Guest blogger Owen Beitsch, PhD, FAICP, CRE, senior director with GAI’s Community Solutions Group (CSG), shares informed insight into the pandemic’s effect on commercial, retail, and hospitality industry property tax and valuation.
I am frequently asked about COVID-19’s impact on local government revenues and spending. This is a logical line of inquiry given reported appeals to the federal government for financial assistance, mostly to support fire, police, and other essential services These are typically the major expenditures in a local government’s annual budget, and costs may be spiking. In particular, the questions I receive center on the impact of declining property values and associated property tax collections.
Commercial Property Value Directly Affects Municipal Revenue
In many states, the market or just value of commercial structures stems from the net rental income those structures generate, much like a normal appraisal. That value is then the basis for an assessment with the final tax calculation a product of the assessment and the applicable rate of taxation. Steep declines in taxable values were experienced in the last recession and have taken several years to recover.
Precise formulas for calculating the actual property taxes generated vary by state law. Still, in almost every case, property taxes are a major source of receipts, and are among the primary means by which local governments fund their activities. In the context of most state laws, property taxes may be the only money available to fund education.
On the face of it, visibly vacant structures would yield declining values and similarly declining tax receipts. However, the relationship among vacant space, value, and property taxes is complicated and relatively slow to respond to external economic conditions.
In many situations, tax valuations were made effective on January 1, 2020, prior to the impacts of COVID-19. Effectively, declining commercial valuations won’t be recognized broadly by local governments until the next budget cycle, and they will differ by use and function. For office buildings, valuation declines may be modest. For retail spaces, the declines and losses may be steep. For hospitality uses, especially hotels, the losses may not be recoverable for several years.
COVID-19 Effects on Office Property Values & Taxes
Starting with office buildings, it ostensibly appears that many are less occupied. However, these buildings may still be generating the same rental income since rent is driven by leases 5 to 10 years in duration, possibly longer for marquee tenants. Office-centric professions are experiencing some loss of business and lower demands, but the ranks have been relatively insulated from COVID-19. Professionals largely associated with office needs have experienced a reduction in work hours and a shifting of priorities, but not massive job loss. Going forward, office users are likely to monitor their space requirements, but for the reasonably foreseeable future building valuations seem unlikely to undermine property tax collections.
Over the longer term, logistics and company flexibility will shape the use and needed inventory of office space. There could be diminutions in value, but the magnitude and speed of loss are speculative. Overall space needs may not even decrease as social distancing best practices require more individual space for each employee. Regardless, technology will become important as a safety and control measure as well for information flow. Declines in the value of the existing office inventory may result more from its capacity to offer smart technology than its capacity to support a certain working population.
Today’s “A” buildings could become tomorrow’s “B” buildings, aging more rapidly than their historical useful life. The future of co-working spaces is now suspect as WeWork and Regus retool their business models.
COVID-19 Effects on Retail Property Values & Taxes
Somewhat surprisingly, national data indicate an upward tick in consumer spending, a key measure of retail health that usually correlates to space needs. According to the Bureau of Economic Analysis, wages were up in September 2020 by 0.9% and spending up by 1.4%. These are significant increases.
Where exactly that money is being directed is widely debated, but “dark” retail spaces are much more of a threat to local government property tax collections than underperforming office spaces: by some estimates, about 10,000 stores closed in the last 18 months. A change in retail behavior was evident prior to COVID-19—and the virus has accelerated the decline in physical retail space needs.
A substantial portion of this retail inventory was formerly occupied by now growing numbers of bankrupt or reorganizing chains. For example, during the week of November 9, 2020, JCPenney had its reorganization plan approved, resulting in the likely close of 600 stores for this one major retailer!
Where leases may have existed for stores like JCPenney, they are now devalued or worthless. Consequently, the rental and income losses are significant, and flow through to property valuations, taxable values, and property tax collections.
In some states, there are movements to reduce property tax obligations further by arguing some part of a retail store’s value stems from the actual tenant occupying the space. The argument is compelling. Setting the reasons aside, it is absolutely correct that retail facilities designed for specific users in certain configurations will become quickly obsolete and further diminished in value. Much of this space may never be occupied again in its present form. If a local government depends upon sales tax collections, the impacts of vacancies will be steeper and faster.
COVID-19 Effects on Hospitality Property Values & Taxes
Hospitality and entertainment assets are among the property segments most damaged by COVID-19. There are no leases to secure revenue flow. The virus has literally wiped out months of income that would generate taxable values and property taxes for affected local governments. In communities strongly oriented to tourist and visitation markets, the loss of these valuations and related taxes are significant in the short run and seem likely to continue through most of next year. Certainly, travel confidence is at a record low.
In Florida, for example, county governments are experiencing the shortfall in tourist taxes and postponing spending allocated to major capital projects. For residents there, the loss of these specific receipts will not directly impact services since these taxes must be applied to very explicit categories of activities. The losses, however, correlate with lost hourly jobs, pushing unemployment in the spring to levels that passed the recession several years ago.
The prospects of full economic recovery for the hospitality industry could take many years, and the industry is already experimenting with space needs, controls, and other system checks. Oddly, because of the hotel’s industry’s personal relationship with its users, it may be better positioned to work through the various smart systems and controls that the owners of office buildings may resist initially.
What We Are Seeing Now
On balance, it is reasonable for local governments to be concerned about their fiscal condition, especially in the face of unbudgeted expenses. The challenges, while real, may not be as severe nor as immediate as speculated because of the valuation cycles driving property tax collections.
Some sectors of the economy are now showing modest improvement, potentially deflecting the most punishing blows. The values of retail property and the property taxes they generate were in a state of decline prior to COVID-19. The virus only accelerates those trends, which may already be recognized in local fiscal planning. Hospitality-centric locations such as Florida remain among the most vulnerable. In those settings, there are simultaneous threats to property taxes, sales taxes, and tourist taxes. However, even Orlando is showing signs of healing based on Q3 2020 reports.
Contact Senior Director Owen Beitsch, PhD, FAICP, CRE, 321.319.3131, for more information about the GAI Community Solutions Group’s urban planning, economics, and strategy services. Message GAI online and start the conversation about how our multidiscipline professionals can meet your unique project needs.
Owen Beitsch, PhD, FAICP, CRE has been active in the management and execution of complex studies for public and private clients for many years. His particular interest in special issues confronting urban areas is demonstrated in both his civic and business activities. A member of The Counselors of Real Estate and a Fellow in the American Institute of Certified Planners, Owen concluded several years of service as a member of the Orlando Housing Board of Commissioners. Owen is a faculty member in the urban and regional planning program at the University of Central Florida.
