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Hoteliers lose court appeal on property cap rates and valuations

MJ Independent reporter Robert Thomas reviews a recent court decision that affects the property assessment of local hoteliers.
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It’s a Saskatchewan Court of Appeals decision that goes back to June of this year, but when it comes to assessing commercial property valuations and determining what Cap Rate should apply for each class of property, it appears the legislation and the interpretation of it sits clearly on the assessment agency’s side of the equation.

It is also a decision that ties into the recent presentation to Council where local small business owner Bernie Dombowsky pointed out the seemingly lack of equitable treatment of commercial properties when it came to establishing Cap Rates and the final property valuation for property tax purposes.

The Court Of Appeals decision directly ties into Moose Jaw.

EXPLAINER - How Do Cap Rates Tie Into Assessments?

Cap Rates for commercial properties is used in the equation to determine final assessed valued. The Cap Rate is derived by dividing the property classes Net Operating Income (NOI) by Sale Price.

Cap Rate = NOI ÷ sale price. 

Assuming NOI is a constant, this means a lower Cap Rate will produce a higher estimate of market value.

Assessed Market Value = NOI ÷ Cap Rate

In a unanimous 3 - 0 decision (authored by Justice J Caldwell) handed down on June 22nd, 2022 the Court of Appeals upheld the decision of the Saskatchewan Municipal Board to override the decision of the City of Moose Jaw’s Board Of Revision when it comes to setting assessment values on the City’s hotels.

In a case involving Prospect Properties Inc - located at 1720 Main Street North (the same location as the Day’s Inn) - versus the City of Moose Jaw and the Saskatchewan Assessment Management Agency (SAMA), the Court of Appeals ruled in the City’s and SAMA’s favour regarding a property tax appeal dating back to an October 15, 2019 appeal before the local Moose Jaw Board of Revision.

Prospect Properties Inc was the main appellant of a group of 13 hotels in Moose Jaw.

The appeal of their 2019 property assessment by Prospect before the Board of Revision was originally granted but the City and SAMA had appealed the decision and won an appeal setting up the matter to be appealed by the Moose Jaw hoteliers to the Saskatchewan Court of Appeals.

Local Board Decision

According to the Court of Appeal decision, the initial appeal at the Moose Jaw Board Of Revision was not only allowed but the local Board had interpreted and ruled on the legitimacy of how SAMA’s assessor came up with the assessments for 13 Moose Jaw hotels involved in the appeal.

The Board had initially set aside the means by which SAMA had decided upon a value of the hotels. 

SAMA had used commercial properties, and not hotels, in determining the Cap Rate for the hotels and thus the Board decided the properties used were “not compatible” with the class of properties hotels fall under.

Under the Market Value Assessment in Saskatchewan Handbook, hotels assessments (or values for property tax purposes) are to be determined under the Income Approach. 

“The theory behind the income approach to value is that a property’s value reflects the present worth of anticipated or forecasted future benefits from the real estate. As such, the income approach analyses the income and expenses from a hotel attributable to the real estate and converts it into an estimate of current value.”  — MARKET VALUE ASSESSMENT IN SASKATCHEWAN HANDBOOK

Under the Income Approach, assessors estimate market value based on a property’s net operating income [NOI] and a Cap Rate derived from sales of similar properties (i.e., market value = NOI ÷ Cap Rate).

In the case of Moose Jaw, there were no hotel sales within the community to use in the formula so SAMA used “ratio comparison method” [RCM] under the “comparable neighbourhood method” [CNM] meaning the hotels’ assessments were based upon a general commercial Cap Rate for commercial properties in the City.

The Board however felt differently and agreed with Prospect Properties Inc. that there was in fact sufficient data because SAMA should have, in the Board’s opinion, used the province-wide hotel sales in determining a Cap Rate. Prospect Properties Inc. felt that two hotel sales - one in Estevan and one in Weyburn - should be used.

“It (local Board Of Revision) found that SAMA’s use of the general commercial property Cap Rate [GCCR] in Moose Jaw, which had been calculated from sales that did not include hotel properties, meant the assessments had failed to meet the market valuation standard and that equity had not been achieved,” the decision read.

“The (local) Board (of Revision) finds the assessor had sufficient sales of hotel properties available to determine a cap rate. It was therefore not necessary to use non-comparable properties in the calculation of the cap rate for hotels,” the decision further read in its background discussion.

SAMA had extrapolated a value from non-similar class property sales and the local Board saw sufficient enough actual hotel sales province-wide that should have been used by the assessor.

The local Board then “ordered SAMA to revise its 2019 assessments of hotels in Moose Jaw by using a Cap Rate of 10.63%, which is the median of the five hotel Cap Rates. The City appealed from this result.”

Saskatchewan Municipal Board Rules In Favour Of The City

In the appeal of the local Board of Revision’s decision, the Committee felt the initial appeal decision favouring Prospect Properties Inc. and 12 other hotels was wrong because there had been no hotel sales in Moose Jaw. The markets were too much different in those other communities to fit into the Moose Jaw marketplace.

A general approach using local commercial properties values should be used, and not the values of five hotels sold in other communities.

“The Board’s reasons and rationale, although brief, were sufficient to allow us to understand how it made the decision it did. However, the decision itself is not reasonable, as the Board believed there were sufficient sales of Hotels, when in fact the evidence was there were no sales of Hotels in Moose Jaw,” the court documents read.

The local Board had erred in using the five hotels sold provincially as they were not in Moose Jaw and the Cap Rate they derived was incorrect.

The Saskatchewan Municipal Board’s (SMB) decision led to the appeal to the Saskatchewan Court of Appeals.

Court Of Appeal Ruling

The Saskatchewan Court of Appeal ruling carefully analyzed the local Board of Revision’s ruling and in the end found they were no point of law errors in the SMB’s ruling.

Key elements in that finding were that the SMB found the local Board of Revision misapplied the reasonableness standard of review when looking at the using the five hotels sold provincially as sufficient enough and related enough sales to establish a Cap Rate.

Prospect’s position was the local Board had not erred in setting a Cap Rate based on the five sales, as SAMA had used single sales in two communities to set the hotel Cap Rate in those communities.

In their ruling, the Saskatchewan Court of Appeal stated that the local Board of Revision did not find an error in SAMA’s use of non-related commercial properties in establishing the hotel Cap Rate.

“Although the Board may have stated SAMA was being “overzealously creative”, at no time did the Board find an error in SAMA’s use or calculation, as the Board simply dismissed it,” the Court of Appeal decision read.

 “The Board certainly thought there was a better way to assess the subject hotels, but it did not state that SAMA’s choice of the RCM was in error and it did not, as the Committee observed, examine SAMA’s application of that methodology in the context at hand.”

The lack of hotel sales data favoured SAMA’s position and strategy to achieve a property value.

“That is, SAMA had to do what it could with the sales data that it had within the confines of the market valuation standard and its duty to achieve equity in the assessments. In that regard, the Committee found it was not unreasonable for SAMA to have chosen to use the RCM (ratio comparison method) to conform that limited sales data with the marketplace in Moose Jaw,” the decision read.

In the end, the three Saskatchewan Court of Appeal justices disallowed the appeal because the local Board of Revision may not have liked the approach used to derive hotel property values but it did not mean it was wrong to use the approach taken. No error was found by the local Board of Revision for the approach SAMA chose to establish Moose Jaw hotel cap rates.

“To put a pin in this, even though the Board saw using the RCM as an ostensibly puzzling or counterintuitive approach, as the Committee concluded, that does not mean it was an error for the assessor to take that approach,” the final decision read.

“I have concluded that the Committee did not err in its application of the standard of reasonableness to the questions of fact and mixed fact and law that arose in the City’s appeal against the Board Decision,” Justice Lawson wrote.

Small Victory For Naught

As part of the appeal, Prospect argued the Cap Rate set by the local Board of Revision was acceptable and the City and SAMA had sufficient and reasonable opportunity to appeal it at the Board hearing despite the actual amount and final methodology used had not been part of the appeal.

When it came to setting a Cap Rate, Prospect had argued and filed an appeal the hotel cap rates should be established off of two hotel sales - one in Weyburn and one in Estevan leading to a 10.66 per cent hotel cap rate.

Whereas the local Board of Revision had used its fact finding powers to consider five hotel sales province-wide to establish a hotel cap rate of 10.63 per cent for Moose Jaw.

The Court of Appeals found that the local Board of Revision was well within its powers to take such actions but since Prospect Properties Ltd could not prove that the SMB had erred in law to review the decision and order the hotel cap rate set at the initial 2019 assessment, the win was a moot one.

In the end the Saskatchewan Court of Appeals decision was in the City’s and SAMA’s favour with the decision saying the SMB was correct to determine the initial 2019 Cap Rate of 8.14 per cent was appropriate. The decision additionally ordered Prospect Properties to pay legal costs.

The original story can be found on the MJ Independent website.

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