With an unstable economy, corporate downsizing, and volatile worldly affairs several hotels across the country are experiencing decreases in overall revenue.
This has led to hotel operators reevaluating their expenses and areas where they can be more efficient, while at the same time, maintaining their quality of service. Several expenses are variable including rooms and marketing, while several are fixed, such as insurance and property taxes. In many cases, property taxes can be between 5% and 10% of total revenue, and can be the difference between a positive and negative net income. This article will compare property assessments and taxes for hotels in major cities in Canada.
Property (or ad valorem) taxes are one of the primary revenue sources for municipalities. Based on the concept that the tax burden should be distributed in proportion to the value of all properties within a taxing jurisdiction, a system of assessment is established. Theoretically, the assessed value placed on each parcel bears a definite relationship to market value. So, properties of equal market values will have similar assessments and properties of higher and lower values will have proportionately larger and smaller assessments. Depending on the taxing policy of the municipality, property taxes can be based on the value of the real property and personal property. Simply stated, real property refers to land and building, while personal property refers to items that you need to do business with, but which are not permanently attached to either the land of the building, such as furniture, fixtures, and equipment, commonly referred to as FF&E. Municipalities sometimes tax business value. This value is defined as a value enhancement that results from items of intangible personal property, such as marketing and management skill, an assembled work force, working capital, trade names, franchises, patents, trademarks, contracts, leases, and operating agreements.
Each jurisdiction uses a different tax rate and a different methodology for calculating the value of each property. Because of the different methodologies used, tax rates are not directly comparable with one another. Most jurisdictions use the income generating ability of each business as a basis for assessing property values, while the province of Saskatchewan still uses the Cost Approach. Generally, the Cost Approach estimates how much it would cost to construct the building in question as new, and then making subjective adjustments to account for the age and condition of the building, as well as other factors. The Income Approach, which is deemed to be more representative of the way investors in the market make purchase and sale decisions, consists of converting the expected returns from a property (cash flows from operation and the eventual sale of the property) into a value. In some jurisdictions, when calculating values through the Income Approach, a reserve for replacement is deducted from house profit, while in others, no such reserve is allowed. It is generally considered that a reserve for replacement ranging from 3-5% of total revenue is sufficient to provide for the timely replacement of FF&E.
In the province of Ontario, the Municipal Property Assessment Corporation (MPAC) is the jurisdiction responsible for establishing the assessed value. In 1998, a new assessment system called Current Value Assessment (CVA) was introduced. Under this new system, assessments were based on current market value, as opposed to the previous system where property taxes were based on historic market values. Initially properties were to be assessed every three years, then after two years, and subsequently every year thereafter. The first reassessment for 1998/99/00 was based on the 1996 market value. The 2001/02 assessments were based on the 1999 market value, and the 2003 assessment will be based on the 2001 market value. Thereafter the properties will be reassessed annually. According to MPAC the market value is determined primarily by using the income approach. This shift to the CVA in 1998 was a significant change resulting in major increases in taxes for some properties and declines for others. To ease this transition of this assessment methodology change, a capping system was established. The cap for commercial properties, which includes hotels, was 5% per annum of the previous year taxes. This capping system may result in situations where the actual taxes payable are different from the straight function of assessment times the tax rate, as the taxes will depend on the relationship between the actual previous years' taxes paid as well as the assessment and tax rate. It is generally believed by the real estate industry that the capping system will stay in place, but this is not certain.
Real estate in the City of Montreal is assessed at 100% of market value. Values for real property are based on a blend of the three valuation approaches according to the assessor's office, with the Income Approach being the primary method.
A stabilized net income is used to determine the real value, which is capped at a market rate of between 10% and 13%. An FF&E deduction of 10-20% of the total value is taken. There is no reserve for replacement taken. Hotels are reassessed every three years, with the most recent reassessment having occurred in 1999; it is applicable for the 2001, 2002, and 2003 tax years. For the 2001, 2002, and 2003 tax period, assessment increases were phased in over three years. In addition to property taxes, commercial properties in Montreal are subject to a business tax. The business tax is based on a percentage of the assessed value, usually ranging between 12.0% and 14.0% of the assessed value.
Real estate in British Columbia is assessed at market value, utilizing a combination of the income and sales comparison approaches. A deduction for personal property (furniture, fixtures, and equipment) ranges from $15,000 to $30,000 per room. The assessor also deducts between 2-5% for management fees and there is no deduction for reserve for replacement. This income is then capped using a rate of 9-11% depending on the quality of the hotel. Properties are reassessed annually with the assessed value determined by October 31st of the previous year.
The City of Calgary estimates market value using the income approach. Individual hotels provide occupancy and average room rate information and expenses are estimated based on industry averages. After estimating net income prior to the deduction of real estate taxes, the assessor deducts 5% of total revenues for management fees and 3% for franchise fees, 1.5% of net income for intangibles, and between 10-15% of net income for FF&E. The base capitalization rate is 11.5% plus an additional 3% adjustment for taxes, for an overall capitalization rate of 14.5%. A separate business value is assessed based on $9.00 per square-foot of buildable area. In 2003, the business tax rate is 8.96%, compared to 9.04% in 2002.
The City of Edmonton assesses market value using the income approach by using three-year stabilized actual revenue and normalized expenses based on City's benchmarks using market data. From total FF&E, and 1.5% of net income for intangibles. This total net income is then capped at a base rate of 10.5% plus a 3% adjustment for taxes, for an overall capitalization rate of 13.5%. A separate business value is assessed based on 8% of the prior years realty assessment. The business tax rate for 2002 was 6.621 percent of business assessment compared to 6.466 (less received at one time levy discount of .176 bringing the levy to .629 percent) in 2001.
Saskatchewan is the only province using the cost approach to determine its assessment. Replacement value is calculated using 1998 as a base, and then adjusting for depreciation. Property is assessed every four years. Costs are based on the Marshall & Swift Commercial Cost Estimator with adjustments made based on market sales. Land value is based on market sales with some adjustments. Base land rates are adjusted for lot size and corner location influence. The province will shift to the income approach in 2009.
The City of Winnipeg's assessments for 2002-2006 with 1999 as a base year increased dramatically compared to the previous assessment with 1995 as a base year. According to the assessor, the 1999 values were based on more accurate hotel data as well as on actual sales that took place in the market. The City of Winnipeg assesses market value using the income approach based on the actual performance of the hotel, with market adjustments. From total revenues, the assessor deducts 4% for management fee expense and 3% for reserve for replacement. The net income is then divided by the cap rate and 15% is deducted for FF&E. Cap rates for Winnipeg range from 11-14.5%, with the higher rate being applied to beverage hotels. Currently, taxes are based on 65% of the 1999 value. Business value is economic rent, equal to about 10% of total value, plus cost to occupy space. This cost is $1.40 per square foot for hotels. The business tax rate is 9.75% of business value.
The City of Halifax assesses market value using the income approach based on the actual performance of the hotel. The basic cap rate is 11%. The effective tax rate is then added. A typical overall cap rate for a replacement is considered. Business value is calculated at 25% of total value. Base year for 2003 is 2001.
While the information provided in this article covers some of the most general aspects of property valuations, if you think your value assessment does not fairly reflect the value of your property, it is best to consult with a professional who can help you evaluate your situation. Assessment offices are charged with the task of valuing hundreds of properties of many different types, and they do not always have the capacity to hire industry specialists for every type of property they value. Properties such as hotels, are more complex than others and they require specialized training. If you are considering an assessment appeal, make sure you have a specialist on your side.
