New York Can’t Afford a Sluggish Commercial Real Estate Sales Pace
In the 1983 classic “Trading Places,” Eddie Murphy’s character Billy Ray is taught how the fictional commodity brokerage Duke & Duke makes money. Some clients, he is told, are betting prices will rise and others that prices will fall. The “good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions.” Murphy then sums up Duke & Duke’s business plan — and its need for volume — very succinctly: “Sounds to me like you guys are a couple of bookies.”
Just like Duke & Duke, New York’s commercial real estate brokers need volume. And there is a direct connection between volume in the commercial real estate market and the health of the city. There are numerous economic components to every real estate transaction, and essentially every one of them generates a tax. While property tax is the largest single contributor to New York’s coffers, there is significant additional revenue generated by everything from transfer tax to income and sales tax. The ability to collect these taxes directly impacts the city’s ability to pay for everything from teachers and nurses to road repair and housing.
Today, there are significant roadblocks that are making it hard for deals to get done. There is also a failure to understand the economic impact of decreased activity. But it is very simple: When city and state governments incentivize activity, everybody benefits.
Each time a property is sold, numerous taxes are collected. New York City’s transfer tax is 2.625 percent of the sale price, with New York state also charging a transfer tax on top. On a $5 million property, this translates into $131,250 in tax. If there is a new mortgage of $3 million, the mortgage recording tax is another 2.8 percent, or $84,000. Before other taxable events occur, the city just made $215,250.
There are other, broader economic factors to consider. First, new owners often renovate properties, which leads to construction jobs. These jobs lead to the sale of items in local stores to make improvements, which generates sales tax from the materials and income tax from the labor. Sellers are usually represented by a broker who earns a commission and an attorney who earns a legal fee, both of which then generate income tax. If the property has vacancy, more brokers are engaged to lease empty spaces, generating additional income tax. All of these are material benefits that come from incentivizing activity.
But what happens when activity is not incentivized — or, even worse, when it is actively disincentivized? We are seeing that play out in New York City right now. On the apartment leasing side, the city is essentially saying, “We will not help you collect the rent, we will enact and enforce laws preventing you from trying to do so, and we will create a massive backlog in the courts so you get to see a judge less frequently than you see Halley’s comet.” This means tenants will occupy spaces without paying during the term of their lease and will continue to occupy — and not pay — for their space after their lease expires. But a lease is a contract, and a logical question arises of why one party should have to adhere to it, not both.
On the sales side, we have already seen significant and ongoing reduction in valuations. There are numerous data points that show a tremendous drop in values, and more owners are willing to hand their properties back to their lenders. If an owner is unable to make a profit and there is no path to profitability, why would they keep their property let alone throw good money after bad to maintain it?
While this situation and my examples are specific to New York City, this narrative is playing out nationwide. Incentivizing activity creates jobs and bolsters tax revenue and is critical to the way cities operate. As this stagnant period continues, New York City’s elected officials will have to make some very tough choices. They could have to say to its municipal employee groups, “We can’t give you raises or even keep paying you because we have actively diminished leasing and sales volume and the coffers are empty.” I wouldn’t want to be on either side of that conversation.
There is a strong sense in New York’s real estate community that elected officials don’t want to spur transactions but are more than happy to tax property owners. It’s equivalent to saying to an employee, “You have to work all year, but we won’t pay you and you have to pay income tax on money you didn’t earn.”
The late Supreme Court Justice Oliver Wendell Holmes once said, “Taxes are what we pay for civilized society.” The inverse of that statement is, “What happens to civilization when there aren’t taxes being paid?” It is not just brokers who need volume. It is New York City as well. It’s time for government to pump up the volume and help all of us.
Ben Tapper is executive managing director of brokerage Lee & Associates NYC.