How Commercial Office Space Vacancies are Affecting Tax Revenues

We all thought putting masks on for a few weeks would be a temporary blip, and that the scourge of Covid-19 would simply go away. Well, as we all know, it cut much deeper into the very fabric of our economy, affecting us in so many ways. First, PPP money and personal stimulus initiatives from the U.S. government fueled inflation to levels not seen in 40 years. Inventories of all types of goods, from automobile chips needed to assemble cars and trucks to recreational ammunition for sporting weapons, and everything in between, evaporated. But now, the pendulum is swinging back as auto makers are flush with chips, and many retailers are swamped with over-supplies of inventories. 

Sudden changes in tastes from sweatpants to swimsuits to suitcases put retailers in a tough position. The biggest names such as Walmart, Target, Gap, and Kohl’s along with many others are trying to sell through a glut of extra merchandise piling up in store backrooms and warehouses. This is but one of the lingering effects of the pandemic that is cutting deeply into the core of our economy. But a couple of quarters will pass, and excess merchandise will sell through and inventories will come back into balance. But not so with many others, such as inventories of empty office space that keep swelling across the nation.

The Work From Home movement was gaining more and more traction, albeit at a slow pace, until the pandemic struck. The lockdowns, and subsequent closing of offices, dramatically accelerated the WFH movement, and despite efforts by many large employers to re-institute in-office and hybrid work polices with attendance at least a few days a week, the nation’s employee cohort holds all the cards, and many are not going for it.

This has created a seismic shift in the entire commercial office space economy, and the resulting impact it has on property taxes at local and state levels; that looming shrinkage in property tax revenues is turning some taxing authorities on their ear, and looking for ways to replace what they believe will be rapidly evaporating tax receipts. The sharp increase in both vacancies and interest rates have combined to create a decline in office building values, and this is likely to become a growing problem for the budgets of cities, schools and other jurisdictions that depend heavily on property taxes from commercial property owners. 

Property taxes are the largest single expense for most office landlords. Many hope to reduce it to help offset lost revenue from the sluggish return of employees to their desks and the cascading damage it is causing to local businesses catering to these workers. In jurisdictions that reassess property values annually, owner appeals of tax assessments are up an astounding 30 percent to 40 percent compared with a typical year before the pandemic.

If landlord appeals to cut their tax bills are largely successful, cities, school districts and other taxing jurisdictions may face some tough decisions involving cutting jobs or programs—or looking for other ways to raise revenue. Many jurisdictions correct for falling commercial values by automatically increasing taxes on residential, and this swing is likely to accelerate in 2023 and beyond.

The prospect of reduced property taxes could also have implications for the $4 trillion U.S. municipal bond market. The credit ratings of some major cities such as Boston, Detroit and Denver may be particularly vulnerable to office building re-evaluations, because at least 8 percent of their tax base valuation is concentrated in their 10 largest commercial property taxpayers. 

So the danger is that further economic instability and job cuts in the tech sector and other industries might intensify fiscal pressure on municipalities, and eventually lead to weakening credit. This is just another example of how the pandemic has cut so deeply, and will leave taxing authorities searching for new sources of revenues to replace the dwindling values of commercial office buildings. And of course, it does not bode well for near-term office space starts, and the resulting pull-through it has on concrete volumes.

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.