PHF II Norfolk, LLC v. City of Norfolk

• Decision Date: 14 November 2016
• Docket Number: Civil Docket No.: CL15-6886
• Court: Circuit Court of Virginia
• Parties: Re: PHF II Norfolk, LLC v. City of Norfolk

Re: PHF II Norfolk, LLC v. City of Norfolk

Civil Docket No.: CL15-6886

FOURTH JUDICIAL CIRCUIT OF VIRGINIA CIRCUIT COURT OF THE CITY OF NORFOLK

November 14, 2016

DAVID W. LANNETTI JUDGE

John S. Norris, Jr., Esq.

Norris & St. Clair, P.C.

2840 S. Lynnhaven Road

Virginia Beach, Virginia 23452

Adam D. Melita, Esq.

Office of the City Attorney, Norfolk

900 City Hall Building

810 Union Street

Norfolk, Virginia 23510

Dear Counsel:

Today the Court rules on the action brought by Petitioner PHF II Norfolk, LLC ("PHF") against the City of Norfolk (the "City"). PHF challenges the City's real estate tax assessment on certain real property PHF owns within the City of Norfolk (the "Property") for tax years 2011, 2012, 2013, and 2014. PHF contends that the City assessed the Property above its fair market value ("FMV") each year and that the assessments were not uniform in their application. PHF seeks relief in the form of a refund of $866,122, the putative excess real estate taxes paid for the years in question. The Court finds that PHF established a FMV for the Property. With respect to the City's 2011 Property valuation, the Court finds that PHF successfully rebutted the presumption of a correct assessment by proving the City committed manifest error in miscalculating the assessment, which resulted in a tax-assessed value that exceeded fair market value; as a result, PHF is entitled to a real estate tax refund of $160,395. With respect to the City's 2012, 2013, and 2014 Property valuations, the Court finds that PHF failed to prove the following: that the City performed its assessments in a nonuniform manner; that the City's assessed values exceed the Property's FMV as a result of either manifest error or disregarding controlling evidence; and that the City's assessments were not arrived at in accordance with generally accepted appraisal practice. PHF therefore did not successfully rebut the presumption of correctness of the City's 2012-2014 assessments and is not entitled to a real estate tax refund for these years.

Background

PHF owns the Property, located at 777 Waterside Drive within the City of Norfolk, Virginia, on which it operates the Norfolk Waterside Sheraton Hotel. (Compl. ¶ 2.) The City levies a tax on real property annually, with each tax year beginning on July 1. Norfolk, Va., City Code § 24-193 (1979). Pursuant to the Charter of the City of Norfolk and the Norfolk City Code, tax assessments must be complete by the end of February of the year of assessment—essentially four months before the City officially promulgates its assessments. See id.; Norfolk, Va., City Charter § 88(b) (1968).

Elizabeth White ("White") is the Commercial Projects Supervisor in the City's Real Estate Assessor's Office. (Tr. 565.) White testified that she was "aware of all assessment work the City performed during the tax years in question. (Tr. 577.) With respect to the City's assessment of the Property, White supervised the work of two different employees for tax years 2011 and 2012, and she performed the assessments herself for tax years 2013 and 2014. (Tr. 599.)

The City performs assessments on approximately 5,600 properties each year. (Tr. 575.) For improved properties, the City considers three common valuation methods when determining each tax assessment: the cost approach, the comparable sales approach, and the income approach. (Tr. 576.) In support of calculating assessments, the City requests information from the property owners, with the requests tailored depending on the type of property. (Tr. 579-80.) For hotels, the requested information includes the average daily rate ("ADR") per hotel room rented, the revenue collected per available room (RevPAR), and the average occupancy rate of the hotel. (Tr. 580.)

In considering the income approach to determine the FMV of full-service hotels, the City relies on the most recent annual profit-and-loss data provided by each hotel owner. (Tr. 621.) Because hotels typically require several months after year's end to compile such data and send it to the City, data for the immediately preceding year is not available to the City when it calculates the upcoming-year assessments, which are required to be complete by February. (Tr. 578.) Accordingly, the City relies on the taxpayer-provided data from two years prior to the assessment year. (Id.)

From the reported revenues, the City subtracts the hotel's expenses—excepting certain costs, such as amortization, debt service, real estate taxes, and depreciation—to arrive at the net operating income ("NOI") of the hotel. (Tr. 621, 691.) The City also does not subtract a hotel's required reserve fund amount, as the City considers it "not a true expense."¹ (Tr. 625.) The NOI is then divided by a capitalization rate—largely determined based upon rates published by groups such as PricewaterhouseCoopers—to determine the total value of the hotel. (Tr. 626-28.) Finally, to arrive at the property's tax-assessed value, the City deducts the value of furniture,fixtures, and equipment ("FF&E"), which is taxed separately as personal property. (Tr. 636.) The City uses the FF&E value provided by the Commissioner of the Revenue's Office, which reflects the tax previously paid by the taxpayer for this personal property. (Tr. 635, 647.)

For the 2012 tax year assessment, the City did not receive income expense information from PHF until well after the submission deadline,² so the City instead substituted pro forma values it derived from the most recent data available—including the vacancy rate, published room rates, and standardized expense ratios. (Tr. 646-47.)

The City generally uses the cost approach only as a crosscheck reference—or as a backup valuation when reliable income data cannot be gathered—for full-service hotels such as the Property. (Tr. 596, 602, 606.) The City relies upon an online program to arrive at this cost valuation but does not consider the value reliable enough to use as an assessment tool. (Tr. 595, 606.) The City also looks for comparable sales of hotels in Norfolk, but in this case, it could not find any such sales within Norfolk for the tax years at issue. (Tr. 601.) The only reference to comparable sales in the City's assessment work file for the Property was a list of three hotel sale prices. (Tr. 670.)

PHF exercised its option—as provided by the City—to appeal its assessment for each tax year in question. (Tr. 646.) After its appeals were denied by the Board of Equalization, PHF filed this suit, challenging the City's tax assessment for the Property for tax years 2011 through 2014. A trial was held on July 15-17, 2016, and the parties were provided an opportunity to submit post-trial briefs.

Positions of the Parties

PHF's Position

PHF challenges the City's tax assessments of the Property on multiple, and at times overlapping, grounds. As a preliminary matter, PHF argues that the City's assessments are not entitled to a presumption of correctness. Citing Keswick Club, L.P. v. County of Albemarle, 273 Va. 128, 639 S.E.2d 243 (2007), PHF contends that, because the City "failed to consider and properly reject" the sales approach to property valuation—one of three standard valuation approaches—the presumption vanishes, and PHF need only prove the City's assessment is erroneous. (Pet'r's Post-Trial Br. 9; Pet'r's Br. in Resp. to Resp't's Post-Trial Br. 2-3.)

PHF also challenges the City's assessments on several grounds that could, in theory, succeed even if the assessments were granted a presumption of correctness. PHF argues that the City miscalculated the hotel's expenses for tax year 2011. According to PHF, the City's underestimated expense numbers resulted in an inflated NOI, which in turn produced a vastly inflated assessment. To support this claim, PHF asked the City's tax assessment supervisor,White, to run calculations at trial using the profit and loss ("P&L") statement provided to the City by PHF; this resulted in an expense number significantly higher than the one appearing on the City's tax assessment worksheet. A former City employee—whom White supervised at the time—had calculated the 2011 expense number that appears on the worksheet, and White was unable to explain the disparity.

PHF also asserts that the large disparity between the FMVs of the Property—as determined by its expert, Gregory Hartmann ("Hartmann")—and the City's assessed values constitutes manifest error. In fact, PHF contends that the City failed to offer any FMV whatsoever for the Property. Therefore, according to PHF, there can be no "reasonable difference of opinion" regarding the FMV of the Property. PHF also claims that the City's failure to conduct a physical inspection of the Property during any of the four years in question constitutes a failure to use proper methodology, another type of manifest error.

PHF alleges that the City disregarded several items of controlling evidence. These include the City's failure to consider the sales approach, failure to use actual expense data, and use of pro forma inputs in its 2012 assessment calculation for the Property. PHF further faults the City for not including as Property expenses the cost of a franchisor-required property improvement plan ("PIP") and franchisor-established mandatory reserve funds, and for not inspecting the Property. PHF also asserts that the City should have considered as part of the Property assessments several offers made by prospective purchasers of the Property.

PHF contends that the City's simultaneous use of actual revenue data and presumed expense data violates the assessment uniformity requirement found in Section 58.1-3984.

With respect to an amendment to Section 58.1-3984 of the Code of Virginia (the "Amended Statute"), which went into effect in 2012, PHF interprets the added clause regarding generally accepted appraisal practice ("GAAP")³—in Part B of the statute—as establishing a new, independent ground for challenging a tax assessment. PHF asserts that the City's failures to inspect the...