Are You Missing a Chance to Reduce Your Hotel’s Tax Burden?

by | 08 March 2017

One of the lessons the most recent economic crisis taught hotel owners and managers is the value of cutting costs while maintaining excellent customer service and property conditions. Savvy owners and managers continue this practice today, but many overlook a meaningful opportunity for cost reduction that has no impact on guest experience: filing a property tax appeal.

Based on the concept that the tax burden should be distributed in proportion to the value of all the properties within a taxing jurisdiction, a system of assessments is established by the local tax assessor. However, this system can be — and often is — inaccurate. Most systems for assessing property values are also slow to react to market realities.

Oftentimes, there is also a disconnect between a municipality’s assessment of a lodging property and the owner’s assessment due to the complex nature of hotels and a certain portion of the asset that is considered non-realty.

If you can identify such a disconnect, filing a property tax appeal seeking to better align your tax burden with property value can have meaningful results. As an example, a $100,000 drop in property tax burden would result in an increase to net operating income, which in turn would add about $1 million to property value (assuming a 10% capitalization rate and all other variables are held equal).

UNDERSTANDING THE DRIVERS OF PROPERTY TAX VALUATION

Colliers’ approach to property tax valuation involves a comprehensive analysis of a hotel’s position within the marketplace, paying close attention to the drivers of valuation for property tax purposes. These include a realistic position on stabilized operations, brand, asset quality and the overall market cycle.

In our property tax valuation work, we offer several vitally important reminders for clients reviewing their property assessments:

  • The real property assessment should reflect the real estate (land and building) only, exclusive of any intangible assets at the property.
  • The assessment will often represent a percentage (often less than 100%) of market value, after an equalization ratio is applied. In the simplest sense, an equalization ratio (or equalization rate) is a municipality’s level of assessment. Equalization ratios are often used for taxing jurisdictions, such as school districts, that do not share the same taxing boundaries as the cities and towns responsible for assessing properties.

The equalization ratio compares assessed value to the municipality’s total market value and must be considered when developing a supportable “loaded cap rate” for valuation purposes. Equalization rates are calculated as such:  

Equation graphic

KEY AREAS TO WATCH

To ensure your property assessment reflects only the land and building, it’s important to consider the impact that property improvement plans (PIPs) might have. As the pace of the transactions market has heated up, many hotel brand parents have implemented change-of-ownership PIPs to maintain brand standards. One of the downsides is that PIPs can be laden with FF&E requirements.

For example, a PIP on the recent sale of a hotel in Cleveland, OH included an FF&E budget representing 20.4% of the PIP. This loads a lot of value into the personal property component. To avoid overpaying taxes, it’s important to strip out this value along with associated intangible components to get to the taxable real property.

Another potential stumbling block is presented by states that place a heavy reliance on sales transactions. Oftentimes, an allocated price and a market value assessment will not be equal. A failure to properly assess this impact can lead to drastic and unsubstantiated increases in tax burden.

For example, in the state of Kentucky, the Property Valuation Administrator (PVA) is likely to place a heavy reliance on the sale price recorded on the deed. For example, on the sale of a hotel  in downtown Louisville that was part of a two-hotel portfolio, the buyers allocated $59.5 million for the Louisville asset. The PVA immediately utilized this number without regard to any non-realty components.

An appeal process ensued for three years with the buyers estimating value for assessment purposes at $41.8 million. An agreement was recently reached that placed an assessment on the property of $53.3 million. This approximately $6.2 million variance from the original allocation allowed nearly $87,000 to drop to the net operating income line. This serves as a good reminder that a proper evaluation during due diligence can validate or invalidate any increases.

It’s always beneficial to ensure that your tax burden accurately reflects the value of your property. This becomes particularly important if you are considering selling your property, when any reduction in taxes reflects directly on overall value.

If you think there might be an opportunity for adjustment, find a trusted partner to help with the analysis and due diligence required to prepare a property tax appeal. Doing so might make quite a difference!

Tim Simpson is a Valuation Services Director with Colliers International Valuation & Advisory Services in the Hospitality and Leisure specialty group. His real estate valuation experience includes the analysis of luxury resorts, condotels, water parks, commercial and convention hotels, airport facilities and special land use projects.

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