Are Your Hotel's Property Taxes on the Decline?
By Thomas Dolan and Christopher Elder
Thursday, 1st January 2009
An HVS property tax review has the potential to lower a hotel's tax burden and increase its profitability, especially in these troubling financial times.

From 2003 through 2007, the hotel industry experienced unprecedented growth in terms of revenue per available room (RevPAR) and net operating income (NOI).

Ultimately, hotel values recorded the highest levels in history. Normally, hotel owners would consider such increases in value a boon—except when it comes to calculating the hotel's real property taxes.

In the midst of increasing capitalization rates and decreasing NOIs, it's time to consider how a hotel's real property assessment should be adjusted. The result could mean substantial savings for hotel owners.

Valuation Methodologies and Tax Implications

Hotel valuation methodologies place the greatest emphasis on the income capitalization approach, which estimates a property's value in terms of its ability to generate financial returns as an investment. The income capitalization approach takes into consideration the cyclical nature of the hotel industry; hence, in theory, property assessment values should vary according to the cycle's ups and downs.

The problem is that many municipalities do not reassess real properties every year, and even if they do, most tax assessors are not versed in the intricacies and fluctuations of the hotel market. This can result in a property tax assessment that doesn't necessarily reflect the true market value of the tangible real estate.

The key factor is stabilization, that is, whether or not a property's revenue was stabilized when it was reassessed. The stabilized year is intended to reflect the anticipated operating results of the property over its remaining economic life, given any or all applicable stages of build-up, plateau, and decline in the life cycle of the hotel. Thus, income and expense estimates from the stabilized year forward exclude from consideration any abnormal relationship between supply and demand, as well as any nonrecurring conditions that may result in unusual revenues or expenses.

Assessors often assume that values consistently increase, but the financial meltdown that began in the summer of 2007 has in fact contributed to the downturn of the hotel industry—and hotel values—in 2008. This decline is expected to continue into 2009 due to increasing cap rates and other less forgiving investment parameters.

In the current economic environment, controlling expenses becomes an integral part of a hotel's profitability. Most often overlooked are so-called fixed expenses, which typically consist of property taxes (real and personal property), insurance, and rent/leases. The perception that these expenses are actually fixed is somewhat misleading. Real property taxes, which are calculated by multiplying the tax rate by the real property assessment, can in fact be controlled through the revaluation of a hotel's real property assessment.

The assessment is simply the real property market value multiplied by an equalization ratio, which is often 100 percent, but can also be lower or higher. Contrary to the ten-year discounted cash flow method utilized by many real estate appraisers to determine a hotel's value for financing, a hotel's value for assessment purposes is typically calculated through a direct capitalization method, whereby the appraiser capitalizes a one-year stabilized level of income and expense.

The Industry Downturn's Effect on Assessments

What hoteliers need to understand is that many hotels may be over-assessed if the municipality based its stabilized level of income and expense or cap rates on data from 2004 through mid-year 2007, when hotel values began to reach their peak in many markets. By the end of 2007, supply had outpaced demand for the first time in five years, and hotels in many cities and towns across the U.S. began to experience lower occupancy as a result.

Average rate growth helped RevPAR remain healthy in 2007; however, the downward trend has continued into 2008, which has resulted in revenue growth lower than inflation. Higher expenses have only worsened this situation.

More conservative valuation parameters have brought about increasing cap rates, which have in turn produced the greatest impact on value over the last two years. Mortgage interest rates have increased, amortizations have shortened, and loan-to-value ratios are lower. The lack of transactions in 2008 demonstrates a gap between what buyers are willing to pay and the asking price. More transactions should occur in 2009, but primarily at prices discounted from 2006 and 2007.

The Hotel Valuation Index (HVI), developed by Steve Rushmore and HVS, provides a rigorous analysis of trends in hotel value based on hotel value changes in 65 major markets and the U.S. as a whole. The HVI is developed by means of an income approach, using market area data provided by Smith Travel Research and operational and capitalization rate information from HVS, and is indexed to the 1987 U.S.A. value (1.0000).

The table at the end of this article represents the historical yearly change in the value per room from 2000 through 2008 for each of the 65 major markets and the nation as a whole.

The table shows 47 of the 65 markets losing value in 2008, a slight increase over the 43 markets that lost value in 2007.

The HVI provides further support that hotel values generally improved from 2001 through 2006, but have fallen sharply in 2007 and 2008.

Questions Hoteliers Need to Ask:

Q. How often are hotels reassessed, and when was your property's last assessment?
A. Hotels in some municipalities are reassessed every year, others not for decades. Every munici¬pality differs. However, if the hotel was reassessed in the last two to three years, then hotel ownership may have a good argument for an appeal because the assessment was likely based on data or assumptions that were not representative of a "stabilized" year, and cap rates at the time of the last assessment may have been much lower than at present.

Q. When real property taxes increase, is it as a result of an increase in the assessment, an increase in the tax rate, or both?
A. This is easily determined by examining the tax bill. Taxes will inevitably increase over time, but not necessarily every year. Real property values can vary depending on market conditions. The important point to remember is that while the tax rate is relatively uncontrollable, the tax assessment is not.

Q. How long do real estate owners have to appeal taxes?
A. Again, this varies from municipality to munici¬pality, but one thing is for sure: It is not too late to prepare an appeal for 2009 and beyond, and it may still be possible to appeal a 2007 or 2008 assessment in some municipalities.

Q. What were the effects of the credit crunch and the subprime meltdown on an individual hotel's market?
A. Some hotel markets actually improved in 2007 and 2008; however, most markets have declined. Consult the snapshot from the HVI presented earlier in this article, and contact us for help in determining the status of markets not represented in the list.

Q. Do costs associated with the appeal of an as¬sessment outweigh the potential savings?
A. In most cases, costs can be mitigated with a solid valuation estimate from the owner that shows support for the decline in value. Representation should be handled by a reputable hotel expert that can assess both the tangible and intangible value to produce a well-supported analysis and increase the potential for a warranted reduction. The backing of an HVS analysis can also help avoid a costly litigation process for the assessor and hotel owner.

Q. How much can a successful appeal return to the NOI?
A. This depends on the reduction in assessed value. Assume a hotel that was over-assessed by $10,000,000 successfully appeals its assessment. At a tax rate of 3.0 percent, this translates to a $300,000 reduction in the real property tax burden, which is then compounded yearly. Potentially, this reduction in taxes can result in $3,000,000 ($300,000 divided by a capitalization rate of roughly ten percent) of additional value to the hotel.

Net Overall Effect

The net overall effect of an appeal can result in substantial gains depending on the extent to which a hotel has been over-assessed. While a portion of these gains may be offset by the cost of the appeal, the benefit can be quantified in two ways.

First, the hotel's real property taxes will decrease proportionate to the reduced assessed value, resulting in an increase in NOI. Second, the increase in NOI may result in an increase in the overall going concern value of the hotel, thereby allowing ownership to command a higher value if it chooses to sell, or borrow more money to refinance.

Ultimately, the bene¬fit usually outweighs the risk, and there has never been a better time to file an appeal of a real property tax assessment. This argument is easily supported by nearly two years of declining values, exacerbated by a sluggish economy.

While RevPAR has continued to grow in 2008, indications are not so optimistic for next year. In the present economic climate, experts advise hotel owners to exercise discipline and to fix their sights beyond the short term.

Even a lengthy appeal process can prove well worth the time, effort, and capital invested. Let our hotel property valuation experts guide you to the light at the end of the tunnel.

For more information please contact Tom Dolan (tdolan@hvs.com) or Chris Elder (celder@hvs.com)


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