Empty offices in Southwest may become drag on property tax revenue
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The onset of the COVID-19 pandemic and shutdowns in 2020 to combat the virus’ spread emptied offices nationwide and Southwest cities are not immune to the lingering effects, which could impact their property tax collections.
The return to offices around the U.S. has been gradual as many employees embraced a lifestyle free from commuting. Full days worked from home in June 2023 accounted for 28% of paid workdays, which was four times the estimated share in 2019,
In its 2024 outlook report for U.S. states and local governments, Fitch Ratings said: “Higher interest rates due to Fed action and uncertainty about commercial property values given the persistence of remote work will likely suppress real estate transactions and pressure tax revenues over time.”
Bloomberg News
The work from home trend is contributing to weaker office building values, which are factored in formulas to calculate property taxes, according to an October report from Moody’s Investors Service that noted cities’ willingness and ability to adjust tax rates or modify budgets will be tested.
“Cities where tax rates are automatically or easily adjusted to maintain property tax revenue, such as Chicago, will face fewer credit challenges than peers with less rate-setting flexibility,” the rating agency said. “Still, even cities with an ability to increase tax rates may face pushback from property owners facing higher bills, especially if a greater burden falls on residential homeowners.”
It added that while school districts in many big cities are “highly dependent” on property taxes, state aid equalization funding formulas provide some insulation from revenue loss.
The office sector in eight out of 14 big cities is under stress with supply outstripping demand and high or rising vacancy rates, according to the Moody’s report. Houston scored the lowest, while other Southwest cities — Denver and San Antonio — were also stressed. Phoenix joined cities like New York, Boston, and Philadelphia with scores in the cautionary zone.
Property taxes are Houston’s
Office vacancy rates in the nation’s fourth largest city have been elevated for a while, according to Moody’s analyst Grayson Nichols.
“Houston’s vacancy rate does ebb and flow with what’s going on with the energy industry,” he told The Bond Buyer, adding that an across-the-board decline in commercial property values has not materialized, “so it has not impacted revenues at this time.”
Houston Controller Chris Hollins, who took office last week after winning a Dec. 9 runoff election, is keeping an eye on the situation.
“Office vacancies in major cities throughout Texas pose serious risks to revenue collection and, along with it, our state’s ability to attract new businesses,” he said in a statement. “At the same time, vacancy rates in Houston mirror those we’ve experienced and rebounded from in previous economic cycles, and there are a number of opportunities to repurpose underutilized commercial real estate, including housing, retail, and restaurants.”
He added that it is incumbent on the state to work with local governments and the business community “to mitigate the challenges we’re facing and come up with solutions that will best serve our cities in the long term.”
Moody’s analysts said a decline in commercial property value has not really materialized in Texas and that new office construction in recent years has raised assessed valuations and also impacted vacancy rates.
“So you have a lot of new property in the total (assessed value) there,” Moody’s analyst Nicholas Samuels said. “But, because it came online right during this period when there’s sort of been a shift to more hybrid work, that’s what’s keeping the vacancy rates high and it also limits landlords’ abilities to get the rent that they really want.”
Austin, Dallas, and Houston ranked in the top 20 for the amount of office space under construction nationwide according to a
It added that Texas office vacancies are likely to remain elevated in 2024.
“Sublease availability remains high, and a substantial amount of new office space is on track for completion,” the report said. “Despite the likelihood of elevated vacancy rates overall, higher demand for new Class A properties means the buildings under construction are more likely than an average property to be successfully leased. Excess supply is likely to cause larger problems for older buildings.”
Austin’s office vacancy rate of 16.7% in the third quarter was almost twice the rate in 2019’s third quarter, Wells Fargo said in a recent report on the Texas economy.
“Broadly speaking, the metro’s large concentration of tech firms appears to be consolidating space in the wake of increased hybrid work, cost-cutting measures and reduced access to capital,” the report said, noting a “substantial amount of new construction underway.”
The 6.8 million square feet of office space under construction through the third quarter equated to about 5.1% of total inventory, which tops the national average of 1.4%, the bank said.
In Houston, vacancy rates vary depending on a building’s age with those built since 2010 having the lowest rate of 12.2% in 2023’s fourth quarter and those built between 1980 and 1999 having the highest rate at 31.8%,
“As the flight to quality trend persists, some older, less-desirable office buildings may face obsolescence,” the report said. “Once interest rates begin to fall and inflation eases, the conversion of vacant office buildings to other uses could become more attractive and financially viable, especially if there are any incentives offered by state and local government entities.”
A Municipal Market Analytics report last month contended that landlords of struggling office buildings likely have been appealing their property tax assessments since 2020, “strongly suggesting that a material portion of current losses have been baked into city tax rolls for years already.”
Texas was one of the earliest states to take steps toward ending COVID-19 pandemic shutdowns. Republican Gov. Gregg Abbott
“We must now do more to restore livelihoods and normalcy for Texans by opening Texas 100%,” Abbott said at that time.
The Houston, Dallas, and Austin metropolitan areas have generally outperformed other major areas of the nation in office occupancy since March 2020, according to the Kastle
