Due diligence key in tax consultant evaluation
Due diligence key in tax consultant evaluation
18 MAY 2012 6:32 AM

When considering consultants to handle your hotel's property tax matters, make sure they know what makes the hotel asset different from all the other commercial properties they represent.

Local taxes and specialty assets: two things that do not necessarily go together very well in the property tax world. Managing property taxes is perceived by most institutional owners as something that is best left to the experts. But who are the experts? How should they be compensated? And should they be evaluated?

In a series of quarterly articles, we will examine some of the pros and cons of outsourcing the management of property taxes. Specifically, we will address issues with 1) consultants, 2) assets and 3) the process for choosing, compensating and evaluating third-party consultants. The fourth and final article will be a synopsis of the prior articles that will provide owners with ideas and information to re-think how they manage property taxes and improve results. Read the first part here.

Hotel assets are more than just real estate
Hotels are unlike the usual institutional grade real-estate investments, namely Class A office, high-end multifamily or even regional retail with Class A anchors—especially when it comes to valuing the real estate for taxation purposes.

Hotels are the only class of real-estate investments that are typically valued by assessors with the income of the business. No one values an office building by asking for the business income of all the tenants that occupy the space. No one values a regional mall by asking for the income of all the businesses that occupy the real estate. However, hotels are valued that way.

As a result, what happens (to the unknowing evaluator) is the going concern is the end result of the analysis, which includes the value of the significant tangible personal property needed to generate income and the significant intangible personal property needed to generate income.

Only in the taxation of real estate is it necessary to separate the value of the real estate from the going concern. Hotels are traded on going concern value; lenders lend against the going concern value; all appraisals for any other situation are of the going concern value. But for the ad valorem taxation of real estate, the appraisal must be inclusive of the real estate, which only requires the appraiser to separate the value of the tangible personal property and intangible personal property. Therefore, understand if you have financing appraisals in your possession they can be shielded from discovery in the property tax process because they are not of the real estate—they are of the going concern.

If assessors ask if there are any appraisals of the real estate, the answer is “no.” For assessment purposes, all but 10 states have a business personal property tax, so it’s commonplace for the assessor to recognize the reported value of the business personal property and deduct that from the value determined by capitalizing net income. While there are good arguments to be made that could dispute that methodology for the sake of time and money (in most cases), it is just accepted that, that is how the tangible personal property component will be handled.

The Rushmore approach
The more difficult part of this situation is how to remove the “business” value or contributory value of the intangible assets (trade name, trained workforce, franchise agreement, management agreement, etc.). This has been the subject of much controversy for more than 20 years. Most assessors ascribe to what has become known in the industry as the Rushmore approach. Simply stated, Rushmore says by deducting a management fee and franchise fee, the business value has been removed from the equation. This method is easy for assessors to quantify and use. If your consultant is not monitoring to check that the assessor is, at a minimum, deducting a market level management fee and franchise fee, your property is probably over-assessed.

Arguably, by deducting a management fee and franchise fee, the appraiser has simply recognized the expense to ownership of management and franchise. The effect being to basically say there is no business value. Owners (and lenders) certainly hope they are paying those fees for a bottom-line benefit. That’s the piece that needs to be quantified and removed so as not to pay real-estate taxes on the intangibles.

Other issues to be aware of include expenses that should be considered that do not necessarily show up on an income statement. Many companies do not book the reserve for replacement; however, it is an industry standard and lender requirement to consider a 4% reserve for replacement. Consultants also should fully understand the relationship between the manager and the owner and understand that he or she, as the consultant, is representing ownership. There may be other legitimate expenses of ownership that do not show up on the income statement, such as funding for shortfalls of capital replacements.

When considering consultants to handle your hotels property tax matters make sure they know what makes the hotel assets different from all the other commercial property they represent. Ask them how they handle removing the tangible and intangible personal property. Make sure they’ve included an appropriate reserve for replacement in their analysis. Ask them if they know what a STR report is (STR is the parent company of HotelNewsNow.com). If they have the right answers, you may have the right consultant.

Bernice T. Dowell is a Senior Managing Consultant for Paradigm Tax Group in Washington, D.C. A former Senior Manager of KPMG and President of Cynsur, LLC, she has focused her career in real estate transfer and property taxes on hospitality assets and the concept of removing the value of intangibles from a going concern. She began this endeavor as an employee in Marriott’s Tax Department in 1991. While at Marriott she was a member of the inaugural class at George Washington University for the Master’s of Science in Finance program and focused her senior thesis on the topic of hotel investment analysis and the contributory value of a trade-name to a going concern. Please visit our website for additional information on Paradigm Tax Group: www.paradigmtax.com or contact Lisa Story at (617) 517-3100 X 101 or lstory@paradigmtax.com.

The opinions expressed in this column do not necessarily reflect the opinions of HotelNewsNow.com or its parent company, Smith Travel Research and its affiliated companies. Columnists published on this site are given the freedom to express views that may be controversial, but our goal is to provoke thought and constructive discussion within our reader community. Please feel free to comment or contact an editor with any questions or concerns.

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