Real estate is a business, but it in its simplest form, represents land and building(s). It is my opinion that certain types of real estate, particularly hotels, have value only as a going-concern.  That�s not to say that a hotel that has been developed, but is not yet operating doesn�t have value, but its real value comes from the entrepreneurial skill of its developer/owner/ operator. Real estate investors don�t invest in hotels for the bricks and mortar, but rather for the cash flow that they can produce. As such, these investors expect to receive a return of and return on capital invested and the only way that can be achieved is through creating an operating business. The real estate (land and buildings) provides a conduit for achieving these objectives.

The assessment of hotels and other income producing properties for real estate assessment purposes does not adequately address the tangible and intangible personal property including the entrepreneurial skills required to operate the business that occupies the real estate. In fact, the better a property performs, the higher it is assessed, which is in effect creating an income tax, rather than providing for a tax on the real estate.  It has been well established that the total value of a hotel property includes both real estate and business value.

Determination of Real Estate Value and Business Enterprise Value

The sale of a hotel includes the going-concern, and, as such, does not reflect the market value of the property for real estate purposes. In order to determine the value for real estate assessment purposes, both tangible and intangible personal property must be extracted.

There is no single approach to extract tangible and intangible personal property. Assessment authorities across Canada and the United States use different approaches to define and extract business value. In some jurisdictions, assessors believe that the management fee paid to a third-party management company represents business value. Consequently, assessors and in some cases Assessment Review Boards have seen fit to apply a management fee to the hotel�s income to remove business value. Clearly, management fees are an operating expense of the business. The fee represents income to the management company for its expertise and provides an asset to the management company that can be sold to recognize that value. It does not represent the business value of the hotel enterprise. This area remains highly controversial in assessment appeals.

I will briefly discuss the elements that comprise tangible and intangible personal property and that should be extracted from the going concern value to fairly establish the value of a hotel for real estate assessment purposes.

Tangible Personal Property

Tangible personal property comprises furniture, fixtures and equipment in guest rooms, restaurants, lounges, meeting rooms and public areas, hotel offices and includes computer systems, telephone systems, guest program systems, reservations terminals and other proprietary equipment. The tangible personal property is separable from the real property. These costs new are determinable for a hotel property. The tangible personal property (chattels) comprises a significant portion of the total value of the property. The owner of the property is entitled to a �return of and a return on� capital invested in personal property.  In hotels, the tangible personal property is comprised of three components: reserve for replacement; return of capital invested; and return on capital invested.

The reserve for replacement ensures that capital is available to refurnish guest rooms, public areas, hotel offices and the like and purchase new business equipment at the end of its useful life. It does not provide for a return of or a return on capital invested. It is purely for the on-going replacement of furniture, fixtures and equipment.  The return of capital refers to the recovery of invested capital.¹ The return of capital is not the reserve for replacement, but recovery of the capital that has already been invested in furniture, fixtures and equipment. A reserve for replacement is no different than spending capital on repairs and maintenance or energy. An owner of a hotel property is entitled to a return of capital invested, not only in the business enterprise, but also the real estate.

An owner is also entitled to an annual return on the capital invested in tangible personal property.  This return should be based on alternative risk related returns that could be available to the investor or at a minimum, the cost of capital required to purchase furniture, fixtures and equipment.

Intangible Personal Property � Business Enterprise Value

Business Enterprise Value includes intangible personal property which is defined as including trademarks, copyrights, permits and licenses, reservation and referral systems, proprietary distribution systems, proprietary guest programs and established marketing relationships. I have defined the intangible personal property into the following components � brand: the value of the brand itself and those services provided by the brand; working capital; assembled work force; and initial start-up costs. These elements need to be extracted from the market value of the property to arrive at the assessable real estate value.

The contribution of a brand to going concern value is embodied in brand recognition, reputation, national and international customer relationships that have been established over a long period of time, advanced bookings, ability to generate premiums in occupancy and room rates or revenue per available room (RevPAR), established standards of operation and strong supplier relationships. The costs attributed to the Brand are normal operating expenses of a hotel; however, simply deducting these expenses from income does not account for the total influence of the brand on the value of the property. The brand contribution to generating income and controlling costs must be considered.

In addition, there is also a value attributable to the services provided by the brand that includes national and international sales, marketing, reservations and proprietary guest programs. Most major brands have an international network of sales offices staffed by professionally trained sales personnel, a state-of-the-art global reservation system and a marketing focus on the brand, which ultimately drives revenue for an individual property.

Another approach to determining brand value is to determine if the hotel being assessed achieves a significant premium in RevPAR in its market.  A RevPAR premium clearly demonstrates the benefit derived from the brand and management.  Working capital is the amount of cash required to fund daily operations. Working capital is defined as regular cash balances, accounts receivable and inventories less accounts payable and accrued expenses (current assets � current liabilities). Purchasers of hotel properties typically have to fund operations for a period of time until sufficient cash flow can be generated to cover operating costs.² A purchaser would include in the purchase price an amount to cover working capital.

Prior to the opening of a hotel, management recruits, hires and trains employees. The purchase price includes a component attributable to the cost of assembling and training the required work force.

The balance of pre-opening and initial start-up costs including the costs of brand affiliation, due diligence and legal fees, property signage, pre-opening marketing and sales and initial operating losses, comprise part of the purchase price, enabling a buyer to generate immediate cash flow.  Hotel investors are prepared to pay a premium to acquire an existing asset to mitigate the risks associated with development, start-up and the market.

Assessable Real Estate Value

The assessable real estate value of an hotel should be arrived at by first determining its going concern value after providing for both a management fee and a reserve for replacement and applying market appropriate capitalization rates to the net operating income (EBITDA). Tangible and intangible personal property is then extracted to arrive at the assessable real estate value of the hotel.

1  The Appraisal of Real Estate, Second Canadian Edition, Appraisal Institute of Canada, 2002, p. 20.15 
2  Sean F. Hennessey, Myths about Hotel Business and Personalty Values, The Appraisal Journal, October 1993.

Joel Rosen is the Chairman and CEO of Horwath Horizon Consultants and Chairman of Horwath International�s global hospitality practice. Mr. Rosen has acted as an expert witness in property tax appeals for hotels and retirement homes in various jurisdictions in Canada.