Cities, counties and other local governments have traditionally relied on property taxes as a sizable and stable source of revenue, but as remote work takes hold after the pandemic, studies have found that the value of office buildings in many cities could fall by half. The question facing policymakers isn't whether this will affect local budgets, but how badly.
A new analysis looked at how reliant 47 major cities are on commercial property tax revenues and combined that data with estimates of future office values to come up with two projections of revenue shortfalls by 2031 in 13 cities for which complete data is available.
Projections show that revenue shortfalls are severe in some cities and relatively manageable in others. However, several cities saw large variations in projected revenue shortfalls under different forecasts, highlighting important questions policymakers should ask about their fiscal futures.
Cities vary in their reliance on commercial property taxes
In a post-pandemic economy, heavy reliance on property taxes doesn't necessarily pose a problem for local finances, as home prices have soared over the past few years. But some cities are particularly reliant on commercial property tax collections, which could pose risks to future budgets.
For example, in our data, Boise is one of the cities with the highest reliance on property taxes overall, but its reliance on commercial property taxes is not in the top 10. In contrast, Atlanta is not one of the cities with the highest reliance on property tax collections overall, but its reliance on commercial property tax revenue is the seventh highest in our data set. This discrepancy could stem from the underlying value of real estate in the city, or the way the city assesses and taxes these different types of property.
Overall, of the 47 cities studied, Boston, Knoxville, Manchester and Dallas were most reliant on commercial property tax revenue. In each case, commercial property taxes made up more than 20% of their general revenue. For more detailed data on all 47 cities, see the full report.
Projections based on declining commercial real estate values
The first forecast compared a post-pandemic decline prediction with another prediction that office building values would rise at the same rate between 2022 and 2031 as they had over the past decade.
As a result, our median city faced a shortfall of 2.5 to 3.5 percent of total revenue in 2031. (We give a range because each city’s share of office buildings is the big unknown.) Notably, while a 2.5 percent decline may not seem like a lot, it translates to hundreds of millions of dollars and could force significant tax increases or spending cuts to balance a city’s budget.
Cities most at risk in this projection are those that were highly dependent on commercial property tax revenues before the pandemic (Boston) or that have experienced particularly strong growth in commercial property values over the past decade (Austin), while cities at the low end of the projection (San Diego) are mostly cities with relatively low reliance on commercial property tax revenues.
Projections based on percentage of commercial property tax revenue in the budget
In our second forecast, we asked a different question: In the new reality of declining commercial property tax collections, how much revenue will cities need to raise from other sources to cover their projected expenses in 2031? In other words, if values fall but reliance on commercial property taxes does not, what will the shortfall be? Our forecast found an overall shortfall of 0.9 to 3.2 percent for the median city.
Considered this way, the District of Columbia has the largest deficit, due in large part to recent trends in revenues and expenditures. That is, the District of Columbia's fiscal position before the pandemic was dependent on commercial property taxes to support relatively high levels of expenditures, and the growth rate of expenditures over the past decade has been higher than the growth rate of commercial property taxes. Now, with a projected decline in commercial values, the District of Columbia will need to find other significant sources of revenue or cut spending. Houston and Chicago face similar problems.
In contrast, Austin and Dallas do not anticipate an overall revenue shortfall in the current projections because commercial and residential property taxes have grown at a much faster rate than expenses over the past decade. As a result, these cities will need to significantly slow commercial property tax growth rates to maintain their current reliance.
Importantly, both forecasts assume that values of other types of commercial property (such as retail and industrial buildings) continue to rise. If values of these other types of commercial property also fall, the projected shortfall could be even larger.
Across local governments, policymakers should pay close attention to their city’s reliance on commercial property taxes and how it lines up with other fiscal trends. If other revenue sources are expected to grow, cities may experience little budget impact from declining commercial property values. However, if government spending is predicated on strong commercial property tax collections, policymakers could face significant budget challenges in the coming years.
Unfortunately, there are no easy budgetary solutions to declining office values, but an important first step is understanding how commercial property tax collection works and why cities’ fiscal futures can vary widely.