Pump the brakes on property tax hikes

Editor’s note: This roundtable on tax reduction strategies was sponsored by O’Connor & Associates. O’Connor & Associates participated in the curation of participants but had no influence on the final editorial content.

Not so long ago, property taxes were just another line item buried in the P&L. But in recent years, as communities have seen post-Covid revenues from office buildings and retailers shrink and residents have made it clear at the ballot box that they’re not going to take the brunt of spiraling rate hikes, hotels have been spotlighted to pick up the slack.

Hotel valuations have risen sharply since Covid shut down the travel industry in 2020. With the current supply/demand imbalance likely to continue at a time when development financing remains tight, the best hope may be for a slowdown in value increases rather than any near-term stability or retrenchment.

The result is that, for many hotel owners, taxes now rank among the top three operating costs, just after labor and utilities. And, that level of expense has investors focused on finding relief.

In an exclusive virtual roundtable discussion, Hotel Investment Today asked five experts to share their insights and solutions to manage surging property taxes. Participating in the discussion were Dustin Kline, senior vice president, The Chartres Lodging Group; Ahmer Naushad, vice president of analytics/franchise administration, Sonesta International Hotels Corp.; Vinay Patel, president, Fairbrook Hotels and past chairman of AAHOA; Abraham Tieh, director of national property tax operations, O’Connor & Associates and Mark VanStekelenburg, executive vice president, CHMWarnick.

The group looked at trends in commercial property tax, how increases are affecting portfolios and asset values and strategies for successfully challenging incorrect assessments.

Brace for more tax hikes

Over the last several years, depending on the region, “We are looking at 6% to 8% increases in property taxes,” said Naushad. He added that major metros like Chicago and New York have experienced the biggest jumps.

“What’s happening is that [tax authorities] are exceeding the assessed values you had pre-Covid,” he added, “even though the income has been lagging.”

U.S. hotels’ strong performance in 2023 was welcome news for owners, but that prosperity has a downside. Tieh expects 2024 property tax bills to soar by an average of 20% across the country, with rates in some states to rising even further as they catch up on property valuations.

Patel pointed out he started seeing that the acceleration in assessments on hotels five to seven years ago, depending on the asset and the tax district. Covid provided a bit of a respite from that climb, but that tragedy-driven moment is over.

“I think the local jurisdictions have realized that here’s a pot of gold, so they’ve really expanded the focus on hotels,” he said. “So now we’re looking at it a lot more closely.”

Patel acknowledged the bump in ADRs, but noted that the cost of doing business has also increased. “I think the costs are surpassing some of the ADR gains, so as owners, we’ve got to be cognizant about some of these costs. I think property taxes are at least something we can kind of manage and try to mitigate,” he added.

VanStekelenburg observed that when hotel revenues dropped off precipitously in 2020, property taxes did not decline proportionally. In fact, while revenue was declining, he added, the property tax hit actually grew by 2% across CHMWarnick’s portfolio.

“We’ve been recommending to our clients that they spend time working with tax consultants,” he said. “We’ve had some significant success in some of these markets where [taxes] have been going up 10% to 15% per year, in terms of clawing that back and being able to figure out what methodology the assessor is using,” he said.

“We’re seeing in some hotels it’s in the double digits, more than 10% of total revenue. Even when you’re underwriting something, you would never imagine that,” Nashaud added.
“It [property tax] has to be looked at and dealt with proactively, just like payroll, utilities or any other large expense.”

With the crazy quilt of assessment methods and rules, Naushad stressed the importance of either hiring a property tax specialist who is familiar with the local taxing authority rules. With so many variations in each jurisdiction, not even giant hotel corporations can maintain large enough teams to be expert in each market with the company’s flags.

Kline agreed. “At least on the ownership and management side, he said, firms that “have boots on the ground, that are living the real estate tax day not just once a year but day in, day out” are essential.

The key to successful tax reduction

Tieh noted that many taxing bodies, faced with declining revenue from office and retail properties as well as inflationary pressures, are looking to fund the budget from other commercial properties. “As their budgets go up, the taxes will go up,” he observed. “If assessments are low, they bump the tax rate. Then they send you a bill to meet that budget.”

Tieh stressed that hotel owners should take a close look not only at the tax bill but at how it was calculated. He pointed out that the property tax should reflect the value of the real estate, but the problem is that valuation can be skewed. “You have to look at how your hotel compares [with the competition] in valuation per room,” he added.

Patel has seen a trend for some localities to assess based on overall revenue, not real estate, which has resulted in escalating bills. But those assessments often fail to factor in the expenses of running a hotel or items like PIP reserves.

“Typically, assessors will give you some kind of reserve, but it’s very low—1% or 2%,” Tieh noted. “We typically go for 5%, 6% or more, depending on whether it’s a luxury or full-service hotel.”

How tax trends impact portfolio decisions

When evaluating a portfolio addition or potential brand conversion, property taxes have reached a point where they could be a deal breaker, Patel said. “The key thing is due diligence,” he noted. “The numbers today are significant enough in terms of does it make sense or does it not make sense.”

“We just assume that the city will take the CapEx that you spend to renovate the hotel and apply that discount to the valuation of the property,” Kline observed. “But how do you argue that when you go to the appraisal district?”

Adaptive reuse of former office towers into hotels presents a special challenge when it comes to projecting the property tax burden. “It all comes down to the underwriting and the deal economics,” VanStekelenburg said. “You’ve got to find that balance of it being an appropriate tax amount for the operation that you’re creating there.”

Often renovations take rooms out of inventory, which inevitably affects revenues—another argument for a lower tax assessment, Tieh noted.

Counter arguments and strategies

“When you hire an expert to do the work for you, they must know how to challenge the assessors from all angles to do a good job for you,” Tieh noted. That includes having the in-house expertise to analyze the market or appraise a property.

Intangibles represent a case in point.

In all 50 U.S. states, tax codes specify that intangibles ―items such as franchise agreements, training, quality control, that can’t be touched or felt, but bring additional benefit to an operation ―should not be taxed, Tieh observed. Determining the value of those intangibles is typically difficult, but in the last six years, his firm has developed its proprietary O’Connor Approach, a method of calculating that number.

That formula worked to the hotel owner’s benefit in a Utah trial, Tieh said, reducing the tax bill by 34%. O’Connor & Associates has successfully made use of the formula in similar cases in other states.

Renovations and new construction pose additional challenges. “When you do renovations or switch brands, or if you’re building a new hotel, you have a partial shutdown or partial year revenue, the assessor typically uses the cost approach to assess your hotel — the cost to build or the cost to convert. And typically it’s two to three times higher than the value with the income approach,” Tieh observed.

O’Connor’s approach is to argue for an assessment based on equity rather than cost, which is strictly based on valuation and requires significant market data to support it.

While many law firms’ initial salvo is filing a lawsuit, Tieh said a city or county tax board appeal hearing is the best place to start disputing a tax bill.

“We go to the county-level hearing, because that can be a 50% savings if you develop a good argument and prepare the right case,” Tieh said. “You will get something. If that’s not sufficient, a lawsuit would be the second step.”

Five tips every hotel owner should know

Although the issue of tangible vs. intangible assets lies at the heart of many successful tax reduction efforts, there is more owners can do to prevent or address overpayment.

The panelists shared their drill-down:

Kline: We don't typically maintain a staff person for real estate tax appeals, just because every county in every district is different. It's significantly more effective to have somebody who's impactful across the city rather than sharp shooting across your portfolio.

Naushad: Look for where there could be—and your consultant can help you with that—concessions and credits.

Patel: Hire a smart consultant, because at the end of the day, I'm a hotel owner. You tell me to run a hotel, I can run a hotel. If you're an asset manager, you can manage the asset, or if you’re a brand, you can provide the services of a brand—that's your specialty. So, in the same way, you’d outsource tax issues to an expert because that’s what they do every day.

Tieh: Does your consultant know how to carve out the intangibles? That's a such an important, crucial component in assessment, and very few people know how to do that.

VanStekelenburg: Within our industry, people are scratching their heads over how to figure out capitalization valuations…the assessors out there are dealing with all the asset classes and not focused on this. So I think the point is just stay vigilant. We’ve got to keep educating the assessors in the broader market. Consider if there’s a going concern [nearby]. That can be as simple as an F&B outlet that’s above market and driving demand to the greater area, which can impact your P&L but not your real estate value.

Megan Rowe is a content strategist specializing in hospitality and travel based North Royalton, Ohio.