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May 12, 1958


The opinion of the court was delivered by: Platt, Chief Judge.

The court has viewed the premises and examined the interior of two five-room apartments in each project and one six-room apartment in Chanute Apartments. The two projects are similar in outward appearance and construction. The Chanute Gardens consists of 13 storage and maintenance buildings and 102 buildings containing 378 five-room apartments, each with 819 square feet, and 224 six-room apartments containing 1050 square feet. The Chanute Apartments consists of 5 separate storage and maintenance buildings and 37 buildings containing 120 five-room apartments each with 922 square feet, and 78 six-room apartments each containing 1050 square feet. Some of the storage and maintenance buildings have laundry facilities.

The construction is wood frame with brick veneer facing on the first floor front and street side, and asbestos shingles covering the composition sheeting on the wood frame elsewhere. The foundation is concrete block. The apartments are heated by a forced warm-air heating system, from a gas fired furnace in each unit located in an enclosed closet in the kitchen. Each unit has individual hot water heaters. The first floor is about two feet above the ground surface. The floors are plywood placed on 2" x 8" floor joists and covered with asphalt tile. There are sliding metal door closets in the bedrooms, and one guest closet with sliding door on the first floor. The windows are steel casement and sash. The walls are one-half inch dry wall finish with the seams taped. Each apartment has a bath with "tylac" lining around the bathtub. All of the apartments are painted, have front and rear entrances and inside doors on the bedrooms. The first floor in each apartment contains a living room, dining room and kitchen. The bedrooms are located on the second floor. Gable roofs are covered with asphalt shingles.

Land improvements include circular streets with asphalt surface and the necessary sewage, water, electric and gas connections.

The ground consisting of some 69 acres for the Chanute Gardens and 27 acres for the Chanute Apartments, (the legal description appears in the leases), was leased by the Secretary of the Air Force to the corporations for a period of 75 years, at an annual rental of $100 for Chanute Gardens and $110 for Chanute Apartments, "to be used for the purpose of erecting, maintaining and operating a housing project."

The leases provided that the premises should be leased to military and civilian personnel designated by the Commanding Officer of the Chanute Air Force Base, provided that it might be leased to others after 30 days vacancy. The Commanding Officer was also given the privilege to replace non-military occupants.

Paragraph 4 of the leases provided:

Paragraph 18 of the leases provided:

    "That except as otherwise specifically provided in
  this lease, all disputes concerning questions of fact
  or establishment of rental rates or standards of
  maintenance and repair after there is no mortgage
  held or insured by the Federal Housing Administration
  on the property and the leased premises are not under
  the control of the Commissioner, which may arise
  under this lease, and which are not disposed of by
  mutual agreement, shall be decided by the said
  Commanding Officer, who shall reduce his decision to
  writing and mail a copy thereof to the Lessee at its
  address shown herein. Within thirty (30) days from
  said mailing the Lessee may appeal to the Secretary
  of the Air Force, whose written decision or that of
  his designated representative or representatives or
  board, shall be final and conclusive upon the parties
  hereto. Pending decision of a dispute hereunder, the
  Lessee shall proceed with the performance of this
  lease and in accordance with the Commanding Officer's
  decision. The provisions of this paragraph shall not
  be deemed to limit the provisions of Condition 4 of
  this lease with respect to rents."

The leases further provided that no assignment could be made without the Air Force consent, and that any local taxes levied upon the leaseholds would be paid by the lessees.*fn1 Also upon termination of the leases the buildings and improvements were to remain the property of the Government without compensation.

As of May 1, 1957, each leasehold was encumbered by a mortgage held by the New York State Employee's Retirement System, and guaranteed by the Federal Housing Administration. There was also outstanding a loan to the defendants from the Air Force to complete the projects. At the start of the trial it was stipulated that as of May 1, 1957, there was a total balance due on the mortgages of $6,145,694.31, and a balance due on the Air Force loan of $410,771.26, subject to any credits and offsets which the defendants might have.

The Government presented two real estate appraisers as witnesses. Mr. Walter Kuehnle, an experienced appraiser, testified that, in his opinion, the market value of the defendants' interest in the leaseholds, which he termed their "equity", as of May 1, 1957, subject to the mortgages but not the Air Force loan, was $360,000 for the Gardens and $250,000 for the Apartments, for a total of $610,000. He defined market value as "what a willing purchaser not forced to buy will pay to a willing seller not forced to sell, both familiar with the property and the conditions." In reaching his conclusion Kuehnle studied, among other things, the community off the base to determine the economic rental potential, and the terms and restrictions of the mortgages and the Air Force leases. He determined that the maximum net rental income was limited to $321,515 for the Gardens and $119,370 for the Apartments. He based this upon his consideration of the FHA directives and the original project analyses compiled by the FHA which purported to limit the net rental return to 6½% of the original estimated construction cost. Kuehnle also considered the audits of rents and expenses for the years 1953 through 1956, raising and lowering various items which he thought justified according to his knowledge and experience in the management of such rental property. He noted an increase in monthly rentals for Chanute Gardens of $8.60 per apartment granted in June, 1954,*fn2 and a flat monthly charge of $8.40 per apartment in each project to cover the cost of cooking gas and electricity, which were not provided for in the original project analyses. Kuehnle believed this property to be investment property, and noted that the typical purchaser of such real estate resorts to financing. Finding that the cost of the mortgages guaranteed by the Federal Housing Administration was 4% plus ½% required for the payment of mortgage insurance, he testified that, in his opinion, these mortgages were quite favorable, considering prevailing mortgage interest rates as of May 1, 1957, and that if the properties were free and clear of these mortgages the value of the premises would be less. Kuehnle valued the projects according to capitalization of prospective income and replacement value. His opinion was that reproduction cost less depreciation of $633,558 amounted to $8,733,561 on May 1, 1957. He estimated the remaining useful life of the projects at 37 years. Kuehnle rejected net replacement cost as representing the fair cash market value for the reason that the income produced was not sufficient to justify it. He determined that prospective net income, after payment of mortgage principal and insurance but before depreciation allowance, would amount to $55,164 for Chanute Gardens and $35,199 for Chanute Apartments. In capitalizing this income, Kuehnle estimated that a willing purchaser would require a 15.4% yield on Chanute Gardens and a 14.3% yield on Chanute Apartments, and therefore multiplied the prospective income of the Gardens by 6.5 and of the Apartments by 7.4 to arrive at market value. Kuehnle referred to the sale of an apartment building in St. Louis, Missouri, in July, 1957, and to the sale of a housing project at Fort Devins, Massachusetts, on March 31, 1956, which attracted investments at yields of 14.3% and 16.1% respectively. Both of these projects were constructed under the National Housing Act.

The evidence disclosed that the defendants defaulted in their repayment of the Air Force loan and the Air Force took over the management of the projects on May 28, 1954. It was determined that a large savings in expense could be attained by the purchase of the distribution system for electricity, and the defendants attempted to induce the Air Force to allow the purchase of a distribution system. Purchase contracts were concluded but the purchase was never consummated. In determining the net prospective rentals ...

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