The property tax factor in the “urban doom loop” – who is really at risk?

Office value declines and the urban "doom loop" theory

Fears of an urban doom loop arising out of the post-pandemic work from home were originally raised in a working paper titled The Remote Work Revolution: Impact on Real Estate Values and the Urban Environment, authored by Columbia Professor Stijn Van Nieuwerburgh. Van Nieuwerburgh co-authored a later paper with the more onimous title Work from Home and the Office Real Estate Apocalypse, which modeled a 49% long-run decline in NYC’s office stock. According to the “doom loop” theory, declining office values in the downtown cause a drop in property tax revenue, which leads governments to reduce spending on services and improvements, which leads to further migration out of the downtown, which further depresses real estate values.

Figure 1 - Repercussions of commercial real estate valuation on governments

According to CBRE reports, office occupancy rates have been in free fall in major cities across North America.

Figure 2 - Office vacancy rates – US and Canada – select cities

With insufficient revenue to meet costs as loans come due, companies may need to divest struggling assets. To this effect, a number of offices transacted in 2023 at a fraction of their former valuations, from 350 California Street in San Francisco selling at less than 20% of its asking price, to five offices in Washington, DC selling at losses of more than 60%. With transactions like these raising eyebrows and spawning headlines, warnings have begun to circulate about pending “doom loops” in urban centers – beginning with San Francisco and New York, but spreading to Boston, DC, Chicago, and elsewhere.

How do falling office values impact property tax revenue?

For real property tax revenue to be impacted by falling values of commercial real estate, two things must happen. First, the loss in value must be reflected in assessed values for property tax. Second, the amount of tax that can be raised by the jurisdiction must be dependent on the total assessed value of its commercial real estate. Every jurisdiction has the potential to meet the first condition, but the second is dependent on tax policy and legislation

Assessments for property tax are often not in sync with market values

Property tax assessments are often very different than market values, due to the effective date of valuation, as well as mass appraisal methodology. The circumstances of the market in 2023 have contributed to increased disparities, and in some cases have resulted in rising property tax assessments while market values are actually in decline.

Assessments are based on a legislated valuation date, which means they are required to reflect market value as of a certain point in time. In many cases, this date is a year or more in the past. While assessments are updated annually in New York, Houston, Dallas, Calgary, and Vancouver; in Chicago, property tax valuations reflect 2021 market values, and in Toronto, they are still based on values as of January 1, 2016.

Property tax assessors use mass appraisal techniques to determine values. They extrapolate values for a large number of properties based on limited data, including income and expense information provided by taxpayers, as well as reported transactions. Valuation parameters are usually standardized, and atypical lease deals, tenant inducements, and transactions considered “below market” are often excluded from the analysis.

For jurisdictions that update assessed values for property tax each year, the 2023 data available for analysis by property tax assessors would have been extremely limited. Not only were sales volumes down, but limited new leases with market standard lease terms would have been available for analysis, and those would be for only the best-performing properties.

When property tax assessments are out of sync with market values, assessed values can increase when market values are actually in decline. The 2025 preliminary values released for New York City in January are an example of this. The chart below compares the overall “market-derived” assessment changes indicated by the New York Department of Finance, to the changes in Altus’ average appraised values between Q1 and Q4 2023.

Figure 3 - Property tax value increases vs. median appraised value changes 2023

In Washington, DC the Department of Finance recently made the proposed assessments for the 2025 taxation year available. A review of these assessments for office buildings sold in 2023 indicated that of 19 sales, 9 were identified as “unusual”, “speculative” or “foreclosure” sales by the assessor. The proposed assessed values for these sold properties were well above their sold prices (see figure 4).

Figure 4 - DC office properties sold in 2023 – Assessment/sale price (in millions)

Total tax revenue is not always dependent on assessed values

In California, Massachusetts, and DC, property tax rates are set by statute. This means that the total amount of amount of property tax revenue is determined based on the total assessed value multiplied by the statutory tax rate. As a result, the cities of San Francisco and Boston, as well as DC, are at risk of collecting less revenue if overall assessed values drop.

In other regions, including NY and Chicago, as well as Toronto and other Canadian cities, the amount of required revenue is established first, then divided by the total assessment base to determine the tax rate. If assessed values drop, the rate of taxation rises to compensate. Taxes for individual properties go up and down based on their relationship to the average change. In this situation, a substantial loss in value for downtown office buildings means that those buildings will pay lower property taxes, while properties experiencing increasing values will pay more.

If property taxes don’t fall, a different kind of “doom loop” emerges

Right now, office building values are falling because they are struggling to maintain occupancy. This means net operating incomes (NOI) may be strained or even negative, and properties may be struggling to refinance with rising interest rates. In this situation, even if a property tax assessment is lower than the current market value, having property taxes remain the same or even increase can create a different kind of “doom loop” – as the property’s costs increase, net operating income falls further. The property owner is therefore less able to maintain the property, the property becomes less attractive to tenants, rents or occupancy are reduced, and the value continues to decline.

Reduced property tax fuels recovery

In San Francisco, under California’s Proposition 13, assessments are reset when a property sells. As reported in the Wall Street Journal, 350 California Street – which raised alarms when it traded in early 2023 at about 20% of its pre-pandemic value – has not only begun to show signs of its own recovery but helped to reset valuations in the market. In fact, the building has leased two floors to new tenants since the purchase. 60 Spear Street in San Francisco, which sold later in August 2023 for $40.9 million, had a total assessed value (set from a previous sale and annual 2% increases) of $123,604.000. Based on the sale, the assessment will reset to $40.9 million, reducing the property’s annual taxes by about $974,000. The savings will allow the new owners to add amenities to help attract and retain tenants. New buyers can afford to charge rents that undercut the rest of the market and still be profitable.

Not only do assessments reset to market value when properties are sold, but taxpayers in California have the ability to appeal when the market value falls below the assessed value (as was the case with 60 Spear Street). The number of appeals filed in San Francisco increased from 2,577 in 2022 to 7,508 in 2023.

While these appeals fuel fears of falling revenue, assessed value lost on appeal has not yet outpaced the assessment growth. In August, the assessor for the City of San Francisco announced that the total assessed value of commercial real estate had grown to $350 billion for 2023-2024 – an increase of $15 billion over the previous year.

Breaking the “doom loop” cycle

Some cities are taking action to boost office values by investing in redevelopment incentives. A much-touted solution to burgeoning office vacancies in the face of chronic housing shortfalls is the conversion of vacant offices to housing. Office-to-residential conversions can mitigate the “doom loop” by revitalizing downtown space, increasing traffic, and supporting the return of retail and service providers, while also boosting office valuations by removing excess supply. The following criteria must be met for these developments to be successful:

• Permissive or flexible zoning

• Appropriate building construction

• Financial feasibility

In Calgary, Alberta, downtown office space was already facing significant challenges after the oil price downturn of 2015. By the end of 2023, downtown office vacancy rates sat at 30.2%. At the same time, the city is facing tremendous housing pressures, with record population growth in 2023. Calgary implemented its Downtown Incentive Program (DIP) in 2022 and currently has a pipeline of 17 office conversion projections which are forecast to convert 2.3 million square feet of vacant office space to more than 2,300 housing units. The program provided a grant of $75 per square foot for development. One of the first of these projects, The Cornerstone, is a building that was formerly occupied by SNC Lavalin but had been entirely vacant for several years. The 129,000 square foot building has since been converted into 112 residential units, with retail and residential amenities on the ground floor, and coworking space on the second. It is projected to welcome its first residents in April 2024.

While the redevelopment will dramatically increase the value of the property (from $5.5 million to an estimated $41.25 million when complete), the increase in property tax revenue from the project is somewhat limited. In Calgary, multifamily properties are taxed at the residential rate, which is much lower than commercial ($3.36 per $1,000 vs. $22.07 per $1,000 value). As a vacant office building, the property is currently assessed at $5.5 million and would pay $121,385 in property tax. The completed project has an estimated assessed value of $41,250,000 and will pay approximately $138,600 in property tax. The modest increase in taxes will not offset the cost of the development grant provided, but this is not the primary goal of the program. Not only will the project provide much-needed affordable housing inventory, but removing excess inventory from the office sector will reduce the overall vacancy for office buildings and will help to stabilize remaining properties in the surrounding area. In addition, more residents living downtown will generate additional economic activity for restaurants, stores, and services.

According to Dave Mewha, VP of Property Tax for Altus Group in Calgary, the development of some of the approved DIP projects has slowed due to the impact of rising costs on feasibility. However, the demand for apartment rentals is showing potential upside for revenues, which may start the process moving again.

Similar projects are currently planned or underway in many US cities, although financial feasibility continues to be an obstacle for many.

Boston Downtown Residential Conversion Incentive Pilot Program

Boston’s Downtown Residential Conversion Incentive Pilot Program, which was launched in October 2023, amends the planning code to expand residential uses and downtown office conversions, with a more streamlined review of certain projects. A property tax credit of up to 75% for 29 years is also provided. The program has received four applications so far.

New York City’s Office Conversion Accelerator

New York City’s Office Conversion Accelerator provides tax exemption during construction if 5% of units are designated for affordable housing. A property tax credit of 50% for 15 years is offered in South Manhattan, and 35% in other areas. The program expands eligibility for conversion and eliminates caps on density, and 52 properties are enrolled.

Chicago’s “LaSalle Street Reimagined” initiative

Five historic buildings are set to be converted to more than 1,600 new apartments with more than 600 affordable units as part of Chicago's LaSalle Street reimagined initiative, assisted by Tax Increment Financing. Deputy Mayor Samir Mayekar says the project will be transformational for the previously business-exclusive neighborhood. “More residents will naturally bring more small businesses and nightlife to the area and improve public safety with more foot traffic and eyes on the street throughout the Loop."

San Francisco’s Proposition C

San Francisco’s Proposition C, passed earlier this month, will exempt eligible office conversion projects from paying the transfer tax when sold. In San Francisco, properties sold for more than $25 million pay a transfer tax of 6% on the purchase price. An office converted to rental apartments that sells for $40 million would save $2.4 million in transfer taxes. If the office is converted to condominiums, however, the savings would be reduced – the rates for properties valued below $5 million are less than 1%. The program has been accused of not going far enough. to close the financial feasibility gap.

Leveraging market analytics and property tax management can give values a lift.

The value declines in many downtown office buildings have been steep and sudden, and for many class B and C office buildings, values are likely to remain depressed. As we have seen from property assessments released so far this year, these losses in value are not likely to have an immediate impact on property tax liability. Fears of a “doom loop” and crushing tax revenue losses are likely overblown.

Programs such as office conversions will remove some excess inventory while bringing more residents downtown. This should contribute to a resurgence of values in downtown areas, adding greater diversity and stability to the assessment base. The extent to which these programs have a positive influence on office values in the short term will need to be measured and verified before assessed values rise as a result.

Assessment valuation dates and methodologies vary considerably by region, and the impact of market changes on property tax liability is often muted, unless the assessments are appealed. While it may result in lower property tax revenues in the short term, property tax assessors need to take into account market trends and transactions to ensure that assessments move in connection with market forces. This is the defining principle of taxation based on market value assessment. A higher-value property should have more ability to pay taxes. Conversely, as a property’s value drops, reducing its tax liability can boost NOI and contribute to its recovery.

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