A battle is taking shape in the U.S. between office property owners and the cities where those buildings stand.

Property taxes are based on a building’s value. And as we had forecast over two-and-a-half years ago, but now just making the mainstream news, the COVID War-related closure of hundreds of thousands of businesses and the new normal of remote work has slashed demand for office space, shrinking its worth across the U.S. 

A litany of factors are weighing down office property values. Among them:

● a national office vacancy rate of 16.2 percent at the beginning of this month, according to real estate research service CommercialEdge;

● layoffs in the tech industry, signaling even less need for square footage in the sector most responsible for growth in demand for space in recent years;

● 132 million square feet of new office space under construction across the U.S., flooding an already weak market;

● rising interest rates that make it much harder to afford to refinance mortgages or take loans to improve properties or keep them up to code;

● the need to cut rental rates and offer free months or free redecorating to compete with other landlords.

Higher interest rates also make it harder for landlords to escape troubled properties by selling them.

Landlords, undergoing a long-term cash flow crunch that could throw properties and companies into bankruptcy, want to reduce their tax bills to reflect those lesser values.

However, property taxes also are the main source of revenue for municipalities and school districts, giving them an existential stake in keeping office properties’ assessed values as high as possible.

As a reflection of that conflict, municipalities that reassess property values annually for tax purposes are seeing 30 to 40 percent more appeals of their valuations than in 2019, real estate service firm CBRE reported.

With the office property bust well underway, that rate of appeal is a sign of what awaits cities and towns that readjust property values less often.

Office properties have lost about 25 percent of their value since the COVID War began, according to real estate data service Green Street.

In contrast, assessors who are accounting for COVID-related loss of value in their assessments of office buildings are reducing their valuations by an average of only 10 percent, CBRE said.

“We’re definitely appealing,” Oliver Carr, CEO of office building owner Carr Properties, told The Wall Street Journal. “We have higher interest rates. We have less demand for space. The math just doesn’t work.”

Carr estimates the value of his office properties has fallen 15 to 40 percent, depending on the building and location.

If assessments reflect offices’ shrunken values, cities and school districts will confront the sudden need to cut services and staff to fit smaller budgets. 

The alternative would be to make up the loss by raising taxes on residential properties, risking the kind of taxpayer revolt and ballot referendums that have rocked California in the past.

Falling office values also could damage the $4-trillion market in municipal bonds.

In several major U.S. cities, including Boston, Denver, and Detroit, at least 8 percent of their tax bases rest on 10 large commercial property owners, according to Merritt Research Services, which tracks the municipal bond market.

A wobbly or shrinking tax base can weaken a city’s creditworthiness and move lenders to demand higher interest rates on loans, Merritt pointed out.

“This is one you have to monitor like an asteroid you’re worried about,” Merritt CEO Richard Ciccarone told the WSJ.

In at least 10 to 15 percent of states, cities are using tax assessments made before the COVID era, when vacancy rates were nil and property values were among their highest since the Great Recession.

Also, many tenants are still paying monthly rent on long-term leases signed pre-COVID, even if most of their employees are working remotely. Because property values are often determined in part by their cash flow, those leases still in place can mask deteriorating market conditions and property worth.

“I don’t think there are too many places where assessors are getting out in front of this,” said J. Kieran Jennings, managing partner of the Siegal Jennings law firm in Cleveland, which specializes in property tax appeals.

TREND FORECAST: Early in the COVID War, in articles such as “Real Estate’s Reality” (7 Jul 2020), we warned that demand for office space would crash and never fully return. Events have long since proven our prediction correct.

We also have accurately predicted the resulting financial damage to cities, warning of it in articles including “New York Office Vacancies Set Record”(13 Jul 2021) “Mass Expiration of Office Leases Threatens Landlords” (26 Apr 2022), and “‘Dimming Hope’ That Pre-COVID Demand for Office Space Will Return” (22 Nov 2022).

TREND FORECAST: Thousands of office buildings, especially older ones, across the U.S., are doomed. 

Some may be converted to apartments, but only those accidentally suited to financially feasible conversion. Most are not suited, for reasons we explained in “Plan to Turn New York’s Vacant Hotels To Housing Not Working” (5 Apr 2022) and “Wall Street, Dead Street. Office Buildings Going Condo” (28 Jun 2022).

As we have noted before, some creative landlords will meet city-dwellers’ need for experiences by opening their empty office space to yoga studios, music academies, coffee houses, adult education centers, and other service-oriented enterprises.

These landlords will find interested partners in city agencies that will need to provide waivers or changes to zoning ordinances, building codes, and other regulations to accommodate these new tenants.

However, landlords will be stuck holding many buildings, even newer ones, unable to pay their way. 

Eventually, the owners will default on their taxes or mortgages. Ultimately, cities will wind up owning portfolios of empty office buildings that no one can afford to keep up.

At that point, the real estate will be sold for cheap, relatively speaking, and buildings will be demolished to prepare the sites for new lives in a new economy.

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