The shift to remote work since the COVID-19 pandemic has created a cloud of uncertainty around office commercial real estate and could potentially do the same for city government budgets, Thomas Brosy, a Tax Policy Center research associate, recently wrote.
CRE property values have fallen 12 percent during the past 12 months, bringing them down to where they were in May 2018, according to industry research and advisory firm Green Street. Meanwhile, residential property values are approximately 50 percent higher than they were in mid-2018.
The disparity in CRE and home property values makes it difficult to forecast any financial consequences local governments may endure. Given that property tax revenue makes up 30 percent of local general revenue, however, major cities with big commercial districts will likely feel most of the pain, according to Brosy.
For example, the drop in office CRE values is predicted to cost Washington, D.C., $464 million in combined tax revenue during the next three fiscal years. Meanwhile, San Francisco could lose between $150 million to $200 million a year by 2028 — approximately 5 to 6 percent of all current property taxes. Boston is also likely to endure financial difficulties, as almost 75 percent of its current total general revenue comes from property taxes. More than half of that comes from commercial, industrial and tangible personal property, with 22 percent coming just from office CRE, according to The Tax Policy Center.
Between employees’ expectations about their work location and the declines in urban population, these trends aren’t likely to change, Brosy said. New York City could see a 44-percent decline in office CRE value — equal to about $50 billion, according to a recent SSRN study. Researchers estimated office values could fall more than $500 billion across the U.S.
Trouble analyzing property tax data
At first glance, not all major cities are suffering from the remote work trend, according to Brosy. CRE and residential real estate increased between 2019 and 2022 in a number of big cities, except for New York. The CRE tax base outpaced residential in Austin, Dallas and Miami.
This isn’t necessarily a sign that trouble’s been averted, however. Brosy noted that a lot of leases are long-term, and those signed prior to 2020 will be renegotiated. If office demand continues to fall, so could the properties’ values. For example, data shows that office occupancies remain between in 40 and 60 percent in the U.S.’s largest cities, despite more people coming back to the office. Meanwhile, a lot of governments haven’t accounted for recent shifts in CRE property values in their tax data.
The fact that cities use different assessment techniques also makes it hard to forecast their financial futures. New York uses the net operating income that CRE owners submit instead of recent sales to determine assessed value. Changes are phased in over five-year periods. If the city comptroller’s estimation of office values dropping by 40 percent between now and 2029 is correct, property tax levies would decline three percent in 2027.
Cities that could hurt the most from declining CRE office values
Brosy analyzed 12 major U.S. cities, and noted Boston counted on CRE property taxes the most — approximately 36 percent of the city’s total general revenues come from commercial property taxes. Dallas and Atlanta also rely heavily on CRE property taxes, at 26 and 19 percent, respectively. On the other side of the equation, Phoenix (3 percent), Chicago (7 percent) and Charlotte (8 percent) rely on commercial property taxes the least.
While Brosy’s analysis focuses just on city-level government, he noted that school districts and county governments count on property taxes, too. They could also feel the impact of any drop in CRE property values.
As for how local governments will react, Brosy noted three traditional choices. The first involves raising the CRE property tax rate, which could raise revenue, but also increase tenants’ tax burden and decrease demand. A second option is to scale back spending and services, but the drawback is a city’s most vulnerable residents could suffer and in turn the city becomes a less desirable place to live and do business. There’s also the option to increase tax revenues from areas such as residential property, sales tax or fines, but doing so could make cities’ local tax systems more regressive.
“Cities may get creative and try something new,” Brosy said. “But to do that, they must start planning now. 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.”