Are you asking the right questions on your taxes?

Hotel owners and operators annually review each line of an asset’s profit and loss statement but are you asking the right questions? From 2012 to 2014 there was an estimated 20-percent increase in property taxes per room for U.S. hotels. One question that is often missed is: “What factors comprise the taxable value of my hotel?”

But this question poses difficulty for owners as they try to determine the latest procedure and complexities involved in assessing more than just the physical asset. A hotel is a business operation and the value is not commensurate with the real property solely. Its role as a service provider is an integral component of the income stream and therefore the property’s market value. Management must hire and train the staff, establish contracts, provide for marketing and sales and much more. These services are intangibles that contain substantial value and are essential to the heart of a business’ operation. The key question is, are they taxable for ad valorem purposes? Most property tax assessments only include the sticks and bricks or pure real estate value. So how do you arrive at an income representing solely the real estate? 

Estimating a property’s value by utilizing the income capitalization approach is the preferred methodology for income-producing properties. This method, however, takes into account much more than just income deemed attributable to the real estate. It also includes income from both the business enterprise and personal property. Removing that and capitalizing the residual net operating income derives a true taxable opinion of value to the real estate only. 

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Here are three more factors to consider when reviewing hotel property taxes:

  • Evolving market dynamics: While deteriorating economic conditions offer the most obvious grounds for hotel property-tax appeals, other evolving market dynamics can also provide ample justification for a property-tax reduction, even in an environment of healthy economic growth. For instance, new supply, whether recent or looming, may have a material impact on a property’s future cash-flow potential and, therefore, its fair market value. The entry, exit or relocation of a principal demand generator within a particular market may also impact a property’s positioning with respect to its competitors, thus altering its fair-market value.
  • Brand suitability and sustainability: The franchise and/or management agreement by which a hotel property is encumbered may have a material impact on its marketability. If a hotel’s brand is not well suited to the demographics of its market or if that brand is less desirable in the investment market, as demonstrated by prevailing capitalization rates for similarly branded hotels, then a case may be made for a reduction in the hotel’s fair-market value. Alternatively, the expiration of a value-enhancing franchise and/or management agreement may be on the horizon for a hotel, in which case its fair-market value is likely to be negatively affected as well.
  • Capital requirements: Hotel operations can be highly capital intensive, and at times, hotels may face capital requirements that far exceed typical deductions for replacement reserves. Hotels with franchise agreements that are subject to renewal frequently require multimillion-dollar property improvement plans, and hotels in markets where new supply is prevalent may also be required to make substantial capital expenditures simply to defend existing cash flow from new market competition. The fair market value of a hotel should appropriately reflect such capital deductions.

Upon receipt of the property’s annual assessment notice, the owner or the appointed representative should also:

  • Request a copy of the property record card and worksheet to determine what is being assessed.
  • Request a meeting with the assessor and discuss how removal of the subject property’s intangible asset value, or business enterprise value, was addressed.

Property taxes represent only one of myriad line items on the hotel’s profit and loss statement. Reviewed improperly, and the hotel could be at a competitive disadvantage with similar property types.