How Will Cities Deal With Falling Office Valuations?

Tax growth on commercial real estate has always been a budgetary business concern, but now the pressure has been mounting. For multifamily, it has become one of the growing operational expenses, with the top growth in a metro hitting 15.3% year over year, according to Trepp.

That’s multifamily, where even with economic headwinds the basics should remain strong, as a Morningstar analysis suggested. Now try the calculation with office. Thomas Brosy at the Tax Policy Center, a venture of the Urban Institute and Brookings Institution, looked at overall falling commercial property values — in July down 12% over the previous 12 months, according to Green Street, compared to a 50% increase in residential values over 2018 — and then considered what that means to cities and the potential implications.

“The divergence in commercial and residential property values makes it hard to predict the fiscal consequences for local governments broadly,” Brosy wrote. “Total property tax revenue accounts for 30 percent of local general revenue, but the pain from this transition will likely be concentrated in major cities with big commercial districts.”

He offered some examples, such as Washington, D.C. seeing a $464 million drop in tax revenue over the next three years or a $150 million to $200 million loss to San Francisco. About three-quarters of Boston’s revenues are from property taxes and half of those — more than a third of the total from “commercial, industrial and tangible personal property.”  More than a fifth sets on the taxes from office buildings.

CRED iQ recently reviewed 190 appraisals of major properties across all assets classes to determine the impact of current market conditions on asset values. Retail and office led the declines, with an average 41.2% valuation decline in $10 billion in assets. Retail was down 57% while office was on its heels at 48.7%.

Brosy points to some data suggesting that “the property tax base of both commercial and residential real estate grew between 2019 and 2022, with the notable exception of New York. In Austin, Dallas, and Miami, the tax base for commercial real property actually grew faster than residential property.” 

But that should give little comfort, depending on when the measurements were taken in 2022. Peak values occurred in March 2022, as Green Street had noted. That raises the question of whether valued measured in 2022 might have during an elevated period compared to the present, so it’s impossible to say from this data whether the view commercial property tax base is remotely accurate.

If companies ultimately can’t get all workers back to the office, this could mean significant revenue shortfalls for cities. “Of the 12 major cities I analyzed, Boston has the highest reliance on commercial property taxes,” Brosy wrote. “Taxes on commercial property account for almost 36 percent of its total general revenues. Dallas (26 percent) and Atlanta (19 percent) also have high reliance on commercial property taxes. In contract, commercial property taxes are less than 10 percent of general revenue in Phoenix (3 percent), Chicago (7 percent), and Charlotte (8 percent).” And none of the analysis looks at county governments or school districts.

That could leave cities with one of four options:

They could raise tax rates on commercial properties, potentially transferring the burden through owners to tenants, dissuading even more from maintaining current levels of property.

Cities could cut spending and services, potentially hurting the most vulnerable residents and making areas less attractive for residents and businesses.

They could increase revenues from other sources, like sales taxes, residential property taxes, or fines and fees, which could have negative consequences in attracting residents and businesses.

Cities could do something different, like a Detroit proposal to tax vacant land while reducing taxes on buildings, making development more attractive. But, as Brosy noted, “We don’t have perfect data, but we know office values are falling, so major cities must find ways to become less reliant on commercial property taxes.”