Budget Deal’s Good News for the Industry
Tom Acitelli March 31, 2011, 8:46 a.m.
Over this past weekend, it appeared that a budget deal for New York State was agreed upon in principle. If finalized, the agreement would provide Governor Andrew Cuomo with a remarkably decisive first victory by delivering an early budget deal that would erase a $10 billion budget deficit without raising taxes and without borrowing, something he pledged to do during the campaign but something few expected he could actually deliver. The deal also would begin a long-term overhaul of the state’s out-of-control Medicaid programs.
The tentative agreement between the governor, Assembly Speaker Sheldon Silver and the majority leader, Dean Skelos, results in a $132.5 billion budget that mirrors very closely the initial proposal made by the governor less than two months ago. The agreement calls for a 2 percent year-over-year reduction in spending, or roughly $3.4 billion less than 2010 levels. The governor promised significant change, and this budget reflects real spending cuts for the first time in nearly 15 years.
Spending in the state has been spiraling upward during the past decade as inflation grew by 2.4 percent annually and tax receipts rose by 3.8 percent per year. Simultaneously, state spending increased by 5.7 percent on an annual basis. This difference is stunning, particularly when compounded. Additionally, spending increases in some areas were mandated to increase by as much as 13 percent per year!
Remarkably, the governor was able to convince legislative leaders to agree to a cut of more than $2 billion in spending on health care and education. These two components of the state budget make up nearly 50 percent of all spending.
Powerful unions have thwarted cuts in these areas in the past and the governor’s ability to garner public sentiment and support for these cuts is impressive. He was able to pull together support from some of the unions (which were given a stake in process of formulating a resolution) as well as business leaders to “sell” the need for dramatic fiscal action. In addition to reduced spending in these areas, significant fundamental reforms must also be undertaken.
ew York City alone has approximately 300,000 public employees, operating under more than 100 collective-bargaining agreements. These public-sector employees operate under far too many rules and protections that hurt, disproportionately, the very people progressive reformers care about most: the disadvantaged members of society, who rely most heavily on effective support services.
The existing labyrinth of work rules, protections and employment guidelines has created a system that hires without discretion, provides raises and promotions without merit and lays off teachers without considering performance. A system like this is not in the best interest of New Yorkers and certainly does not truly serve those who need support, particularly children.
Additionally, unsustainable pension burdens have been imposed by state legislators who have been pawns in the collective-bargaining process. Powerful unions have had the ability to mobilize large voter bases and to provide massive levels of campaign contributions to the very people whom they will then sit across the table from and negotiate contracts with. Is it any wonder that these elected officials have made promises they can’t possibly keep?
In fiscal year 2012, $8.4 billion will be spent from New York City’s operating budget to fill a hole in unfunded pension obligations. The new budget deal will force the city to face an even larger fiscal challenge, as state funding to the city will be cut substantially. This will likely lead to the significant number of layoffs that Mayor Bloomberg warned of, as tax increases would be untenable in today’s environment.
Trying to tax a city into prosperity has become an increasingly futile approach for urban mayors across the country. New Yorkers’ tax burdens are already the highest in the nation; therefore, figuring out how to do more with less is the new political reality.
It appears the governor has utilized the threat of passing his complete budget proposal under an extender bill if the Legislature did not agree to an on-time budget. This approach worked well for Governor Paterson, and, clearly, his successor was taking notes.
The version of the budget that appears to have been agreed to restores about $250 million that was projected to be cut in the governor’s initial budget. Clearly, both sides retreated from positions in which they appeared to be entrenched. Shelly Silver backed off his position of reacquiring the renewal of an income tax surcharge on people making over $200,000 per year, and Dean Skelos agreed to have upstate prisons containing as many as 3,700 beds closed.
FOR COMMERCIAL REAL estate, any budget deal would have profound impacts on two issues central to the health of the industry: both income taxes and real estate taxes; and New York’s rent-regulation laws, which are set to expire on June 15.
With respect to taxes, a budget deal that bridges the deficit without increasing the tax burdens of New Yorkers was critical. When the federal government has to bridge a budget deficit, it has three options: cut spending, increase taxes or print money. Recently, the feds have opted to print money in almost every case. At the state level, this option is not available. Therefore, to the extent that the state government cannot control spending, they have no option other than to increase taxes.
From a real estate perspective, New York’s income taxes are important, as they are already the most burdensome, on a per-capita basis, in the nation. To the extent these burdens continue to increase, New York becomes a less attractive option for residents and businesses, both of which occupy residential and commercial space in our city. Fiscal responsibility and controlling taxes will serve to make New York more competitive, increasing the city’s attractiveness as a place to live and to work.
More importantly to the industry, spending cuts encourage those who are hopeful that we are more likely to have a somewhat reasonable real estate tax policy moving forward. Increasingly, politicians have relied on the real estate industry to provide tax revenues. Last year, real-estate-related revenues reached nearly 50 percent of tax collections for the city.
These revenues were generated via real estate taxes, mortgage-recording taxes and transfer taxes. Many people point to the financial services industry as the backbone of the city; however, when you look at revenue, it is difficult to argue that real estate is not the most important industry in this town.
There is no doubt that real estate taxes will continue to grow, but they are likely not to increase as much as they would have in the absence of spending cuts. The inequities within the current real estate tax system are numerous and certainly need to be addressed. Income-producing Class 3 and Class 4 properties and multifamily rentals pay a disproportionately high share of property taxes; single-family homes and older co-ops get essentially what amounts to a free pass from vote-conscious legislators. This latter classification of properties represents 49 percent of total market value, yet pays only 15 percent of real estate taxes.
ANOTHER POSITIVE NOTE for the industry is that it appears (as of press time Monday) that the renewal of rent-regulation laws has not been linked with any of the existing budgetary compromises and will be left to separate negotiations prior to the June 15 deadline. It is unclear whether any promises were made to effectuate the pending budget agreement, though it would be naïve to think otherwise.
Mr. Silver, the Assembly boss, desperately wanted to tie rent-regulation reform to the budget negotiations. A central theme of the negotiations here will revolve around the $2,000 rent threshold for deregulation. Former Governor George Pataki endorsed guidelines that permitted vacant apartments to be removed from regulation if legal rents rose to $2,000 per month. Additionally, occupied apartments could be deregulated if the legal rents rose to more than $2,000 per month and the occupant of the apartment earned in excess of $175,000 for two consecutive years. From 1994 to 2009, nearly 100,000 units were deregulated, motivating building owners to invest heavily in the housing stock in order to compete for tenants.
It is clear that the $2,000 threshold seems to be working well, as deregulation is occurring slowly. At the present pace, it would take about 150 years before regulation was phased out completely. The Assembly and housing advocates want to increase the $2,000 threshold to further delay the elimination of this restrictive price control, which constrains supply and artificially impacts pricing.
Rent regulation is a public assistance subsidy program that, as I have argued in this column, is doled out on a random basis, leading to a gross misallocation of our housing stock. There is no means testing to determine if recipients of this public assistance are actually in need of it.
While the $2,000 threshold appears appropriate for vacancy deregulation, it is completely backward to use it in high-income, high-rent “luxury decontrol.” The threshold should not be raised here; it should be eliminated altogether.
For example, let’s assume a market rent for an apartment is $2,500 per month. If the occupant of the unit earns more than $175,000 per year and has for two years running, and the legal rent reaches $2,000 per month, that high-income earner is receiving a rent welfare subsidy of $500 per month, or $6,000 annually. This unit would be eligible for deregulation, and the subsidy, which is paid by everyone who is not rent-regulated in the form of higher market rents and higher real estate taxes, would cease to exist.
However, if that same high-income earner was paying only $750 per month the unit would not be eligible for deregulation. The subsidy to the tenant in this case would be $1,750 per month, or $21,000 per year. If the tenant were paying only $750 per month, the burden on the non-regulated taxpayers and the market would be significantly higher. Therefore, the lower the rent is, the more appropriate the high-income deregulation becomes. The thinking behind raising this threshold is backward as the lower the rent is, the more burdensome the subsidy becomes.
AS OF PRESS TIME ON MONDAY, a budget deal had not been finalized, and, certainly, the devil will be in the details, but it appears that if an agreement can be forged along the lines released on Sunday, it will be beneficial to the industry.
Income taxes could stay relatively flat, making the city less undesirable as a location for potential residents and businesses. Legislators will not be forced to raise real estate taxes more than they normally would (now we just need a sensible system); and rent-regulation renewal can be negotiated within an appropriate time frame, not in an expedited way, nor used as leverage tied to other concessions.
Rent-regulation renewal has profound implications for the future of our city, the quality of our housing stock and our real estate tax base. Crafting housing policy that is well thought out is essential for commercial real estate and our city’s future.
Robert Knakal is the chairman and founding partner of Massey Knakal Realty services and in his career has brokered the sale of more than 1,125 properties, having a market value in excess of $7 billion.