The Rushmore Approach vs. the Business Enterprise Approach The Judge Renders his Decision
Last month a property tax judge in New Jersey ruled on a precedent-setting case that supported and vindicated the "Rushmore Approach" for allocating a hotel’s total value among the real, business, and personal property components. The opposing methodology, known as the "Business Enterprise Approach" (BEA), has recently come into favor with hotel property tax reps and several appraisers because it moves a disproportional share of the hotel’s value out of the real property component and into the business and personal property components, thereby significantly reducing a hotel’s property tax assessment. A bigger concern that goes far beyond this New Jersey tax case is the potential that widespread adoption of the BEA could radically reduce the values derived for hotel mortgage loan appraisals.
The Rushmore Approach separates the business component by deducting management and franchise fees from the hotel’s stabilized net income. The BEA also makes these deductions but further subtracts business start-up costs. The Rushmore Approach handles the tangible personal property component by deducting a reserve for replacement along with the actual value of the personal property in place. The BEA follows this procedure but also deducts a return on the personal property in place, which effectively double counts the value of the existing personal property. The end result of all these erroneous BEA calculations was illustrated in a New Jersey tax case whereby the Business Enterprise Approach estimated the value of the real property component to be only 36% of the hotel’s total value while the Rushmore Approach said it was a more plausible 60% of total value. The judge in this case concurred with the testimony of Stephen Rushmore and confirmed that the Rushmore Approach produces the most credible hotel valuations.
This was the first and only trial in which Stephen Rushmore, the creator of the Rushmore Approach, and David Lennhoff, who developed the BEA, have faced each other in court. While Rushmore did not actually prepare an appraisal of the subject property (the Marriott Saddle Brook Hotel), he was called in by the court to address three issues: (1) the calculation of the flag value; (2) the necessity for a separate deduction from capitalized income of the value of FF&E in addition to the expense allowances for return of and return on FF&E ; and (3) the appropriateness of the amortization of start-up costs. By the time Rushmore testified, both sides in the case had stipulated to the hotel’s stabilized net income and capitalization rate. Therefore, the court was able to focus on the above three critical issues, which are precisely the differences between the Rushmore Approach and the BEA. Furthermore, since the judges in the New Jersey Tax Court hear only property tax cases, they have far greater expertise in this specialized area than judges in other jurisdictions who hear many different types of disputes. The Marriott Saddle Brook Hotel case therefore became the perfect showdown between these two opposing approaches.
The following are pertinent excerpts from Judge Pizzuto’s decision in this New Jersey tax case entitled Chesapeake Hotel LP vs. Saddle Brook Township.
The judge’s decision starts by pointing out that the Rushmore Approach was adopted by the New Jersey Tax Court back in 1989. Pizzuto describes,
The judge then summarizes the valuation procedures used in the Rushmore Approach and its widespread acceptance by New Jersey Tax Courts and other jurisdictions.
Judge Pizzuto then focuses in on the Marriott Saddle Brook Hotel case and compares how Lennhoff adjusts the Rushmore Approach in presenting his Business Enterprise Approach.
One of the deductions made by Lennhoff was a concept known as residual intangibles, which is the same as the competent management concept in the Rushmore Approach. Lennhoff argued that the stabilized net income for the Marriott Saddle Brook should be reduced because the subject’s RevPAR was higher than those of its competitive set. While this competent management concept is sometimes appropriate in property tax valuations, the application by Lennhoff was incorrect. He compared the RevPAR of the Marriott with those of its competitors, some of which were not comparable – i.e., a functionally obsolete Howard Johnson and Holiday Inn. When Rushmore utilized a more comparable set of hotels, including other Marriotts, Hiltons, Hyatts, Sheratons, and Westins, he found that the Marriott Saddle Brook’s RevPAR was exactly the same as the RevPAR of these comps.
Judge Pizzuto again concurred with Rushmore’s approach.
One of the key premises that forms the basis of the BEA is the concept of making a deduction for business start-up costs. While typical hotel buyers never look to recover the sunk costs incurred prior to opening by their predecessors, the BEA attempts to quantify a hotel’s pre-opening sales and marketing expense, the cost of assembling a work force, and the investment in working capital. During the trial, Rushmore argued that a hotel is in a constant state of "start-up." Because of the short-term nature of a hotel’s tenancy it must constantly expend monies for sales and marketing. In addition, a hotel is constantly assembling a work force because employee turnover in the hospitality industry often approaches 100% per year. Lastly, appraisal literature has documented that hotels typically do not have a positive working capital, so this deduction is also not appropriate.
Judge Pizzuto did not accept the concept of deducting business start-up costs. He went on to note that a business start-up cost deduction makes absolutely no sense for a hotel that has been operating for more than 30 years.
The last area where Rushmore and Lennhoff differed was the appropriate methodology for removing the value of the tangible personal property – FF&E. During court testimony, Rushmore clearly illustrated that it was permissible to deduct a reserve for replacement and either a return on FF&E or the actual value of the FF&E in place – but not both. Lennhoff’s approach effectively double counts the value of the FF&E in place, which error Judge Pizzuto wisely catches.
Judge Pizzuto’s decision on this important hotel property tax issue totally supports all aspects of the Rushmore Approach while condemning the BEA as not being "persuasive either for theoretical or empirical reasons." Hopefully, the various appraisal organizations that in recent years have suppressed the Rushmore Approach from their seminars and literature will now allow this time-tested methodology to again be part of every appraiser’s educational curriculum.
Lastly, and most importantly, hotel owners and lenders can breathe a little easier because it is now unlikely that the Appraisal Standards Board, which mandates proper appraisal methodology and standards, will impose the Business Enterprise Approach for all hotel appraisals, including mortgage loan appraisals. Just imagine what would happen to hotel economics if lenders could only lend on a hotel’s real property component representing just 36% of a hotel’s total value?
Click here to download a complete copy of Judge Pizzuto’s Marriott Saddle Brook decision. Click here for a copy of Rushmore’s article detailing the differences between the Rushmore Approach and the Business Enterprise Approach using actual data from the Marriott Saddle Brook trial (written prior to Judge Pizzuto rendering his decision).
Leora Lanz
HVS Sales & Marketing Services
516-248-8828 Ext 278
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