Declining Values Could Lower Your Taxes

Daniel J. Pollak Perhaps no segment of the economy has been more affected by the financial downturn than the real estate market. While much of the recent discussion has been focused on the perceived drop in residential property values, the current economic crisis has also had a profound effect on owners and operators of lodging properties. Lodging owners have grown all too familiar with the poor economic forecast, but they may be unaware there may be a silver lining to the weak market conditions—in the form of real property tax appeals.

The fact is the assessed value of lodging properties most likely was set before the economic downturn. If so, they probably don’t reflect current market values. Since taxes are based on a property's market value, as valuations decline owners have the opportunity to challenge the assessment of their properties in order to reduce their real estate tax burdens.

The Current State
Although there has been discussion recently, no doubt prompted by the tepid stock market recovery, that we may be at the start of a potential recovery, the prospects for the lodging industry in 2010 are not strong. In a recent survey by Standard & Poor's Equity Research, the outlook for lodging and gaming in 2010 is for "a long period of continued tough operating conditions, with oversupply becoming more the story as demand somewhat recovers. We think this will likely lead to only a small uptick in industry occupancy rates from severely depressed levels. The continued growth in supply, coupled with a continuing shift in hotel guests' preference for less-expensive rooms, will likely lead hotel operators to lower rates, pressuring revenue per available room."

Since commercial real estate is typically valued by the income approach (which capitalizes net income to arrive at a value for the property), as a property’s income declines so too will the value of the real estate. Fewer sales of hotel properties and the decline in the median sale price per room in 2009 continue to reflect the depressed hotel real estate market. Moreover, as investments in income-producing properties become riskier due to market conditions, capitalization rates may increase, which, in turn, can also put downward pressure on real estate values.

Hope in the Form of Tax Relief
Since real estate taxes are generally computed based on the market value of a property, the silver lining to the continued economic crisis is that owners have the opportunity to examine the existing assessment for their properties and potentially reduce real estate taxes.

Real estate taxes are typically calculated by first determining the market value of real estate as of the relevant assessment date and then applying the tax rate, which in some jurisdictions may be comprised of a municipal, county and a school component. A key factor to any valuation analysis of commercial properties (and therefore property taxes) is the income a property can generate. As income and valuations decline, so too should the property assessment and real estate taxes. But, in order to preserve the ability to appeal the valuation of a property, a complaint or petition for reduction must be timely filed.

The following example illustrates the magnitude of potential tax savings that can be achieved through a successful appeal. A hotel and banquet facility is assessed in 2009 for a market value of $11 million, and the owner pays $180,000 in real estate taxes. The property is appraised by the owner/operator as of the 2009 valuation date at $9.785 million (which indicates a tax of $160,000, or an annual tax reduction of $20,000).

However, in 2009 in addition to decreased banquet bookings, the average daily room rate drops seven percent and occupancy falls nine percent All other factors being equal, the appraised value through the income approach would decline to a value of approximately $7 million, resulting in a further 25-percent reduction of the annual tax to $117,500.

While it’s unknown how long the economic crisis will continue, as the above example illustrates the current state of the real estate market may offer an opportunity for lodging owners, arguably the hardest hit industry in the recession, to successfully challenge their property tax assessments and in turn, reduce the taxes assessed against their properties. Additionally, it gives property owners the opportunity to review tax assessor records to ascertain the basis for, and accuracy of, assessments. Since reassessments are not typically done on an annual basis, the tax savings achieved by an appeal can extend into the future until the jurisdiction completes its next reassessment. In some instances, the savings may continue for many years.

Planning a Tax Appeal
As owners of commercial property experience reductions in income and the accompanying decline in the value of their real estate, often the only available remedy is to pursue a real estate tax appeal.

As with most legal proceedings, there are pitfalls; before filing an appeal an owner should consult with a qualified tax specialist. For example, there are strict filing deadlines, filing requirements for owners of income-producing properties and tax payment provisions that vary by jurisdiction. In fact, some jurisdictions require property owners be represented by an attorney. While owners may prefer to work with attorneys on an hourly fee arrangement, attorneys frequently handle tax assessment appeals on a contingency basis, which is calculated as a percentage of tax savings. If an appeal is successful, the tax savings may be retroactive to the first year for which an appeal is filed, and interest may be payable on the tax overpayment.

In any case, it’s important to carefully review and analyze an assessment to avoid needless and potentially frivolous litigation. If an appeal is filed without cause, it can in some instances result in a tax increase.

The appeal process generally commences with the review of the case and then filing of a complaint or petition of appeal. Appeal deadlines vary by jurisdiction and may be set by the state, county or local municipality. In order to begin the process, hotel owners (1) should familiarize themselves with the real estate tax appeal rules and procedures for their relevant jurisdiction, or contact an expert; and (2) analyze tax records and market data to determine whether a property tax assessment should be appealed. If an appeal is warranted, it’s incumbent upon shrewd owners to become familiar with the appropriate steps to potentially lower one of their largest annual operating expenses for the current and future tax years.