Fuzzy Math: Property Taxes Haven’t Officially Risen in More Than a Decade. So Why Have Collections Doubled?

A few years ago, a city Department of Finance official noticed irregularities in the way certain residential properties had been appraised by the agency, leading to slightly lower-than-normal valuations.

To compensate, the official suggested the department decrease its assessments across the board for the group, which mostly comprised single-family homes and small co-op buildings in an area of one of the boroughs.
Dropping the valuations slightly below usual thresholds would reduce the taxes the city could collect, but only by a few percentage points—a seemingly harmless amount in the face of the billions of dollars the agency assesses—and it would allow the department to restore uniformity and equanimity to its calculations, one of the mandates of its process.

What appeared to be an innocuous adjustment, however, garnered a backlash that was swift and forceful. Top officials at the department were summoned to Mayor Bloomberg’s Upper East Side townhouse. There they were confronted by the mayor and irate senior executives from the city’s budget office, the person said.

Though the theme of the meeting was ostensibly to discuss the irregularities and why the department had chosen lower assessments, the underlying message was clear: don’t trifle with the city’s revenue.

“I feel like we got taken out to the backyard to get whipped,” the source said, requesting anonymity because of the sensitive nature of the meeting.

fuzzy math Fuzzy Math: Property Taxes Haven’t Officially Risen in More Than a Decade. So Why Have Collections Doubled?The episode would seem to lend credence to a complaint that real estate industry executives and advocates have voiced for years. Though the city has not raised real estate tax rates in a decade, these people say it has used a complex appraisal process to arrive at values that essentially accomplish the same thing, albeit far more conveniently, because it allows elected officials to avoid the political repercussions of lifting the tax rate.

Indeed, total collections on commercial buildings have jumped from about $3.8 billion in 2001 to nearly double that today.

Few industry observers would disagree that commercial and residential property has appreciated dramatically in that time. But the fact that property taxes never flagged, even in the aftermath of a serious recession, is evidence, analysts insist, that the city has come to treat real estate as a golden goose for revenue.

“We had four years of falling prices, but real estate tax collections never fell,” said Robert Knakal, a chairman at the real estate brokerage and services company Massey Knakal, said. “How does that even work?”

When Mr. Knakal launched his real estate career in the 1980s, the city used a different method of calculating real estate values that was more closely tied to sale prices. The formula was altered in the early 1990s, he said, a conspicuous juncture for those who feel the city has been leaning too heavily on the industry for revenue, because that was when the recession of that period began pulling values down.

“Values started to drop, and then suddenly the old appraisal system wasn’t good anymore and the city abandoned it,” Mr. Knakal said, suggesting the city had adopted a newer methodology during that period in order to raise collections from the industry.

To calculate an assessment for an office building, the city first determines its income, which owners are required to report every September, then plugs that number into a rate of return for the property and deduces the value. Detaching the process from the value of a building as determined by its sale, or the sale of a comparable asset, is not a decision landlords argue with, even though a sale-price-based method would clearly have brought taxes down during the recession when landlords were looking for breaks. Property values during that period plummeted by 40 percent. The flip side of such a system, however, would mean that, as property sale prices have shot up during times of frenzied buying, landlords across the city would have had to suffer the consequences on their tax bills.

“You could have an owner coming in from some far-off place and he just wants to plant his money in a safe haven, and he’s willing to pay a very high price and accept a 2 percent cap rate, but that’s not the value I or another investor might pay,” landlord and developer Edward Minskoff said.

While owners generally agree with the rationale of an income-based approach, many criticize certain assumptions the city makes in its process. For instance, city appraisers factor in both market vacancy rates and rents when determining the value of an owner’s empty space, assumptions that often sway value higher.

So if a Midtown building has, say, a 20 percent vacancy rate, the Department of Finance would blend that with the neighborhood’s overall vacancy, which is currently around 10 percent, and arrive at a 15 percent estimate.

Average rents would be used to then determine income from that phantom occupancy.

The valuation process gets more complicated in determining the cap rate for the property, the return a building earns. To calculate this figure, the city weighs a number of factors, including the debt a building may carry, which it constructs from prevailing market lending rates and leverage levels—debt that may or may not correlate with the actual financing on a property. Some landlords say the city has been quick to adopt lower cap rates, which inflate values, as the sales market in Manhattan swiftly recovered in the aftermath of the recession.

“The assessments are a snapshot of cash flow right now, but it often fails to weigh the real financial conditions of the building,” said Michael Lippman, an attorney with the firm Sherman & Gordon who represents major landlords in contesting their property values with the city.

“I think the city makes an effort to get it right,” he added. “It’s a complex process.”

The result has been that property taxes for commercial buildings have risen steadily. Data released by the city and an individual analysis of the tax bills for several major office buildings show that assessments have grown since at least the mid 1990s. During the last 10 years, total collections for commercial properties in the city doubled from $3.87 billion in 2001 to $7.67 billion this year, even though the period includes two recessions.

To those who balk at the level of taxes the city levies from the real estate sector, the numbers indicate a system designed to capture steady gains but cede few, if any, declines.

Others, of course, disagree.

Allan Schwartz, a real estate tax attorney, says the steady or rising building assessments of recent years is due to the fact that real estate income is typically locked in through long-term leases that are not impacted by rocky economic times.

“It’s a common-sense question: how is it possible from 2007 to now, a few years after we have suffered a recession, for building values not to have gone down?” Mr. Schwartz said. “It’s because buildings’ incomes haven’t necessary suffered. And the city is using that income to calculate the values.”

But Mr. Schwartz also said that tax gains have begun to consume an unprecedented portion of the income landlords generate from rents, a sign that tax growth has outpaced inflation and other reasonable measures of growth.

“The taxes are approaching 24, 25, 27 percent of the rents commercial landlords collect,” Mr. Schwartz said.

Numerous sources familiar with taxes in other major cities in the U.S. say that New York City’s tax burden is far higher than in other markets.

The situation doesn’t just put a strain on owners but also on tenants, affecting the economic fabric of the entire city, landlords say. That’s because most leases in the city are structured to pass tax increases on to the tenants in a building during their occupancy. The costs make it more difficult for companies to afford to operate in a city that is already expensive, landlords say.

“It would definitely incentivize more and more companies to want to be in the city if taxes went down or stopped rising,” Mr. Minskoff said. “It would be very positive because, by lowering taxes, the city could actually increase its tax base, because more tenants would want to be here.”

Mr. Minskoff, who is in the process of building a 400,000-square-foot office property at 51 Astor Place, said taxes have been an especially big hurdle for new development in the city, construction that is widely seen as necessary to keep Manhattan’s office stock competitive with other global cities. Landlords already have to charge premium rents to justify the cost of these developments, Mr. Minskoff explained, and the tax payments that get layered on top of the base rents make committing to such projects an even more expensive proposition for tenants.

The Real Estate Board of New York, the city’s largest and most powerful real estate industry and lobbying group, has stepped up efforts to intervene on the issue in the hope of staving off further increases. Mary Ann Tighe, chairwoman of the trade association, told The Commercial Observer that taxes would be a leading issue for the incoming REBNY chairman, Robert Speyer, a top executive at the investment company Tishman

Speyer, when he succeeds her in January of next year.

“[It’s a] huge issue,” she wrote in an email.

Surprisingly, some real estate executives interviewed were either resigned to or even supportive of the city’s collection efforts toward the industry.

“No one complains when they’re buying or selling properties at $1,000 or $1,500 a foot that in 2005 and 2006 they were paying $700 or $800 [for],” said Norman Sturner, chief executive of the real estate investment firm Murray Hill Properties. “No one complains that the city has 4 million vistors a month, which is making the retail, hotels and everything else do incredibly well. [And] no one complains that since 9/11 we have been safe.”

“All of these things cost money, and where does it come from?” he added. “I will not complain about a rise in taxes that are being spent properly, and it seems that they have.”

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