Pulp and Paper Case Study – Domtar vs. MPAC
The Background The mill was built up over the last100 years to be a fully integrated forestry facility
comprised of more than 2,000,000 square feet of buildings. As a result of the economic
changes in the Canadian forest industry by 2008 only a portion of the entire facility was
used to produce pulp, the remainder of the sawmill and paper mill buildings either sat
vacant or were significantly under utilized.
The Assessor returned the assessment for the 2008 base year at $50,334,000, a value that
was higher than settled for the previous assessment cycle. The Assessor stated that the
significant number of machine and mill closures, if anything increased the value of those
mills still in operation and that none of the sales of pulp or pulp and paper mills in
Canada could be relied upon because they were sales of properties in distress. The
Assessor was not persuaded that the so called crisis in the Canadian forest industry was
anything more than a typical cycle and therefore did not warrant any adjustments to value
beyond those contained in their standard guidelines for the valuation of industrial
properties.
After a myriad of attempts to reach a mutual agreement on the correct assessed value
failed and the appeal was set for hearing.
The Result The Assessment Review Board reduced the assessment from $50,334,000 to $14,041,000
or 72%.
The Skinny AEC provided a team of expert appraisers, engineers, assessors and tax consultants that
worked closely with the client and their legal team.
• The Board agreed with AEC’s appraisal and valuation expert that no one would pay
more to purchase a property than the cost to replace it with a modern mill of like
utility. Our AEC engineer created a “model mill” that considered only what would be
required to produce the same amount of pulp capacity. The model was based upon a
modern US mill that was modified to take into consideration the Canadian climate.
The model reduced the reproduction cost new of $137,518,844 as calculated by the
Assessor to a replacement cost new of $35,032,029. The Board accepted this 75%
reduction in cost new as the correct starting point from which other depreciation
needed to be deducted.
• AEC deducted the same percentage of physical depreciation from the model as was
found in the existing mill. The Board disagreed with the Assessor that a property
cannot be old and new at the same time. The Board agreed with AEC that a buyer is
AEC Property Tax 10 Carlson Court, Suite 640, Toronto, Ontario M9W 6L2 Tel: 416.224.5115 | Fax: 416.224.1163 | www.aecpropertytax.com Toronto • Calgary • Montréal • London • Ottawa • Vancouver • Edmonton •
Page 2 not getting the new model, but a replica of the model that is the same age as the
existing plant.
An accurate snapshot of the Canadian forest industry was provided to the Board by
financial and operations representatives of the client. The information included
benchmarking information with other mills in Canada, the US, and the world as well
as information on the sale of forest industry properties. AEC’s appraisal experts used
this information to determine the final adjustments for External Obsolescence
(sometimes called Economic). The Board acknowledged that while it may be simple
to identify, it is the most difficult from of depreciation to quantify for special purpose
properties, and is largely a matter of subjective judgment of the appraiser. In reaching
it’s conclusion of -52% instead of the -60% put forward, the Board said that it would
accept Mr. Johnstone’s expert opinion on the methodology and all valuation
assumptions with the exception that they preferred a slightly lower wood cost
differential that was based upon an average of the US mills. The Board had no regard
to the Assessors claim that the adjustment should be only -30% based upon the
Assessors guidelines.
The Conclusion Although our clients have received similar results on other mills in Ontario and BC it
must be recognized that reductions like this require a broad range of expertise and a
partnership between the client, the consultant and the legal counsel. They also require
persistence and determination, as Assessors are known for stall tactics and
recommendations for nominal reductions.
Assessors across the country have a comfort level with the “I see it, I measure it, I cost it”
approach to the assessment of special purpose properties. Few have been given the time
to gain any real experience in understanding the intricacies of the large industrial
properties that they are required to value. As a result they often create and apply
valuation policies in hopes that by getting them all wrong with some consistency it will
be all right with the Board.
The AEC team has applied the model approach across Canada to determine the correct
assessed values of unique and special purpose properties from a wide range of industries.
As demonstrated in the attached decision, the AEC team has the experience, the
background and the ability to tackle these difficult assignments.
We have set the gold standard in property tax consulting for 40 years.
Assessment Review Board
Commission de révision de l’évaluation foncière
File No: ID 115632
Region Number:
Municipality:
Roll Number:
Hearing Number:
Appeal Numbers:
32
City of Dryden
6026-260-005-14800-0000
526777
2025414, 2348901, 2695967 and 2923477
In the matter of Section 40 of the Assessment Act, R.S.O. 1990, c. A.31, as amended, and in
the matter of appeals with respect to taxation years 2009, 2010, 2011 and 2012 on premises
known municipally as 1 Duke Street, Dryden
BETWEEN:
Domtar Pulp and Paper Inc.
Assessed Person/
Appellant
- and The Municipal Property Assessment Corporation,
Region No. 32 and the City of Dryden
Respondents
APPEARING:
J. Walker
K. West
- for the Assessed Person/Appellant
J. Jamieson
- for the Municipal Property Assessment
Corporation
L. McNaughton
- for the Municipality
INTERIM DECISION OF THE ASSESSMENT REVIEW BOARD delivered by:
J. M. Wyger
[1]
These appeals came before the Assessment Review Board (“Board”) on April 11, 2012
in the Town of Dryden and on June 13 and July 19, 2012 in the City of Toronto. During the
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File No: ID 115632
lead-up to the hearing of this matter, counsel for the parties expressed their preference that the
same panel hear the appeals of both of Domtar’s mills in Espanola and Dryden because the
issues were very similar, and they craved some logical consistency in the resulting reasons,
which they requested be released contemporaneously. The evidence and submissions in
each appeal were considered separately, even though there is the occasional reference to one
mill’s appeal in the other mill’s written reason.
INTRODUCTION
[2]
Overlooking the City of Dryden in Northern Ontario is an industrial complex of over two
million square feet situated on over 300 acres of land. It was constructed as an integrated
sawmill, pulp mill, and rolled and cut paper mill. The owner of the property, Domtar Pulp and
Paper Inc. (“Domtar”) has scaled down the operation of the plant so that during the taxation
years in question it produced only pulp for delivery to other end users. A facility that once
converted both hardwood and softwood trees into a variety of paper products, now converts
softwood chips into pulp largely for producing paper towels and tissue. The majority of the
plant is no longer utilized for its intended purposes. There is no question that much of the
property suffers from obsolescence in various forms, but the parties to this appeal cannot
agree on how and to what extent to quantify that obsolescence as a reduction in the property’s
current value for assessment purposes.
[3]
Domtar’s position is that a willing buyer would pay no more than the cost to build a new
mill dedicated to producing pulp only, a model approach that results in an indicated value of
$10.093 million. The balance of the Automated Cost Systems (“ACS”) cost approach value for
the existing mill represents the value of the parts of the mill that are obsolete. Sales of other
mills across the country were put forward to support their indicated value.
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[4]
File No: ID 115632
The Municipal Property Assessment Corporation (“MPAC”) costed the entire existing
mill in the standard “rationalization” approach, on a building by building basis using ACS,
applying varying obsolescence amounts to each component based on their view of current
usage. Their final revised assessment places the current value at $36.566 million.
[5]
The expert valuation witnesses are $26 million apart in their estimates of the current
value for the same property. The task for this panel is to determine at what amount a willing
buyer and seller might have transacted this pulp mill, in or around January of 2008 and to
explain why. This estimated value hinges largely on answering three questions:
1) Which cost approach method provides a better reflection of replacement cost for the
purposes of the principle of substitution, and therefore best identifies or isolates the
functional obsolescence (“F/O”) in the Dryden mill, the model or the standard
rationalization approach?
2) How much physical depreciation, if any, should be allowed?
3) What is a justifiable allowance for external, also known as economic obsolescence
(“E/O”)?
INTERIM DECISION
[6]
This is an interim decision because there are numerous tanks on the property the value
of which, if any, may affect the current value. There is a dispute for all four years with respect
to whether some or all of these tanks are exempt from taxation pursuant to s. 3 of the
Assessment Act (“Act”), and that determination may affect the value of the Large Industrial
(“LT”) portion found in this decision. This Board has no jurisdiction to rule on that issue, so
must await either a resolution between the parties or a determination by the Court. In addition
there is a Commercial (“CT”) component, for which the parties will provide an agreed
apportionment. I have not dealt with the value of the CT portion, so that any reference in this
decision to the LT portion is on the understanding that this value will be altered by a small CT
apportionment. This is an interim decision for all four taxation years, until there is some
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File No: ID 115632
resolution on these outstanding issues. Upon that occurrence or for any other matter that
counsel deem advisable, this hearing may be re-convened so the Board may be spoken to,
and/or adjust the numbers as necessary.
[7]
The Large Industrial (“LU”) (Excess Land) portion is confirmed at $97,288.
[8]
The LT portion is reduced from $50,236,712 to $14,041,000 for all four taxation years.
REASONS FOR INTERIM DECISION
Facts
[9]
The subject property is a 339.7 acre parcel, on which is built a two million square foot
mill, originally built in 1910, that produces only Northern Bleached Softwood Kraft (“NBSK”),
which is a variety of pulp.
[10]
Counsel for MPAC, Jack Jamieson and Jack Walker and Ken West representing
Domtar, provided the Board with an Agreed Statement of Facts which stipulates:

The highest and best use of the property is its existing use as a pulp mill.

The current value is the value in exchange i.e. the price that the property would most
likely command in the open market between a willing buyer and willing seller.

The returned assessment for taxation years 2009, 2010,2011 and 2012 was
$50,334,000.

The sawmill ceased operations in October 2003; the woodroom closed in March
2006; and both paper machines were permanently shut down by December 2008.
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[11]
File No: ID 115632
In addition, the valuation witnesses agree on the land value of $997,699.
The Legislation
[12]
Section 19.(1) of the Act states:
19.(1) Assessment based on current value. - The assessment of land shall be
based on its current value.
[13]
Section 1 of the Act defines “current value” as:
“current value” means, in relation to land, the amount of money the fee simple,
if unencumbered, would realize if sold at arm’s length by a willing seller to a
willing buyer.
[14]
Section 19.2(1)2 states:
1
19.2 (1) Valuation days. – Subject to subsection (5) , the day as of which land is
valued for a taxation year is determined as follows:
2. For the period consisting of the four taxation years from 2009 to 2012,
land is valued as of January 1, 2008.
[15]
Section 44.(3) states:
44.(3) Same, 2009 and subsequent years. – For 2009 and subsequent taxation
years, in determining the value at which any land shall be assessed, the Board
shall,
(a) determine the current value of the land; and
(b) have reference to the value at which similar lands in the vicinity are
assessed and adjust the assessment of the land to make it equitable with
that of similar lands in the vicinity if such an adjustment would result in a
reduction of the assessment of the land.
[16]
Section 5.(2) of the Ontario Regulation 282/98 states:
5.(2). A care home, as defined in the Tenant Protection Act, 1997, to which that Act
does not apply, that is operated with the intention of generating a profit and that
does not have seven or more self-contained units.
[17]
Section 15 of the Ontario Regulation 282/98 states:
15. (1) This section applies to land if all of the following conditions are satisfied:
1
Subsection 5 permits the Minister to prescribe a different valuation day. A different day has not been prescribed.
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File No: ID 115632
1. A building or structure has been built on the land.
2. All or part of the building or structure was used in the past.
3. No part of the building or structure is currently being used. O. Reg. 185/09, s. 1.
(2) If the building or structure is substantially usable, the land is classified in the
property class or classes in which it was classified for the previous taxation year. O. Reg.
185/09, s. 1.
(3) Subject to subsection (4), if the building or structure is substantially unusable and all
or part of the land was included in the residential property class immediately before it
became substantially unusable, the portion of the land that was classified in the
residential property class continues to be classified in the residential property class.
O. Reg. 185/09, s. 1.
(4) Subsection (3) applies only in determining the property class or classes of land for
the 2007 or a subsequent taxation year. O. Reg. 185/09, s. 1.
The Relevant Evidence
Mr. Joseph Tsoi
[18]
Mr. Tsoi, a senior consultant with AEC Valuations Inc., was called by Mr. Walker to
provide the Appellant’s review of the ACS tallies on a building by building basis. He testified
regarding the purpose, function and utility of the various components. He detailed the uses to
which the various components of the mill are put, and the areas, closed or not, in use for their
intended purposes. Mr. Tsoi indicated that he worked with Charles Johnstone, the Appellant’s
valuation expert, on the types and amounts of functional obsolescence F/O to be allowed.
Ms. Sally Sipos
[19]
Ms. Sipos is the controller for the Dryden mill, and gave evidence about the financial
performance of the mill and the fibre industry in general. She detailed a downturn in the mill’s
financial performance in 2009, largely due to competition from abroad, declining demand for
softwood pulp, fibre supply issues, and the high cost of wood, transportation and energy. She
contended that paper is a dying industry and pointed to a Deloitte asset impairment study that
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File No: ID 115632
effectively concluded that the mill had no value for financial reporting purposes. She conceded
that Deloitte did not factor in the benefits of a turbo-generating facility for which Domtar’s head
office allocated $20 million from a government grant to build.
[20]
The turbo-generator which was under construction during the hearing of these appeals
was designed to make the mill energy self-sufficient. Ms. Sipos’s financial projections that
included the turbo-generator showed a substantial increase in profitability over the base case
scenario. In the base case scenario, without the turbo-generator, the mill was still projecting
positive earnings before interest, taxes, depreciation and amortization (“EBITDA”) over 15
years out. This base case projection from 2009 expected a $4.5 million EBITDA in 2010, but
the actual amount earned in 2010 was $65 million.
Mr. Stewart Marcoux
[21]
Mr. Marcoux, who is the Vice-President of Asset Redeployment for Domtar Inc., joined
the hearing by video conference from Domtar’s head office in Montreal. He gave evidence on
Domtar’s perspective and criteria for the purchase and sale of pulp mills, the history of the
troubled fibre industry and on the future of the Dryden plant in their business model.
[22]
Mr. Marcoux catalogued a tale of woe for the Ontario fibre industry due to the softwood
lumber dispute, the dollar exchange rate, reduced demand for paper, and steadily increasing
costs, with no improvement in sight. He explained why Ontario wood costs were so high
compared to highly efficient mills in South America that are continuing to be built in direct
competition. Mr. Marcoux provided information on the sale of three mills across Canada to
support his contentions, although he did concede that the demand for NBSK is stable.
Mr. Kent Ramsay
[23]
Mr. Ramsay is the production manager at Domtar’s Dryden mill, and was called by the
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File No: ID 115632
Appellant’s counsel to describe the pulp-making process and show the Board which parts of
the plant are not required for that purpose, and the function and use of the various component
parts of the mill. Mr. Ramsay hosted a nice lunch followed by a four hour tour of the Dryden
mill.
[24]
Mr. Ramsay described the NBSK produced at Dryden as desirable and able to
command a good price because of its strength and whiteness. He stated that the conversion
of the plant in 2009 to making market pulp was a viable process. He demonstrated that many
of the buildings and conveyors and storage areas would not be re-built, if one was starting a
pulp-making operation from scratch.
Mr. Charles Johnstone
[25]
Mr. Walker called as his valuation witness, Mr. Johnstone, the Director of Property Tax
and Appraisal Services for AEC International Inc. Following a review of his impressive
resume, Mr. Johnstone was qualified to give opinion evidence as an expert in the valuation
and assessment of large industrial properties, including fibre mills.
[26]
Mr. Johnstone characterized his task as determining what someone would pay for this
facility that had so many buildings lacking any utility; to assess which buildings add value and
which buildings actually cost money to own. He testified that the facility is substantially overbuilt for market pulp production and that only 33.4% of the buildings are being used, with the
balance falling in a range of being from 5 % to 100% obsolete. The plant that would replace
the function and utility of the Dryden mill would be much smaller, more efficient and cost less
to build and to operate.
[27]
Mr. Johnstone employed the cost approach that is generally used for special purpose
industrial properties. This requires analyzing the cost of re-constructing the improvements and
then deducting all forms of depreciation and obsolescence. The net value is added to the land
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File No: ID 115632
value to produce the value conclusion. Mr. Johnstone’s preferred method for finding this value
is the “model” approach, whereby one considers the cost of building a hypothetical modern
plant of similar functionality and utility as the subject mill.
[28]
Mr. Johnstone’s choice for such a model is Domtar’s mill in Marlboro, South Carolina
(“Marlboro”). That mill produces a similar amount of market pulp using a similar number of
employees as the Dryden mill. However it requires only 327,925 square feet of plant to do so,
compared to approximately one million square feet of the Dryden plant dedicated to pulp
production. A number of processes and tanks that are outside at Marlboro, and need to be
inside in Canada, would require additional enclosures of 203,971 square feet for a total size of
531,896 square feet. These structures were then costed using ACS as if they were in a cold
climate like Dryden, resulting in a replacement cost new (“RCN”) of $35,032,029. The
difference between this figure and the RCN for the overbuilt Dryden facility ($137,746,616) is
said by Mr. Johnstone to represent the F/O on the order of 74.57% inherent in the
superadequate, under-utilized Dryden plant.
[29]
The winter-adjusted Marlboro RCN of $35,032,029 is depreciated by approximately
35%, roughly the same amount used by MPAC, to $22,959,992. After adding $4.029 million
for yardwork, Mr. Johnstone deducted 60% for E/O to arrive at a figure of $10,795,576. The
60% for E/O is based on the differential of the excess operating costs at Dryden in comparison
to the benchmark Marlboro mill. Mr. Johnstone then deducted $1.7 million for identified site
contamination clean-up costs, and added the land value of $997,699 to arrive at his value
conclusion of $10,093,000.
[30]
Mr. Johnstone arrived at a somewhat higher value employing the more standard
“rationalization” cost approach using the ACS. His review indicates that 1,024,109 square feet
of the existing structures are used in the pulp-making process. On a building by building basis,
he calculated F/O in the amount of 51.88% and depreciation of 34.46%. Deducted from the
total Dryden RCN of $137,746,616, the resulting building net value was $43,439,892. It is
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File No: ID 115632
interesting to note here that this value is only $4 million less than MPAC’s final building net
value of $47,437,178. Mr. Johnstone added yardworks and land value to arrive at a total
property value of $48,264,775. From this value Mr. Johnstone deducted a full 75% market
adjustment factor (“MAF”) to arrive at his current value of $12,066,000 rounded.
[31]
Mr. Johnstone provided ten sales of northern fibre mills in support of his cost approach
conclusion. He contended that the sales suggest the value of a pulp and paper mill would not
typically exceed $2.5 million, and normally sell for only a small fraction of their replacement
cost new.
Mr. Frank Lutz
[32]
Counsel for MPAC, Mr. Jamieson, called as his valuation witness, Mr. Lutz, who was
qualified by the Board as an expert in the assessment of large industrial and resource
properties. Mr. Lutz made several visits to the mill and revised his tallies a number of times
because changes at the mill were ongoing during that time. Parts were opening and closing
and “stuff was being move around” during this period.
[33]
Mr. Lutz used the ACS cost approach to value the mill on a building-by-building
rationalization method. He insisted that he used replacement cost i.e. costing similar
structures using modern methods and materials, rather than reproduction cost which would
involve costing an exact replica of the existing facility. His RCN for the Dryden mill at
$137,518,844 is for all practical purposes the same as Mr. Johnstone’s $137,746,616. Both
experts were clearly costing the buildings under the standard approach with the same
methodology.
[34]
Mr. Lutz applied a 47% deduction for F/O and 35% for physical depreciation to arrive at
his building net value of $47,437,178. It is from this point that the valuation witnesses diverge
greatly, for Mr. Lutz allowed only 30% for economic obsolescence and that allowance is
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File No: ID 115632
applied to the buildings only. This $14,231,153 deduction is followed by the addition of
yardworks and land value resulting in his final conclusion of value at $36,566,000 rounded.
[35]
Mr. Lutz reduced the E/O from a 40% allowance found in an earlier tally because in his
judgment the successful turnaround of the Dryden mill to profitability in 2010 set it apart from
the other troubled mills that received the 40% maximum permitted by MPAC guidelines.
[36]
Mr. Lutz explained why he was not a fan of the model approach used by AEC, for a
variety of reasons: the Dryden mill was operating at peak efficiency and full capacity; local
health and building and engineering standards would have to apply; the different climate
requires costing a lot of hypothetical structures not at Marlboro; the model is not pulp only but
also paper-making, requiring more adjustments. It was his view that if you employed a model,
it should not be depreciated, nor should excess operating costs be a concern, because they
are designed out of the model. He further asserted that the different hardwood and softwood
inputs in the two mills makes comparison difficult, especially with respect to excess operating
costs.
[37]
Using the standard rationalization approach, the valuators are only about 5% apart after
the application of F/O and depreciation. It is the value to be attributed to economic/external
obsolescence or to the MAF that highlights the difference between them. In the rationalization
approach, Mr. Johnstone deducted a 75% MAF from building, yardworks and land value,
instead of an E/O allowance. Mr. Lutz’s rationalization approach deducted a 30% E/O from the
building net value only. In the model approach, Mr. Johnstone deducted 60% E/O from
buildings and yardworks, and then adds land value. It is these percentages and how they are
applied that accounts for the majority of the $26 million difference between the parties.
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File No: ID 115632
Analysis - Model vs. Rationalization
The Model Method
[38]
The parties agree that the use of a model in valuing an existing property is an accepted
method of costing an industrial facility and in particular to isolate the obsolescence within that
facility. The use of a model is an accepted method within the cost approach, according to the
appraisal literature. Mr. Johnstone’s preference for the model approach is reflected by Lee
Fuller, author of the article at Appendix 4E of Exhibit 6(b) entitled "Valuing Special-Purpose
Properties - What Do the Experts Say?” He confirms the well-accepted definition of
replacement cost as the cost to build a facility of equivalent utility, using current standards,
design and layout, as opposed to reproduction cost which is the cost to construct a replica of
the building being appraised with no radical change in the construction, quality, amenities or
any other aspect. In the latter approach "We appraise what is there, not a substitute model".
[39]
Mr. Fuller goes on to note his preference for estimating replacement cost using “recently
constructed examples of buildings with utility similar to the building being appraised" but that in
the absence of such examples "very few appraisers would have the technical knowledge and
experience to, in effect redesign an actual special-purpose building" and so must fall back on
reproduction cost of the existing facility. In this case, such an example is provided with the asbuilt plans for Marlboro, and the re-design for climatic purposes was undertaken by an
engineer with input from knowledgeable Domtar personnel.
[40]
The principle of substitution underlies the cost approach to valuation and holds that a
willing buyer would pay no more than the cost to build a facility of like productivity and
functional utility, using modern materials, standards, design and layout. The question is
whether the facility standing at Dryden or a reasonable facsimile with some corrections for
superadequacy, piecemeal, and some buildings removed is representative of what that willing
buyer has in mind as a substitute. This is the top-down approach provided by the
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File No: ID 115632
rationalization approach, a series of subtractions from what is currently there, that Mr. Lutz
refers to as replacement cost.
[41]
I find it difficult to envision a buyer effectively reproducing the existing mill and then
attempt to tweak it to optimal functionality. Due to the age, layout and disjointedness of the
Dryden plant, I agree with Mr. Johnstone that a prudent buyer considering the cost to build a
replacement would employ the bottom-up approach of costing an optimum facility of similar
productivity from scratch. This is what the model method produces, often a hypothetical layout
from plans alone. In the present case, there are as-built plans of an actual mill of similar
productivity that rules out much of the guesswork that is a natural by-product of anything
hypothetical. I am persuaded that using a real model with some hypothetical add-ons provides
a more accurate estimate of building cost than a totally hypothetical model. Even the add-on
buildings are still based on enclosing actual processes in the pulp making at Marlboro.
[42]
The cost of a fully winterized Marlboro replica provides a maximum value that a willing
buyer would pay for the functional utility of the Dryden mill. In Mr. Johnstone’s analysis, that
buyer would pay up to the cost of building a winterized Marlboro replica ($35 million) which
produces the same amount of pulp employing far less real estate. The difference between that
value and the costing of the existing mill should represent all of the F/O inherent in that mill.
Employing the modeled value of a replacement mill effectively wrings out all the F/O that is
present in Dryden.
[43]
Mr. Jamieson raised several potential problems with the model approach. He
questioned why they would use a mill that produced paper and used hardwood for half its
input, unlike the Dryden mill. He pointed out that Mr. Johnstone was not an expert in the
numerous governmental building standards that would need to be complied with in
transplanting the Marlboro plant from the sunny south to the winter wonderland of Northern
Ontario. Perhaps Mr. Jamieson’s most serious objection to Mr. Johnstone’s model is the
assignment of a 60% E/O allowance based largely on the difference in the operating costs
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File No: ID 115632
between Dryden and Marlboro. On this latter point I agree with Mr. Jamieson that the model
may have been extended too far.
The Rationalization Method
[44]
The standard cost approach using ACS attempts to rationalize the value of the mill by
costing each component of the existing facility separately, as if new, and making deductions
for the depreciation and F/O of each one. The sum of all these costs plus the land value is the
most any rational willing buyer would pay in a perfect world. In the real world, a further
deduction for economic obsolescence or a MAF is often contemplated to take account of any
number of factors that are external to the facility itself.
[45]
In the case of the Dryden mill both valuators start with a nearly equivalent Replacement
Cost New Less Depreciation (“RCNLD”), with MPAC at $137,518,844 and Domtar at
$137,746,616. F/O applied by Mr. Lutz is 47% while Mr Johnstone applied a factor of 51.88%.
The difference of approximately $6.8 million was largely based on disagreement over the
appropriate factor to apply to each structure. Mr. Johnstone asserted that his subtotal of
$66,283,572 before physical depreciation produced by this method still does not adequately
account for all of the F/O in the overbuilt Dryden facility.
[46]
I accept Mr. Johnstone’s theory that the rationalization or building-by-building method
works well enough where the facility being costed bears a reasonable likeness to what might
replace it with some adjustments. I accept the evidence of Domtar’s witnesses that the Dryden
mill bears little resemblance to what Domtar would build to replace it, if it could. In this case,
the rationalization approach provides a value that is closer to reproduction cost than it is to a
true replacement cost as defined in the appraisal literature.
[47]
It is unclear if MPAC is equipped to employ a model approach. Mr. Lutz is very good at
what he does, but it was clear that he is limited by MPAC’s standards and guidelines and
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File No: ID 115632
policies. The further a property moves away from optimal utility, the more difficult it will be to
capture F/O with such arbitrary standards and guidelines. They may work well in most
standard industrial properties, but in the context of a single property appraisal of a large
special purpose property, the rationalization method does not conform to appraisal theory and
practice as well as Mr. Johnstone’s model analysis. I conclude that for the Dryden mill, the
model approach gives a better picture of the quantum of F/O that resides in that existing
facility.
Analysis - Functional Obsolescence (F/O)
[48]
Mr. Johnstone and the other Domtar witnesses have persuaded me that the mill at
Marlboro is a good benchmark and represents what Domtar would build to replace the Dryden
mill to achieve the same productivity. This is the essence of replacement cost. I accept the
detailed costing of the Marlboro mill, performed by an engineer making appropriate
adjustments for the unnecessary paper-making portions, and enclosures for the northern
climate. The RCN for a winterized Marlboro replica was $35,032,029. The difference between
this figure and the Dryden RCNLD of $137,746,616 represents the F/O in that mill being
74.57%.
Analysis - Physical Depreciation
[49]
Mr. Lutz and Mr. Jamieson contended that an adjustment to the modeled cost for
depreciation and some excess operating costs should not be necessary because the use of a
new model eliminates them. On the question of depreciating the modeled value, Mr. Jamieson
characterized it as “you cannot be new and old at the same time”. I disagree with this
assertion because every RCNLD is both new and old at the same time. That exercise always
projects a hypothetical new cost and then makes it old to reflect the reality of the age of the
existing structures being valued. The cost of a new Marlboro replica is the maximum a buyer
would pay for a brand new mill. A buyer purchasing the Dryden mill is not getting a new
16
File No: ID 115632
hypothetical Marlboro replica for that price, but a replica the real age of the Dryden plant. The
example from the AIC Course Manual entitled Depreciation Analysis (Exhibit 30) confirms that
the same amount of physical depreciation is deducted after the F/O represented by the model
RCN is deducted, as was deducted in the standard method.
[50]
The modeled $35 million value represents a hypothetical new mill with no F/O, but that
is not what a buyer of Dryden is receiving. I accept Mr. Johnstone’s opinion that the reality of
the age of the Dryden plant makes a deduction for physical depreciation legitimate. Along the
same lines, but more illustrative is the problem of excess operating costs. The buyer would
pay the price for a mill with the functional utility of Marlboro, but would still be faced with the
operating costs of the many functionally obsolete parts of the actual Dryden plant that is
acquired. Mr. Johnstone combined his allowance for those excess operating costs due to F/O
into his analysis of E/O which was largely based on other excess operating costs.
[51]
The parties generally agree on the total physical depreciation of the Dryden plant at
around 35%. Applied to the RCN of $35,032,029 the resulting value is $22,959,992. There
was not much discussion on yardworks, but I accept as logical Mr. Johnstone’s method of
adding the depreciated yardwork figure of $4,028,948 to the sub-total at this point and applying
E/O to the sum. Such yardworks are intricately attached to the pulp-making plant and would
be expected to suffer a similar degree of E/O. The addition of yardworks results in a sub-total
before E/O in the amount of $26,988,940.
Analysis - External Obsolescence (E/O)
[52]
External Obsolescence (“E/O”) as it is now generally referred to instead of economic
obsolescence, is defined as an impairment of the utility or saleability of a property due to
negative influences from outside of the property. The appraisal literature confirms that while it
may be simple to identify, it is the most difficult form of depreciation to quantify for specialpurpose properties, and is largely a matter of subjective judgment of the appraiser.
17
File No: ID 115632
MPAC E/O
[53]
MPAC’s guideline recognizes the numerous challenges to the assessed values of wood
fibre milling facilities, largely on the basis of under-utilization of production capacity. For the
2008 base year MPAC put in place an E/O of 40% on "most" of these facilities to improve
equity among these industries. Mr. Lutz was not able to report on the rationale for this figure.
It compares to a 45% E/O that MPAC allows on automotive assembly plants in Southern
Ontario. Mr. Lutz allowed a 30% E/O in his analysis of the Dryden mill, and justified not giving
the maximum 40% on the basis that the mill is running at full capacity.
[54]
The fact that the mill is running at full capacity does not translate to full profitability. It
does not attenuate the external factors listed below that result in declining prices and
escalating costs simultaneously, which led to many years of declining profits. This plant, while
currently financially feasible, is not immune to longer term problems that are rocking the
industry in Canada. This general downward trend, requiring continuous re-structuring or "repurposing" for many mills, is the uncertain future that a willing buyer must contemplate.
[55]
On the other hand, there is evidence to suggest that there may be some life left in the
pulp and paper industry. A quantification of E/O requires some measure of foresight.
Ms. Sipos’s presentation "Looking ahead...” states that “The market remains strong as pulp
prices continue to sit at record levels and we have secured a solid customer base." Most of
the pulp from Domtar’s mill at Dryden goes to customers making paper towels and tissue. She
writes that tissue is the "second major category to drive world demand growth" and that "tissue
demand is exploding in developing countries around the world. There are very few substitutes
for tissue..." So while the rise of the internet and electronic communications may spell the end
for newsprint and writing paper, an electronic substitute for toilet paper would seem some way
off.
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File No: ID 115632
Domtar E/O
[56]
A major deduction of 60% was judged by Mr. Johnstone to represent the E/O for
Domtar Dryden based on a number of factors described by Domtar's witnesses:
[57]

ever-increasing delivered wood fibre costs

unfavourable changes to the $US exchange rate

higher transportation, energy and other costs

decline in demand for pulp and paper

downward trend in pulp prices
I am not convinced that the economic obsolesce figure employed in Mr. Johnstone’s
model approach is appropriate. Mr. Johnstone applied a 60% deduction to the Marlboro
modeled value for E/O. This figure was calculated based entirely on the basis of excess
operating costs of the Dryden mill over the Marlboro mill in the production of pulp. Mr
Jamieson questioned why only one plant was used for this purpose rather than using a crosssection of Domtar plants producing NBSK. Mr. Johnstone’s notes (Exhibit 28) confirm that
Marlboro is a star in the Domtar firmament: “Marlboro is recognized throughout Domtar as the
mill all others compare to”; and “This mill has set paper production records for this type of
equipment.” There was no evidence led on whether the model approach envisions a
comparison with the level of near perfection seemingly represented by the Marlboro facility.
[58]
Mr. Jamieson objected to the excess operating costs including business costs that are
un-related to the realty, and derived only from the atypical and worst year of 2009. The charts
in Exhibit 18 showing a precipitous plunge in the market price of pulp in 2009 supports the
suggestion that 2009 was an anomalous year in the pulp industry. Also of note is that the year
2009 displays the highest price for softwood fibre from 2004 through 2011 in Canadian dollars
per air-dried metric tonne (Exhibit 18, page 43).
19
[59]
File No: ID 115632
A review of some of the graphs in Exhibits 6(a) and (b), and Exhibit 18 charting a
comparison of the fibre costs for various mills across North America, show South Carolina at or
very near the bottom in wood costs. In 2009, the Marlboro mill produced pulp at a
manufacturing cost rate of US $142 per tonne lower than the manufacturing costs to produce
the same product at Dryden. Notably, the average difference from 2004 through 2008 was
only $128 per tonne. Of the $142 difference, over half is attributable to wood costs.
Mr. Jamieson contended that this cost, as well as the cost of chemicals and energy, were
purely the cost of doing business, and are not at all related to the realty, or inefficient plant
layout, or unused buildings. He pointed out that there was nothing in the appraisal text to
justify this inclusion.
[60]
Mr. Johnstone’s written analysis states that “Part of these cost differentials are directly
as a result of excess operating costs associated with the additional production, maintenance
and labour costs from the Dryden mill having approximately 1.5 million square feet of buildings
that are not required to produce 325,000 tonnes of pulp per year.” This is the portion that is
related to costs of operating the functionally obsolete parts of the plant and I agree that making
an allowance for this is as legitimate as allowing physical depreciation of the new model, on
the grounds that a buyer of the real mill will face those actual costs that the hypothetical mill
would not incur. A willing buyer would be expected to capitalize those expenses as a
deduction to the price to be paid for Dryden. In the case of Domtar Espanola, Mr. Johnstone
isolated these costs attributable to F/O. In the case of Domtar Dryden, he did not and so of
necessity they will be subsumed in the overall E/O figure.
[61]
The external or locational obsolescence suffered by mills in Ontario is a different story.
Mr. Johnstone writes "Such inefficiencies are recognized by comparing performance of the
Subject plant to a well performing or bench-mark plant" such as Marlboro. This may be taking
the model approach too far, as it appears to be comparing the going concern at Marlboro with
the going concern at Dryden.
20
[62]
File No: ID 115632
To determine replacement cost and F/O, I accept that an optimal model such as
Marlboro can be used, because for replacement cost one would strive to replicate the
hypothetically perfect or optimal facility. However, using the same optimal model’s business
costs to estimate E/O in Dryden is flawed and unsupported by appraisal theory. For a specialpurpose property such as a fibre mill, external or locational obsolescence should compare the
subject location to the rest of the continent, and not to the most low cost jurisdiction to be
found. Using the Marlboro costs effectively extends the model method. It not only posits a
replica winterized Marlboro plant at Dryden, it then effectively assumes that Dryden plant is
actually operating in Marlboro, South Carolina for the purpose of determining costs. I was
unable to find any support for such a narrow interpretation of "external" in the appraisal
literature.
[63]
There are several references (underlining added) in Mr. Fuller’s article at Tab 4E of
Exhibit 6(b) that suggest a broader reference would be appropriate in quantifying E/O: "...a
process that compares actual operating costs and/or profits of the operating entity with norms";
"...operating information on the subject property and a representative sample of competitors
are needed"; and "decisions about economic obsolescence should be based on an
understanding of the industry and the characteristics of the property relative to industry norms".
Mr. Fuller makes specific reference to the pulp and paper industry in Canada, noting that the
"industry has fallen on hard times, and production has shifted to lower cost countries." In
Domtar’s case this shift is to the United States. I conclude from the comments above, that in
determining the E/O for Dryden, Mr. Fuller would advise a cost comparison with a
representative sample of Domtar mills across the U.S. and not just the single lowest cost
jurisdiction in South Carolina.
[64]
The quantification of a 60% economic obsolescence requires numerous other
assumptions beyond the cost differential. Mr. Johnstone’s current value of the cumulative
operating cost penalty is calculated over five years, at a discount rate of 15%. It is then
21
File No: ID 115632
apportioned to the realty based on an estimated 10% ratio of building value to equipment
value. The $16 million that resulted required a series of subjective assumptions by the
valuator and was premised on an over-stated and arbitrarily selective cost differential figure,
and so is not entirely persuasive. The $16 million deduction represents 60% of
Mr. Johnstone’s RCN less depreciation and functional obsolescence for plant and yardworks of
$26,988,940. This substantial deduction reduces his value conclusion to $10,795,756.
Analysis: Quantifying E/O
[65]
I have determined that an appropriate E/O for Domtar Dryden is between 40% and
60%. There is not much detailed information on wood costs from a representative sample of
other mills in North America. Wood cost comparison charts for 2007 and 2010 show a median
wood cost represented by mills in Arkansas and Tennessee that are approximately 25 to 30%
higher than the cost of wood in South Carolina. A graph comparing 2006 actual Dryden paper
cost per ton with four unidentified Domtar mills in the US south shows a differential of only
23%. Other charts show that Dryden’s wood costs in 2009 were between 4% and 8% higher
than median and average wood costs in surrounding years. Indeed 2009 displayed the
highest all-in softwood cost for the years 2004 through 2011. Mr. Johnstone determined
Dryden’s excess wood cost over Marlboro to be U.S $80 per metric tonne or 47% higher. The
evidence suggests that a differential derived from a representative sample of US mills over a
number of years would result in a lower percentage cost differential. That lower differential
should lead to lower E/O allowance.
[66]
There is not sufficient information on wood costs in evidence to extrapolate industry
norms or medians with much precision, unlike in the Domtar Espanola appeal. There is
however sufficient evidence to take Mr. Johnstone’s manufacturing cost differential between
Dryden and Marlboro from a representative sample of years displayed on Exhibit 19. The
average manufacturing cost to Dryden over the years 2004 through 2009 was $461 per tonne.
The average cost to Marlboro across those years was $333 per tonne, for an average
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File No: ID 115632
differential of $128 per tonne.
[67]
I will accept Mr. Johnstone’s expert opinion on the appropriate years, discount rate and
apportionment to land and buildings. When the differential of $128 is employed in place of his
$142 figure for 2009, the resulting cumulative operating penalty is $139,452,000 rounded. Ten
per cent apportioned to the real estate is $13,945,000 rounded. This deduction of E/O
represents 51.7 % of the $26,988,940 sub-total. In dollar terms, this deduction is very close to
Mr. Lutz’s $14,231,153 allowance for E/O. The 51.7% is also reasonably consistent with the
E/O that I determined in the Domtar Espanola appeal which was based on comparative wood
costs from a representative sample of U.S. mills to which I referred earlier in these reasons. I
am persuaded that these results arrived at by different means corroborate each other, and
results in an appropriate quantification of E/O for both mills.
[68]
After deducting an E/O allowance of $13,945,000 from the $26,988,940, the resulting
value is $13,043,940. Adding land value of $997,699 results in a value of $14,041,000
rounded down.
Analysis: Sales Evidence
[69]
For special purpose properties valued under the cost approach, market evidence should
be reviewed to test the value produced. There are significant problems in gleaning any useful
information from the sale of pulp and paper mills in recent years. The main reason for this is
the fact that most have been sold through bankruptcy, receivership, and creditor protection or
at the very least are distressed or even closed. The generally sorry state of this market is clear
evidence of a declining industry, and certainly supports a substantial risk premium represented
by the E/O allowance.
[70]
The nature of the market for these troubled facilities does raise the very real question of
whether they can be compared to a fully operational and sporadically profitable outfit like
23
File No: ID 115632
Domtar Dryden on the basis of differing highest and best uses. This was the basis for Mr. Lutz
not using any of these sales in support of his analysis.
[71]
It is not only the willing buyer that must be considered in the hypothetical transacting of
this mill. I doubt that, as a willing seller, Domtar would be prepared to give away the Dryden
mill at the fire sale prices in evidence while it is still profitable and has the financial feasibility to
attract a willing buyer prepared to carry on the current business or re-purpose to a more
profitable one. At page 491 of the transcript, Mr. Johnstone conceded that the price would
tend to be higher for such a feasible, operating mill than for troubled mills. I conclude that a
profitable operating mill would be expected to sell at a somewhat higher level than the prices of
those distressed mills in evidence.
[72]
The other main issue is determining just what the "sale amount" represents. It most
often includes machinery and equipment, and can also include timber rights, inventory,
liabilities and a host of other non-realty items that are subject to adjustment of up to 90%. The
reported values for the 10 sales in evidence range from negative $18 million (i.e. vendor paid
purchaser to take the mill) to positive $25 million.
[73]
An example of the care one must exercise in using reported sale figures was the sale
price listed at $300,000 for the St. Mary’s Paper mill in Sault Ste. Marie. On the appeal of that
property’s assessment before this panel, it was evident that this figure reported on the Land
Transfer Tax Affidavit was grossly under-stated. I re-iterate my impression from that appeal,
that about the only thing one can infer from the sales data is that pulp and paper mills
generally sell at a sizable discount to their ACS cost-derived values.
[74]
The market evidence supports the conclusion that significant amounts of depreciation
should be deducted from the cost approach valuation. I have applied such significant amounts
through acceptance of Mr. Johnstone’s F/O analysis and a reasonable adjustment to his E/O
allowance. I find nothing in the sales evidence to suggest that the land and buildings of
24
File No: ID 115632
Domtar Dryden could not have sold for $14,041,000 rounded, to a willing buyer in or around
January 2008.
Analysis: Land Contamination
[75]
Mr. Johnstone deducted $1,700,000 from the sub-total for “identified site clean-up
costs”. His written report states that “Domtar has ear-marked $1,700,000 to account for site
contamination issues.” In cross-examination, he confirmed that he relied on Ms. Sipos, the
Domtar controller, for the number that was on the books. This was all the evidence provided to
support an adjustment for contamination. I agree with Mr. Jamieson that this is clearly
insufficient evidence upon which to draw any conclusions on the extent to which, if any,
unspecified contamination might affect the value at which the mill would transact. I will not
make any allowance for site contamination.
Analysis: Classification
[76]
As if there weren’t enough issues to deal with, the parties could not agree on whether
some parts or buildings in the complex should be in the commercial class due to the
operations of Section 5.(2) and Section 15 of O. Reg. 282/98. The two key areas in dispute
were Buildings 140/141 and Buildings10/11.
[77]
Buildings 140/141 were the former sawmill/studmill that are no longer used for those
purposes but are still useable. There is no question that these buildings were properly
classified industrial and remain so due to the operation of s.15 now that they are largely
vacant. If used for storage, I find that they are clearly attached to each other by more than a
minimal connection and so do not qualify under Section 5.(2) for inclusion in the commercial
class.
25
[78]
File No: ID 115632
Buildings 10/11 are used exclusively for storage of the finished pulp product. The issue
is whether they are “attached” to Building 20 which has industrial classification. Mr. Walker did
not strenuously argue the classification issue, largely because his witness, Mr. Ramsay,
agreed in cross-examination that the buildings were connected, and shared a common wall
with a large opening. It was also clear to me on the tour, that it would be stretching the
language to suggest that these buildings were “not attached” to each other. I find that the
Appellant has not met the onus on it to show that MPAC’s classification is incorrect. I accept
Mr. Lutz’s determinations of classification as set out in Tab 25 of Exhibit 6 under the heading
“MPAC Classification”, and trust that the parties will work out the appropriate apportionment
between LT and CT.
CONCLUSION
[79]
The LT portion of the current value is reduced from the returned value of $50,236,712
for the four years in question to $14,041,000. I recognize that this is a substantial reduction to
the assessments as returned. It represents a significant impact on the assessment base for
the City, but I can only say that those financial implications are not a material consideration to
the issue of current value. For the people involved with the declining fibre industry, there are
not many winners, but several losers including industry workers, contractors, suppliers,
managers and investors. The reduction in property value attributable to the decline in the
industry will cause the municipality to lose a significant part of its assessment base, and that is
simply the City of Dryden’s share in the costs resulting from that decline.
“J. M. Wyger”
J. M. Wyger
Member
/sm/ll
INTERIM DECISION RELEASED ON: January 31, 2013