missouri-Kansas-Texas R.R. v. City of Dallas , 623 S.W.2d 296, 299-301 (Tex. 1981).

These approaches are not different definitions of market value; they are simply different ways of arriving

at an estimate of what a willing buyer would pay a willing seller.

The development approach can be viewed as merely a variation of the income approach

to valuation. (4) The supreme court has stated that the income approach to valuation "proceeds on the

premise that a buyer of income-producing property is primarily interested in the income which his property

will generate." Polk County , 554 S.W.2d at 921 . See generally Goff, supra , 15 Tex. Tech L. Rev. at

648-52. Since inventory is, by definition, the goods on hand being sold in the regular course of a business,

any purchaser of a business's entire inventory will naturally be interested primarily in the income that the

later retail sale of the inventory will generate. (5) Thus, the legislature could reasonably have decided to

require use of a variation of the income approach for valuing inventory. Cf. City of Houston v. West , 514

S.W.2d 299, 304-05 (Tex. Civ. App.--Houston [1st Dist.] 1974), rev'd on other grounds , 520 S.W.2d

752 (Tex. 1975) (income approach is appropriate for determining market value of raw land where data

regarding potential income production is more readily available than sales data). Valuing real estate

inventory as a unit is not necessarily the only way to determine its market value. But the example of the

development approach shows that valuing such property as a unit is one fair and reasonable way of making

that determination, thus placing the choice of valuation methods squarely in the hands of the legislature.

Nonetheless, the District, citing Richey v. Moor , 249 S.W. 172 (Tex. 1923), argues that

Texas law unswervingly requires separate valuation and assessment of separate pieces of real property.

The District overstates its case. In Richey , the taxpayer affirmatively sought to pay taxes separately on

each of seven tracts in order that any lien resulting from unpaid taxes on an eighth tract would not attach

to the other seven. Id. at 172-73 . That a taxpayer might be entitled to pay taxes separately on different

tracts, however, does not mean he is required to do so. The Texas Supreme Court has held that

"assessment by separate tracts is for the tax payer's benefit." French Indep. Sch. Dist. v. Howth , 134

S.W.2d 1036, 1038 (Tex. 1940); see also State Mtg. Corp. v. Ludwig , 48 S.W.2d 950, 953-54 (Tex.

1932). This appears to be the rule in other jurisdictions as well. See M. C. Dransfield, Annotation,

Different Parts of Parcels of Land in Same Ownership as Single Unit or Separate Units for Tax

Assessment Purposes , 133 A.L.R. 524 , 525 (1941). If a taxpayer has, for his own benefit, the "right"

to separate assessment of his several properties, it would seem to follow that he also has the concomitant

right to waive that benefit and to treat his own multiple lots or parcels as one unit for tax purposes.

Indeed, it appears that in some circumstances Texas law may actually prohibit landowners

from valuing and assessing multiple tracts of land separately:

[A]lthough the general rule is that the taxpayer is entitled to have each separate tract or

parcel of land separately valued, and assessed for taxes, and the tax lien separately fixed

upon each so that one tract may not be charged or sold to satisfy the taxes upon another

or other tracts (Richey v. Moor, 112 Tex. 493 , 249 S.W. 172 ), yet it is now equally well

settled that where two or more tracts or parcels are occupied and used together by the

property owner for a single purpose, such as a homestead, their separate identities become

merged into one by such use, and they may be valued and assessed in solido, and the tax

lien may be fixed and foreclosed upon all as one parcel.

City of Edinburg v. Magee , 97 S.W.2d 983 , 984 (Tex. Civ. App.--San Antonio 1936, no writ); see also

Manges v. Freer Indep. Sch. Dist. , 653 S.W.2d 553, 566 (Tex. App.--San Antonio 1983), rev'd on

other grounds , 677 S.W.2d 488 (Tex. 1984); Duval County Ranch Co. v. State , 587 S.W.2d 436,

444-45 (Tex. Civ. App.--San Antonio 1979, writ ref'd n.r.e.), cert. denied , 449 U.S. 1077 (1981);

Moody-Seagraves Co. v. City of Galveston , 43 S.W.2d 967, 970 (Tex. Civ. App.--Galveston 1931,

writ ref'd); cf. Electra Indep. Sch. Dist. v. W. T. Waggoner Estate , 168 S.W.2d 645, 650 (Tex. 1943).

We see no reason why the legislature would not be authorized to conclude that lots held as real estate

inventory are owned and used "for a single purpose."

Finally, the legislature may have concluded that valuing the inventory of a business as a unit

is inherently fairer and more likely to produce true market value than other approaches such as multiplying

the total number of inventory items on hand by the retail price of each individual item. For example, imagine

a company that is in the business of selling widgets. The company has on hand a stock of 100,000 widgets,

which retail for $2 each. Thus, the company hopes to receive $200,000 in gross receipts from the sale

of its widgets. Assume the evidence shows, however, that in all likelihood it will take one year to sell off

this entire stock of widgets; during that year, the company will likely spend $25,000 to lease a widget store,

$25,000 to staff the store with salespersons, $25,000 to advertise the widgets, and $25,000 to maintain

the widgets in good condition while they are waiting to be sold. Thus, the company hopes, by the end of

the year, to net $100,000 profit from its widget sales (less the original cost to buy the stock of widgets).

What would a reasonable, willing buyer with full information pay for the entire inventory of widgets at the

beginning of the year? No more than $100,000, possibly less. Yet the simplistic method of multiplying the

number of widgets on hand (100,000) by the retail sales price of each ($2) would produce a "fair market

value" of $200,000, even though no "willing buyer" would pay that much for the company's inventory as

a unit.

Conceptually, the valuation of real estate inventory is identical to the valuation of personal

property inventory. Accordingly, the foregoing widget hypothetical can easily be applied to real estate

inventory. Imagine a real estate developer who has on hand 100 lots that have been subdivided but are

unimproved. The developer plans to sell each lot for $10,000, producing gross receipts of $1,000,000.

Assume the evidence shows that it is predicted to take approximately two years to sell off all 100 lots;

during those two years, he will spend an estimated $100,000 on a sales office, $150,000 on a sales staff,

$200,000 on advertising, and $50,000 to maintain the property. Thus, by the end of the two years he

hopes to net $500,000 from the sale of the lots (less the original cost the developer paid the purchase the

lots). What would a reasonable willing buyer pay for those 100 lots at the present time ? No more than

$500,000, possibly less. Yet, once again, the simplistic method of multiplying the number of lots on hand

(100) by the retail sales price of each ($10,000) would produce a "fair market value" of $1,000,000, even

though no willing buyer would pay that much for them.

An amount that no willing buyer would pay for property is simply not market value:

Market value, as determinable through application of the "willing buyer-seller test"

cannot be ignored. Any method used to determine market value which produces a

substantially different figure as such value is fundamentally wrong and the purported value

thereby ascertained fundamentally erroneous under the Constitution and Statutes of Texas.

To attribute validity thereto would be to ignore market value.

City of Saginaw v. Garvey Elevators, Inc. , 431 S.W.2d 575, 579 (Tex. Civ. App.--Fort Worth 1968,

writ ref'd n.r.e.). In the present case, common sense alone dictates that applying the District's "number

of lots times retail price of each lot" formula produces a figure grossly in excess of what a willing buyer

would pay for FM's entire inventory of lots at a given point in time. Thus, the District's proposed method

for determining the market value of FM's property is itself arguably unreasonable.

Based on the foregoing discussion, we hold that the inventory classification created by

section 23.12(a) of the Tax Code is not unreasonable, arbitrary, or capricious and does not, therefore,

violate the "equal and uniform" provision contained in article VIII, section 1(a) of the Texas Constitution.

II. In Proportion to its Value

The District also complains that section 23.12(a) violates the constitutional requirement that

property be taxed "in proportion to its value." Tex. Const. art. VIII, § 1(b). This requirement simply

means that all assessed valuations must be "based upon reasonable cash market value." Parker County

v. Spindletop Oil & Gas Co. , 628 S.W.2d 765, 767 (Tex. 1982). The test for determining if a tax statute

complies with this constitutional requirement appears to be substantially similar to the "unreasonable,

arbitrary, or capricious" standard discussed above. See Enron , 922 S.W.2d at 935 ; State v.

Whittenburg , 265 S.W.2d 569, 572-73 (Tex. 1954); State v. Houser , 156 S.W.2d 968, 970-71 (Tex.

1941).

In Enron , the Texas Supreme Court recognized that the legislature has discretion to impose

different methods for determining market value: "Although the considerable leeway given to the Legislature

in levying sales, occupation, and excise taxes is not as broad in the area of ad valorem taxes, there is no

constitutional impediment to utilizing differing methods for determining market value for ad valorem tax

purposes." 922 S.W.2d at 936 . Although the supreme court did not stress it, the breadth of the

legislature's discretion in the area of value determination may arise in part from the constitutional mandate

that "value . . . shall be ascertained as may be provided by law." Tex. Const. art. VIII, §1(b). The phrase

"as may be provided by law," when used in a constitutional provision establishing a general legal principle

or administrative framework, has been held to "clearly vest[] the Legislature with the authority to exert

substantial control over the mechanics of [the subject matter addressed]." McAvoy v. H.B. Sherman Co. ,

258 N.W.2d 414, 425 (Mich. 1977); see also State v. Rodrigues , 629 P.2d 1111, 1114 (Haw. 1981);

Wann v. Reorganized Sch. Dist. No. 6 , 293 S.W.2d 408, 411 (Mo. 1956); State ex rel. Agnew v.

Schneider , 253 N.W.2d 184, 187 (N.D. 1977); cf. Hardin v. Central Am. Life Ins. Co. , 374 S.W.2d

881, 884 (Tex. 1964) (legislature has right to provide for method of determining valuation to be placed on

assets of insurance companies for taxation purposes).

The District contends section 23.12(a) is constitutionally infirm because, by limiting potential

purchasers to those who would continue the business of selling the goods that make up the inventory, the

statute imposes an "artificial" market on the valuation of inventory that does not produce true market value.

This view again appears to be based largely on the District's position that multiplying the number of subunits

of property by the retail price for each individual subunit is the only way to produce a reasonable estimate

of the market value of the whole. Although we have addressed that issue in the preceding section of this

opinion, it is worth revisiting briefly here. Because value is a point-in-time estimate, the very concept of

market value seems to contemplate what a willing buyer would pay for the whole property in a single

transaction, not multiple transactions spread over time. Indeed, both the statutory and case-law definitions

of "market value" refer to a single purchaser. See Code § 1.04(7); State v. Windham , 837 S.W.2d at

77 ; State v. Carpenter , 89 S.W.2d 979, 980 (Tex. 1936). The issue, therefore, is not whether it is

reasonable to assess property as a unit. Rather, the issue is whether the process of adding together the

market values of all the subunits that make up the larger tract is, as the District contends, the only way to

produce a reasonable estimate of the market value of the whole. In some circumstances, such an approach

might be proper. But where the subunits are simply held as inventory for the sole purpose of being sold

in the regular course of a business in order to produce a profit, then the value of owning those subunits

arises only from the income they will produce and not from the "usual" bases of value such as the amenities

and personal pleasures derived from owning and occupying the property. In those circumstances, it is

neither unreasonable nor arbitrary for the legislature to require a unit valuation.

Thus, as explained above, courts, commentators, and professional appraisers generally

reject the idea that simply adding together the market values of subunits will, without more, produce the

market value of the whole. "The identification of the value of any given property off the market place with

an amount determined by the current sale prices of units of similar property traded in on the market place,

is so frankly arbitrary that it would be beside the point to argue whether or not it is a 'true' definition of

value." 1 James C. Bonbright, The Valuation of Property 48 (1937).

Moreover, the "development approach" discussed above does consider the retail price of

the subdivided lots. That approach merely requires that various development and marketing costs of selling

the individual lots also be considered. In using the "income approach" to determine the market value of

traditional income-producing property, the expenses of producing such income must always be deducted

to arrive at net income. See, e.g. , The Appraisal of Real Estate 362 (Amer. Inst. of Real Estate

Appraisers, 8th ed. 1983); J. D. Eaton, Real Estate Valuation in Litigation 119-20 (Amer. Inst. of Real

Estate Appraisers 1982); Clifford W. Hollebaugh, Income Approach to Value , in Encyclopedia of Real

Estate Appraisal 54-56 (Edith J. Friedman ed., 1959). Given the conceptual similarity between real estate

inventory and traditional income-producing property, applying such a requirement to real estate inventory

cannot be said to be unreasonable, arbitrary, or capricious.

The constitutional issue is not simply whether section 23.12(a) restricts the market, but

whether the restriction fails to produce a reasonable estimate of market value. As pointed out above, an

owner of business inventory--whether real or personal property--is necessarily interested primarily in the

financial benefit that the retail sale of the inventory will bring in the future. The standard definition of value

applied to income-producing property is the present worth of future benefits expected to be derived from

ownership: "Because value is created by the expectation of benefits to be derived in the future, value may

be defined as the present worth of all rights to these future benefits. All income capitalization methods,

techniques, and procedures attempt to forecast future benefits and estimate their present value." The

Appraisal of Real Estate 408 (Amer. Inst. of Real Estate Appraisers, 9th ed. 1987); see also Real Estate

Appraisal Terminology 215 (Amer. Inst. of Real Estate Appraisers & Soc'y of Real Estate Appraisers,

Byrl N. Boyce ed.,1975) ("Value is the present worth of future benefits arising out of ownership to typical

users or investors."). By directing that inventory be valued at "the price for which it would sell as a unit to

a purchaser who would continue the business," section 23.12(a) essentially requires nothing more than that

the inventory of a business should, for taxation purposes, be considered as income-producing property

and its market value determined pursuant to the income approach.

Finally, in the appraisal process, a recognition of the appropriate market is not only

common, but essential:

Although there is a remarkable similarity in the many definitions of fair market

value, the definitions leave several questions unanswered. For example, the exact market

to be considered to find the proper fair market value may vary depending on the nature of

the property interest, the status of the owner, the volume of assets ordinarily sold, and the

availability of wholesale or retail markets. The market to be considered should generally

be that which the owner of a given property would ordinarily use, but in some instances,

statutes or regulations may dictate that a particular market be considered.

Goff, supra , 15 Tex. Tech L. Rev. at 641; see also Daniel S. Goldberg, Fair Market Value in the Tax

Law: Replacement Value or Liquidation Value , 60 Tex. L. Rev. 833 , 834 (1982) ("[A] determination

of fair market value under the willing buyer/willing seller test cannot be made without first knowing the

market in which the transaction will take place."). Where one is seeking to estimate what a willing buyer

would pay for roughly 200 subdivided residential lots in a single transaction, the "retail market" would not

be a good place to look. Thus, restricting potential buyers to those who would continue the business of

selling the inventory to retail customers is simply a recognition that such business purchasers would pay the

highest price for the inventory sold as a unit.

Moreover, to the extent it is relevant, FM produced evidence that there is an active, existing

market in multi-lot sales and purchases out of subdivisions in Travis County. Thus, as far as the present

case is concerned, the market designated by the legislature in section 23.12(a) is not an imaginary one, but

a real one.

Based on the foregoing, we hold that the market "restriction" recognized by section

23.12(a) produces a reasonable estimate of market value and does not, therefore, violate the "in proportion

to its value" provision contained in article VIII, section 1(b) of the Texas Constitution.

III. Exemption

Finally, the District argues that section 23.12(a) constitutes an unauthorized "exemption"

from taxation for owners of real estate inventory. Because article VIII, section 2 of the Texas Constitution

does not authorize an exemption for such property, the District contends the statute is unconstitutional.

Enron also forecloses this argument. The supreme court held in Enron that a statute fixing

a standard of valuation of inventory did not create an exemption at all where the statute did not delete the

property from the tax rolls entirely. 922 S.W.2d at 940-41 . The present case is almost identical to Enron

in that respect: section 23.12(a) did not delete FM's property from the tax rolls entirely, but merely

established a method of valuing a certain category of property, which FM's land falls into. See Hardin ,

374 S.W.2d at 884 . Accordingly, we hold that section 23.12(a) does not violate article VIII, section 2

of the constitution.

CONCLUSION

Because section 23.12(a) does not create an unreasonable tax classification, it does not

violate article VIII, section 1(a) of the Texas Constitution; because it does not establish an arbitrary or

capricious method of valuation that departs from the market-value standard, it does not violate article VIII,

section 1(b); because it does not exempt real estate inventory from taxation, it does not violate article VIII,

section 2. We affirm the trial court's judgment.

J. Woodfin Jones, Justice

Before Justices Powers, Aboussie and Jones

Affirmed

Filed: June 26, 1997

Publish

1. Amendments to section 23.12(a) in 1993 and 1995 resulted in the addition of the introductory

phrase, "Except as provided by Sections 23.12A and 23.12D of this code . . . ." See Act of May 25,

1993, 73d Leg., R.S., ch. 672, § 1, 1993 Tex. Gen. Laws 2501 , 2501; Act of May 27, 1995, 74th Leg.,

R.S., ch. 836, § 1, 1995 Tex. Gen. Laws 4231 , 4231. Section 23.12A, since renumbered as section

23.121, provides: "For the purpose of the computation of property tax, the market value of a dealer's

motor vehicle inventory on January 1 is the total annual sales from the dealer's motor vehicle inventory, less

sales to dealers, fleet transactions, and subsequent sales, for the 12-month period corresponding to the

prior tax year, divided by 12." Code § 23.121(b) (West Supp. 1997). Section 23.12D provides the same

method of computation of value for a dealer's vessel and outboard motor inventory. See Code §

23.12D(b) (West Supp. 1997).

2. The development approach has also been variously referred to as the "cost of development

method," "anticipated use method," "lot method," "developer's residual approach," "developer's

absorption method," and "subdivision approach." For purposes of consistency only, we will refer to it as

the development approach.

3. The development approach has been discussed in one Texas opinion, although it was not critically

evaluated in that case because the parties did not contest its validity. See Cherokee Water Co. v. Gregg

County Appraisal Dist. , 773 S.W.2d 949, 954 (Tex. App.--Tyler 1989), aff'd , 801 S.W.2d 872 (Tex.

1990).

4. "Under the income approach, an appraiser or other witness calculates the economic rent the

property will command in the open market, deducts normal operating expenses to arrive at net operating

income, and then capitalizes the net operating income by a rate of return to arrive at an opinion of fair

market value." 5 Nichols on Eminent Domain § 19.01[2] at 19-8 (rev. 3d ed. 1997, Julius L. Sackman,

co-author).

5. Using the income approach to find market value of real estate inventory is not inconsistent with

the restriction in section 23.12(a) that the property "produce[] no income," because the purpose of that

statutory restriction is obviously to exclude real estate that produces income while owned .

les and purchases out of subdivisions in Travis County. Thus, as far as the present

case is concerned, the market designated by the legislature in section 23.12(a) is not an imaginary one, but

a real one.

Based on the foregoing, we hold that the market "restriction" recognized by section

23.12(a) produces a reasonable estimate of market value and does not, therefore, violate the "in proportion

to its value" provision contained in article VIII, section 1(b) of the Texas Constitution.

III. Exemption

Finally, the District argues that section 23.12(a) constitutes an unauthorized "exemption"

from taxation for owners of real estate inventory. Because article VIII, section 2 of the Texas Constitution

does not authorize an exemption for such property, the District contends the statute is unconstitutional.

Enron also forecloses this argument. The supreme court held in Enron that a statute fixing

a standard of valuation of inventory did not create an exemption at all where the statute did not delete the

property from the tax rolls entirely. 922 S.W.2d at 940-41 . The present case is almost identical to Enron

in that respect: section 23.12(a) did not delete FM's property from the tax rolls entirely, but merely

established a method of valuing a certain category of property, which FM's land falls into. See Hardin ,

374 S.W.2d at 884 . Accordingly, we hold that section 23.12(a) does not violate article VIII, section 2

of the constitution.

CONCLUSION

Because section 23.12(a) does not create an unreasonable tax classification, it does not

violate article VIII, section 1(a) of the Texas Constitution; because it does not establish an arbitrary or

capricious method of valuation that departs from the market-value standard, it does not violate article VIII,

section 1(b); because it does not exempt real estate inventory from taxation, it does not violate article VIII,

section 2. We affirm the trial court's judgment.

J. Woodfin Jones, Justice

Before Justices Powers, Aboussie and Jones

Affirmed

Filed: June 26, 1997

Publish

1. Amendments to section 23.12(a) in 1993 and 1995 resulted in the addition of the introductory

phrase, "Except as provided by Sections 23.12A and 23.12D of this code . . . ." See Act of May 25,

1993, 73d Leg., R.S., ch. 672, § 1, 1993 Tex. Gen. Laws 2501 , 2501; Act of May 27, 1995, 74th Leg.,

R.S., ch. 836, § 1, 1995 Tex. Gen. Laws 4231 , 4231. Section 23.12A, since renumbered as section

23.121, provides: "For the purpose of the computation of property tax, the market value of a dealer's

motor vehicle inventory on January 1 is