Profitable Hotel Companies Absorbing Steep Property Tax Increases

Hotel property taxes grew 6.2 percent in 2005, the highest single-year increase since 1987, according to a new PKF Hospitality study, which sampled year-end 2005 financial statements of more than 5,000 hotels nationwide. Yet, while property taxes are moving up—PKF predicted them to rise another 5.1 percent in 2006—the amount is being masked and absorbed by the robust profits that the hotel industry currently enjoys.

Analysts do not believe, however, that higher property taxes by themselves will fuel further room rate hikes.

Upward property tax movement directly correlates to the increasing value of hotels. Cities now understand that the hotel industry is enjoying good times—Smith Travel Research estimated that the industry amassed profits of $22.6 billion in 2005. "Municipalities will go to hotels and say, 'We know you are dropping more money to the bottom line,' and one way to measure the value of a hotel is by the relative nature of its profits," said Robert Mandelbaum, director of research information services for PKF Hospitality. "With profits up, one assumes that value is up, and therefore municipalities will reassess the value of the hotel and then apply the existing tax rate. They don't necessarily raise the tax rate, they raise the assessed value."

The difficulty with property taxes, like most other taxes, is that they are out of the control of hoteliers. While hoteliers can fix rates to their liking, they don't have the ability to dictate taxes. "Property taxes are a cost that hotel managers have limited control over, and when fixed expenses start to escalate, operators get concerned," said Mark Woodworth, president of PKF Hospitality. As profits have risen, so to have energy and labor costs. "Municipal tax assessors know that property values have been escalating and that profits have been increasing in the lodging industry. The cities and counties want their piece of the pie," PKF's Woodworth said.

Steve Rushmore, president and founder of HVS International, a global hospitality consulting organization, said that the current success of the hotel industry is spurring higher property taxes.

"As hotel values go up, and they've gone up significantly recently, property taxes will follow, but the assessed value will go up. If the tax rate stays the same, then the owner is going to pay more property tax," he said. Yet the ascendancy of property tax rates, although a dent to the bottom line to some extent, still are rather innocuous to hoteliers. According to Rushmore, "A hotel won't sell its property because of high property taxes."

While property taxes are increasing, PKF concurred that the effect on the hotel industry as a whole is minimal. "If you look at revenue and expense growth of the hotel industry compared to other industries, expense growth has always been above inflation," said PKF's Mandelbaum. "Fortunately, the industry has enjoyed revenue growth also greater than inflation, attributable to the fact that hotels can raise and lower prices at the drop of a hat. Frequently, we cite the fact that expenses go up, but they tend to be masked by the enlarged increases in revenue. Property taxes this year were up significantly, but still at a pace less than revenue growth, so the effect on the margin wasn't all that great."

Mandelbaum said increased taxes were not necessarily the catalyst for increased rates, but rather that room rate growth was still influenced by market conditions.

Another finding by PKF favoring the hotel industry was that there was a higher lag on property tax increases than on rises in property value. PKF estimated that hotel values increased at a compound rate of 6.9 percent from 1992 to 2005, compared with a 2.9 percent rise in the actual property tax during that same period. There is one exception: Many property tax reassessments are elicited when there is sale activity, which has characterized the hotel industry over the past year. Many companies actively sought to buy property in 2005, which spilled over into 2006, because of the financial strength of the industry. A case in point was Starwood's disposal of 33 properties to Host Hotels this year.

"Hotel transaction activity has been at an all-time high the past three years, with eager buyers chasing discriminating sellers," said PKF's Woodworth. "Given the increase in transaction activity, there has been more opportunity for city and county appraisers to reevaluate their assessments."

Along the same lines, new renovations attract property reassessments. During the hotel industry downturn, many hotel companies were forced to shelve planned renovations. However, the industry upturn allowed companies to resume their previously planned renovations. PKF said that from 2004 through 2005 there was a distinct uptick in property tax reassessments.