Anatomy of a Hospitality Property Assessment Notice
by Ed Cheung, AACI


Benjamin Franklin once wrote, “In this world nothing can be said to be certain except death and taxes.” Most people are resigned to paying property taxes, but begrudge paying more than their fair share. So the question of the day is, “What is my fair share?”
Before we can answer this question, we need to understand how property tax is calculated. Essentially, it is a 2-step process, based on property assessment and tax rate. Assessing authorities set the assessed value (usually by estimating the market value of a property at a specified valuation date), and taxing authorities such as municipal governments set the tax rates. Hence, the property tax is the product of assessed value and tax rates. 
Most hoteliers have some sense of what their hospitality property is worth if they were to sell it. In BC, for example, BC Assessment sends out notices to property owners advising them of their property’s assessed value. When the assessment notices are sent out in early January of each year, it is basically a notification to the owners that the stated assessed value is the basis upon which their property tax will be calculated for that calendar year. There is a dispute mechanism if the owner should disagree with the information or values as stated on the notice. For most types of property, assessed value is synonymous with market value; however, it is not necessarily the same for operating hotels. 
As hoteliers are well aware, an operating hotel is a collection of assets: real estate, furniture, fixtures, equipment (FF&E), and other intangible business assets. Generally, the selling price of hotels is the going concern value, representing the sum total of all the assets. Assessment legislations typically allow for the assessment of the value of real estate only. If the market value - in this case, the going concern value - is not the yardstick that can gauge the accuracy of the assessed value, then what is?

Valuation
The initial process for the assessment of a hotel is typically an exercise in estimating the going concern value of the hotel. The going concern value is usually estimated by capitalizing an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) with an overall capitalization rate. Once the conclusion of value is arrived, adjustments need to be made or considered in order to satisfy the legislative criteria of assessing only the real estate. 
One of the considerations for adjustment is to extract the value of the FF&E from the going concern value. Over the years, articles in the appraisal community have opined various methodologies on how it should be done. The general consensus is to account for the recapture of the invested capital in FF&E (return of), and the payment for the use of capital invested in FF&E (return on). In addition to the “return of” and “return on”, the authors of some articles also advocate that annual reserve for replacements of FF&E is also part of the extraction process. More recently, in August 2003, the Property Assessment Appeal Board (PAAB) in BC considered many of the methodologies in rendering its decision on how to extract the value of FF&E in an operating hotel. The Board concluded that “the reserve for replacements has nothing to do with extracting the value of the FF&E in place - it has to do with valuing the going concern.” The “return of” and “return on” calculation is what attributes value to the FF&E in place. 
Another consideration is the extraction of contributory value for intangible business assets, or non-realty value, from the going concern value. It has been suggested that these intangible assets could include working capital, a trained workforce, name, personal or business goodwill, and pre-opening marketing expenditures and start-up losses. Similar to the FF&E issue, the appraisal community is divided on the extraction process. One school of thought suggests deducting management and franchise fees from the income stream of an operating hotel will account for all business value. Others suggest a more rigorous item-by-item investigation; however, there is no consensus in principle on how these non-realty items can be considered. One doctrine subscribes to the notion that intangible assets are personal property and can never be part of the real estate. Another takes the view that intangible assets can add value to the real estate, but the value may become inextricably intertwined with the real estate and be part of the real estate. 
The same Board was asked to adjudicate on the proper deductions in recognition of non-realty items. The Board was presented with evidence, which included expert testimonies, numerous academic articles, and text extracts relevant to the issues. In an appeal by the hotel, the Board concluded that the only deduction that would be allowed would be one for goodwill. 
I think it is fair to say that the assessment of a hotel property is a complicated undertaking, embroiled in controversial valuation issues. Because of the legislative requirements, the assessed value will almost certainly be something less than the going concern value. 
But to answer the question, “What is my fair share?” there are 2 additional considerations beyond valuation. Valuation is only 1 of the 3 parts in the assessment process; the other 2 are classification and exemption. 

Classification
In BC, properties are classified in 1 or more of the 9 prescribed classes according to the use of the property. Each property class has its own set of applicable tax rates. Depending on taxing jurisdictions, the tax rate for Class 6 - Business and Other - can be 2 to 5 times higher than that for Class 1 - Residential. Generally, hotels and motels are classified as Class 6 - Business and Other. However, under specific circumstances, the hotel property could be classified in Class 1 - Residential - either in part or in whole, thereby lightening the tax burden. It is the encumbrance of owners to ensure that their properties have been classified correctly. 

Exemption
For BC hotel properties that are assessed under $3,000,000, the assessed value can be lowered through the operations of the Tourist Accommodation (Assessment Relief) Act. Owners should examine the exemption status of their properties to determine if they qualify for relief under the Act in completing a review of their assessment notice. 
In summary, property tax is a function of assessed value and tax rates, but only the assessment side of the tax equation is challengeable. The assessment process has 3 components (valuation, classification, and exemption) that have direct impact on how property taxes are calculated. If hotel owners wish to satisfy themselves that they are paying no more than their fair share of taxes, the onus is on them to understand how their property is assessed. 

Ed Cheung is Director, Realty Tax Services, with Colliers International Realty Advisors Inc. in Vancouver. Prior to joining Colliers, Mr. Cheung had more than 30 years of service with BC Assessment. In addition to providing services and advice in property tax matters, he is also experienced in offering services in feasibility study and due diligence, market rent analysis, and market value appraisal.