It is property tax appeal time in the great state of Georgia and Atlanta hotels have been through an awful time during the Great Recession. Although much of the commercial real estate sector is now on the upswing and cap rates have been falling, hotels still have some of the highest cap rates of any commercial property class. I know many hotel owners who continue to tell me that the hotel market is still bad. If your gross revenue is down and your operating expense ratio has shrunk, and there appears to be no end to your nonexistent net operating income, then the Great Recession is not over.

Real Estate Research Corporation (RERC) stated in their most recent report that demand for hotels and a lack of new supply makes the hotel sector a good investment opportunity. But they also went on to say that replacement cost is higher than value. As a result, development capital is not readily available. RERC's required pre-tax yield rate for the hotel sector decreased in the fourth quarter, although it retained the highest yield rate among the property sectors. According to Smith Travel Research fourth quarter hotel occupancy declined to 45.4%, a 7.2% year-over-year decrease, the average daily rate fell 1.6%, and revenue per available room declined 8.7% to $68.43. Apparently lack of new supply is not helping out the existing hotels.

In the Income Approach, the deductions from gross income are typical and reasonable operating expenses, and taxes are considered typical and reasonable expense items. However, for tax assessment purposes, the taxes are not known. The values are being established so that the tax rate can be calculated for the current year. If the assessor is establishing a value for 2013 and is doing it at the beginning of the year, the tax rate is typically not known yet. If they are to include a tax component in the Income Approach as an operating expense, then they would have to use the prior year’s tax amount. Because the Income Approach and resulting value is going to have an impact on the current year’s tax rate, last year’s tax would affect the new tax rate. As a result there is a circular argument against using last year’s tax in the Income Approach.

Instead of including property tax as an expense item, the tax assessors add their effective tax rate to the appropriate capitalization rate for a particular property type in a particular market area. This gives a property tax component influence on the final value, but it’s not used as an operating expense and it’s not used as an actual number, such as the prior year’s tax amount. The loaded capitalization rate is then applied to all net income produced by the property, which, in turn, produces a value estimate.

Direct capitalization is used to convert a single year's income into a value estimate. The income is converted by a capitalization rate. Capitalization rates can be determined in a variety of ways, but the best way is to derive them from market transactions of similar properties. The overall capitalization rate is determined by dividing a single year's net operating income (NOI) by the sale price of the comparable property. From an adequate sample of market transactions an appropriate capitalization rate can be reconciled and used to estimate the value of similar properties. 

If you have a 10 year old community retail center in "Eastside Neighorhood" then ideally you will use sales of retail centers in this neighborhood, that are similar in age, quality, size, etc. You must be certain that the sale comparables used have net operating income calculated in the same way as the subject NOI. Any financing that affected the sale prices of the comparables requires adjustment, as do nonmarket rents. The objective is to compare apples to apples, because a small change in capitalization rate can result in a big difference in the value estimate.

Net operating income (NOI) is defined by the Appraisal Institute as "the actual or anticipated net income remaining after all operating expenses are deducted from from effective gross income, but before mortgage debt service and book depreciation are deducted."

Effective gross income (EGI) is "the anticipated income from all operations of the real property adjusted for vacancy and collection losses. This adjustment covers losses incurred due to unoccupied space, turnover, and nonpayment of rent by tenants." This definition refers to market estimates of gross income adjusted for market vacancy and market collection losses. Your actual income may be very different from the "market."