Cities with a heavy reliance on commercial real estate taxpayers — particularly downtown businesses and hotels — could face fiscal pressure long after they’ve spent the federal COVID-19 relief that has propped up their budgets.
Pandemic-related fallout has changed the
“Much is at stake if big cities suffer a real estate version of “Long Covid,’” Merritt Research Services warns
“I think it’s too early to make a prediction whether it’s a temporary impact or there will be structural change so it’s something that should be on investors’ radar and deserves close watch,” said Richard Ciccarone, president of Merritt and author of the report.
Between the
A slow recovery could lead to property tax assessment appeals and missed payments along with foreclosures, raising questions for the buy side to consider about how prepared a city is with available liquidity to cope with the lost cash flow.
Longer term, if the shift to hybrid or at-home work policies brings permanent structural changes, cities may face widespread changes in valuations with a cascading effect on businesses that support office workers.
Investors need to consider how prepared a city is to manage those losses as shifting the burden for a revenue stream relied on to repay debt, pensions, and governmental operations to residential payers or other revenue stream poses other consequences.
“The question is whether cities are resilient enough and flexible enough because it has the potential to raise considerable havoc on stable financial management for cities as well as schools and counties. It could cause credit erosion and impact bond prices,” Ciccarone said in an interview.
Developers are generally hopeful about recovery prospects but analysts who assess risk on tax-supported municipal general obligation bonds are skeptical, the report said.
“In worst-case scenarios, marginal taxpayers who are deep in debt may be pushed over the edge into foreclosure, which would also contribute to lower tax collections on budgeted levies,” Ciccarone wrote.
To assess cities’ risk, the report looks at the top 10 taxpayers among the nation’s largest 33 cities with a population base of at least 500,000.
“Getting a handle on the ten largest property taxpayer lists sheds light the ability of local government and school districts to withstand a serious shock to their revenue projections should one or more of these payors find themselves unable to pay their tax bill,” Ciccarone said.
The examined cities have a median top 10 taxpayer dependency rate of 5.4% of their total taxable property assessment base. The median rate for all U.S. cities regardless of size is 8.1%.
“Big cities are generally less dependent on a concentrated list of taxpayers that could potentially expose them to cash flow shocks that can’t be recovered in due time. However, maintaining reserves to cover short term delinquencies remains an important strategy to handle any disruptions,” the report said.
Los Angeles leads the list of cities with the most diverse tax base that is least dependent on their top ten taxpayer list at 1.7%, followed by Philadelphia at 2.5%, Jacksonville at 2.6%, Austin at 3.1%, Chicago at 3.2% and Albuquerque at 3.3 %
Even though Los Angeles’ top ten taxpayer list is led by real estate payers, its top three taxpayers represent less than 1% of the city’s taxable property.
As with other cities, L.A. vacancy rates are high, with unoccupied office space exceeding 20% since the pandemic began. Chicago’s Central Business District had an 18.5% office vacancy rate in the last quarter of 2021.
Like Los Angeles, Philadelphia’s top three taxpayers are all relatively small real estate-oriented properties. Office vacancies in Philadelphia’s central business district have crept up during the pandemic but were lower in the central business district 14.4% than the entire metro area's 18.2% in the fourth quarter.
Six of the cities examined have a total Top 10 taxpayer assessment valuation of 8% or higher, led by Detroit at 27.4%, Boston at 10.4%, Denver at 9.1%, Tucson at 8.6%, Memphis at 8.5%, and New York at 8.1%
“Detroit’s vulnerability has more to do with its limited economic strength and diversity and less to do with the commercial real estate risks impacting the other cities, although it is not entirely insulated from the downturn in central business activity,” the report said.
The city’s heavy reliance on its top ten taxpayers stems mainly from its lack of a robust high value commercial and residential tax base with a full value per capita ratio of $29,979 in 2020 far below the median of $113,327 of all 33 cities analyzed.
Boston’s top 10 taxpayers represent 10.4% of the city’s total taxable assessed valuation. Two out of the top three taxpayers are real estate entities, while the third is a utility. Boston enjoyed healthy economic growth and rising property values over the past ten years. Total office vacancy levels in the fourth quarter of 2021 stood at 13.7% in the city, and higher in the metro area.
New York City is the sixth-most-dependent city on the list due largely to the enormous size and valuation of its electric utility, Consolidated Edison, which represents 6.1% of the city’s tax base.
“Currently, no city stands out as a clear loser on all corners of evaluation relative to their dependency on their largest taxpayers,” Ciccarone said. "Cities like New York, Chicago, and Denver, to name a few, are likely to be in the headlines because of their high office vacancy levels and will remain an analytical challenge until we learn whether there has been a permanent restructuring of the workplace environment. If so, these cities will likely suffer potential reassessment allocations and tax resistance.”
