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Oct
30

Dueling Valuation Methods Fuel Property Tax Disputes

As rising interest rates and other challenges worry commercial property owners with loans nearing maturity, a running theme in the real estate industry is to "survive until '25." For hotel owners, however, the year-to-year struggle to stay afloat has been ongoing.

Hoteliers that survived the industry's downturn from the COVID-19 pandemic may have thought their troubles were ending, only to be slammed with record-setting inflation and skyrocketing interest rates. During the pandemic and the uncertainty it unleashed on hospitality operations, many jurisdictions across the country provided hotel owners with some form of property tax relief. For example, one jurisdiction removed all improvement value from hotel assessments and only applied land value in determining property tax liability.

Relief measures are winding down, however. Many jurisdictions have begun to value hotel properties as they did prior to COVID, claiming that the hospitality industry has rebounded.

While in many instances, industry statistics such as occupancy and revenue per available room or RevPar show some markets recovering, it is important to know that each hotel property is unique. That's why it is critical for property owners to review individual property tax assessments annually and determine whether the asset may be a good candidate for a reduction.

Competing approaches

Many jurisdictions have recognized that hospitality properties are operating businesses, with real estate serving as only one component of the overall valuation. Property owners typically must prove the proper allocation of that real estate component when challenging their tax assessments.

Over the last two decades, appraisers, tax assessors and property owners have employed two competing methodologies to allocate value to the real estate component of hotel properties in calculating taxable value. Those are the Rushmore Method and the Business Enterprise Value Method.

Taxing jurisdictions often value hospitality properties using the Rushmore Method, which removes management and franchise fees from the income stream as part of an income-based assessment. Proponents of this method argue that removing management and franchise fees offsets the business value, and that all remaining income should be applied to the real estate value.

By contrast, the Business Enterprise Value Method applies a more in-depth analysis to identify income streams attributable to each component of a hotel's going-concern value. The appraiser or assessor can then capitalize the remaining income stream, which is attributable to the real estate alone, to determine taxable property value.

A hotel owner should be sure to differentiate and clearly communicate the business' various income streams on a profit-and-loss statement. This will ensure that their property tax counsel and appraiser adequately understand and allocate income to appropriate components of the business.

While these methodologies may seem foreign to some hotel owners or taxing jurisdictions, they are familiar to business valuation professionals. These experts apply similar methods to valuing business components during mergers or the outright acquisition of a business.

In a conventional, income-based real estate valuation, an appraiser applies a market capitalization rate to a property's income stream to determine value. In the valuation of a business, experts can develop an appropriate capitalization rate for components of the business' income by taking the weighted average cost of capital, less an appropriate long-term growth rate, such as an inflation forecast. A similar approach can derive a going-concern or valuation of non-realty components from individual income streams within a larger hotel operation.

On top of analyzing the income streams for a hospitality property, it is important for the taxpayer's appraiser to analyze property improvement plan requirements. Hotel owners report anecdotally that as the effects of COVID have waned, hotel brands have grown stricter in enforcing post-COVID property improvement plan requirements.

Taxing jurisdictions often review building permits pulled during these renovation periods to gauge improvements made to the property. This often translates into higher property tax assessments. Depending on a jurisdiction's laws, however, these improvement plans carried out for brand compliance do not necessarily increase real estate value.

Business Enterprise Value advances

Rushmore was taxing authorities' go-to method for valuing hospitality properties for a long time because of it simplistic and straightforward nature. Over the past decade, however, significant legal decisions have found the Business Enterprise Value Method preferable over the Rushmore Method.

The first major decision in this area was SHC Half Moon Bay LLC vs. County of San Mateo. In this 2014 California case, the court found that the county's real property valuation methodology failed to properly exclude business values for the hotel's workforce, the hotel's leasehold interest in the employee parking lot, and the hotel's agreement with a golf course operator.

The second major decision occurred in 2020 in Florida. In Singh vs. Walt Disney Parks and Resorts U.S. Inc., the court found that in using the Rushmore Method, the county's appraiser failed to remove all intangible business value from the real property assessment.

Although taxpayers have notched key victories in employing the Business Enterprise Value Method to allocate value to the real estate component of hotels, there are still jurisdictions that steadfastly apply the Rushmore Method to hotel property tax assessments.

Hospitality owners seeking to improve their odds of success in a property tax dispute should consider working with tax counsel that intimately knows both the case law in their jurisdiction and the differences between competing valuation methodologies. This knowledge is critical to communicating strong arguments to tax tribunals and assessors.

Phil Brusk is an attorney in the law firm Siegel Jennings Co. L.P.A., the Ohio, Illinois and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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