New Appraisal Theories Will Reduce Hotel Assessments

As published by Real Estate Forum, November 2002, by John Garippa

Hotels are unique real estate investments and differ significantly from other income-producing property types in that they are essentially business operations that use real property in order to generate income.  In establishing appropriate hotel property tax assessments, it has always been critical to value only the real property portion of the investment, as distinguished from the non-real-property component, which includes both tangible personal property and tangible business assets.

For the past 25 years, US taxing jurisdictions have utilized a formula for assessing hotels and properties with significant business components.  That formula relied on income deduction of furniture, fixtures and equipment (FF&E) and portions of the management and franchise fees.  Through the removal of these components, the formula's proponents maintained that all non-real-property elements were removed from a hotel's valuation for tax assessment purposes.

Opponents have argued that significant elements of business value remain in the income stream when this valuation formula is utilized.  The Appraisal Institute has not only recognized this problem, but has provided guidance in how to remove these non-real-property components.

In its most recent edition of its text book, "The Appraisal of Real Estate," the institute spells out its position by replacing the terminology "going concern," which means an active, operating business, with the terminology "total assets of the business."  TAB includes real property, tangible personal property and intangible personal property.  The personal property is broken down into FF&E and inventory.  The intangibles are made up of contracts, business name, patents, copyrights, work force and cash.

This change in terminology is important.  Intangible assets are recognized as contributing to value.  Preopening costs, for example, are now considered important intangible assets that need to be identified and removed from the income stream as non-real-property components.  Without the preopening expenses, the bricks and sticks of a hotel remain inert and unproductive.  Only upon the hiring of a work force and the expenditure of preopening dollars does a property evolve into a hotel, creating investment income.  Obviously, these expenditures add to the income stream's value.  Now, under the evolving theory supported by the Appraisal Institute, this additional value will also be deducted for tax assessment purposes as a non-real-property component.

Another challenge to the old valuation formula is that it fails to remove all of the FF&E in place on the assessment date.  The proponents of the new theory argue that merely setting a deduction from the income stream for a return on the investment on FF&E does not remove the FF&E from the assessment.  They argue that even after these deductions for FF&E, the total value of the personal property still remains in place on the assessment date.

A simple hypothetical situation justifies the proponents' position:  assume there's a taxing jurisdiction where a roof would not be considered real property.  A roof certainly is required at the property and is a necessary component to generate income.  However, if the roof is not considered to be real property under the law, at the conclusion of the income approach the value of the roof must be subtracted from the total value calculated.

Over the past 25 years, as significant new research has taken place in the appraisal industry, it was inevitable that new appraisal theories developed.  If this were the automobile industry, some of those locked in the past would still be using the Model T.  But time has passed.  Just as we recognize the need to drive modern cars, we must also recognize the change in the modern appraisal thinking.

The recognition of these new appraisal theories will have a significant effect on hotel assessments.  Real property will be assessed based on market value, unaffected by the value of the owner's brand name.  Also, only real property and not intangibles or intangible personal property will be assessed.  And in using these new appraisal theories, it is possible that current assessments will be reduced by at least 25% from present levels.  Also, over time these new theories will have wider recognition and acceptance, and other property types with substantial business components will be valued using the new theories.

The need to separate non-real estate components from a hotel's operating business is a critical exercise for tax assessment purposes.  Property owners will soon understand the significance of this application to the bottom line and, hopefully, begin utilizing these new theories in appealing their property taxes.

John Garippa is the senior partner of Garippa, Lotz & Giannuario, a law firm based in Montclair, NJ, and president of the Chicago based American Property Tax Counsel, an affiliation of property tax attorneys.  He may be contacted at john@taxappeal.com.