A closer look at property taxes and “doom loop” risks in US and Canadian cities

Examining the role of assessment cycle and tax policy in evaluating doom loop risk

Researchers continue to speculate that falling downtown office values in select regions will result in property tax revenue shortfalls, leading to declining maintenance and services, which will exacerbate outmigration, loss in value, and urban decay. This cycle is commonly referred to as an “urban doom loop”.

For a “doom loop” to occur, four things must be true:

• Fundamentals (rents, occupancy, capitalization rates) must continue to negatively impact values

• Losses in value must be reflected in property tax assessments

• Tax rates must be fixed or heavily weighted to commercial properties

• The city must have a heavy reliance on property tax revenue from office properties

Many jurisdictions have flexible tax policies that adjust rates when values drop, meaning there is no net loss of revenue – but there is a shift in tax burden between properties. Where the tax burden is weighted to commercial properties, the impact of declining commercial values will be magnified.

Are commercial property tax assessments being reduced to reflect losses in value?

The disconnect between market values and assessments is an ongoing problem across the US. In our 2024 US Real Property Tax Benchmark report, we looked at assessed value changes by comparison to the change in fundamentals and market values (per the NCREIF ODCE index), as well as how property taxes compared to sale prices in 10 major US cities. This exercise revealed that the tax-to-sale ratio for office properties was above other sectors in most of the cities, indicating that assessments have not been lowered to match the change in market values.

At the annual conference for the Institute of Professionals in Taxation (IPT) in June of this year, property tax experts and attorneys operating in multiple US jurisdictions expressed their frustration with the high volume of appeals that have been necessitated as a result of assessors’ refusal to recognize falling values for office properties. The increase in appeal volume has contributed to lengthy delays, further increasing the disconnect between the current market value and the value that taxes are based on.

When do falling values cause property tax revenue shortfalls?

In the 2022 paper that originated the “urban doom loop” theory, the authors estimated that NYC office building values could fall by 49%, which would result in a 7.3 reduction in total city revenues. The estimate was based on the following calculation: property tax makes up 48% of NYC revenues, of which 31% come from office and retail. Therefore, if office and retail property values drop by 49%, total revenues drop by 7.3%. Using this formula, the greater the reliance on property tax, and the greater portion of that tax that comes from office and retail properties, the greater the risk of a doom loop. This holds true; however, the way tax rates are calculated also has an impact. A jurisdiction with fixed tax rates has a greater risk of revenue loss than a jurisdiction where tax rates are established based on budget requirements. Moreover, a city that levies a higher rate of tax on commercial property is more at risk than a city that taxes all properties equally.

Some taxing jurisdictions, including the entire state of California as well as Washington, DC, have “fixed” tax rates set by legislation, which can only be altered with voter approval. In these cases, if the total assessed value of all properties declines, or does not rise enough to keep pace with increasing costs, local governments could experience revenue shortfalls. If values decline at the same time as costs increase, the shortfalls will be magnified. As California’s Proposition 13 requires the assessments of sold properties to be updated to the sale price, many office building assessments have been substantially reduced. Thus far, that decline has been offset by growth in other sectors – either rising values or new developments that bolster the assessment base.

In most property tax jurisdictions in the US, and in all of Canada, property tax rates are determined based on the budgetary needs of local governments and school districts (in Canada the school portion is set by the provincial government). Each municipality calculates the tax rate by dividing the amount of revenue needed by the total assessed value of all properties in the municipality. If the total assessed value of all properties (including new construction) drops, the tax rate must increase to compensate. The amount of revenue raised remains the same, and the effect of the change in assessed values is “revenue neutral.”

Although a loss in property value for one sector will not result in a loss in revenue following a “revenue neutral” reassessment, it will shift the tax burden between property sectors. If the assessments are significantly out of date, or values in one sector have declined rapidly as others increased, the shift of taxes between sectors of property may be dramatic.

If a jurisdiction applies the same tax rate to residential and commercial properties, the decline in office values and recent rapid increases in residential property values may result in property tax increases for homeowners. For example, Texas, Tennessee, Florida, and Georgia are states where municipalities typically tax residential and commercial properties using the same millage rate.

Some jurisdictions allocate a proportionately higher burden to commercial properties, either through a higher assessment factor (the portion of the assessed value that is taxable) or through a millage rate or tax ratio that burdens the commercial tax class more heavily. To this effect, Altus Group’s Canadian Property Tax Rate Benchmark report examined the commercial-to-residential tax ratios across major Canadian cities. In 2023, the cities included in that study charged property tax to commercial properties at 2.82 times the rate of residential properties. Many cities in the US – such as Washington DC, Denver, Boston, Chicago, and New York – also charge a higher effective tax rate for commercial properties, since those properties are taxed a higher percentage of the value (the assessment factor) and/or a higher millage rate. In these cases, the effect of a decline in value for the commercial class will be magnified – and the affected cities may need to weigh the cost of increasing property tax rates for residents against further penalizing struggling businesses.

To avoid or limit tax shifts, cities may try to implement caps on assessment or tax increases, or implement other policies that mitigate the increases. Unfortunately, such limits often increase the share of taxes paid by properties whose values are declining to protect the higher valued properties from increasing. In Boston, the share of taxes paid by commercial properties is weighted at 1.7 times the overall rate. If the value of properties in the commercial class drops, the amount of taxes to be paid by properties in the residential class will increase. Boston’s mayor is seeking authority to increase the commercial weighting to 2.00 – asking commercial properties to pay double the share of taxes that would be indicated by their values. Other regions are seeking to freeze or cap assessment increases. In both examples, properties that are declining in value (and in Boston’s case, already bearing a greater share of the tax cost burden) will be asked to pay a higher rate of tax on their values to reduce the burden of properties that are increasing in value.  

Interested in how commercial property taxes compare in 10 major US cities?  Download the US Real Property Tax Benchmark Report.

Conclusion

Over taxation of commercial properties makes cities particularly vulnerable to the formation of a doom loop. Tax policy that continues to shift the cost of municipal operations and schools onto business properties makes cities less attractive to business and can further contribute to outmigration and, subsequently, the decline of downtowns. While protecting vulnerable taxpayers from unsustainable increases is necessary, jurisdictions need to strike a better balance of relief for properties that are declining in value, and programs and policies that facilitate, rather than hinder, recovery for the commercial sector.   

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