Flood of Property Assessment Appeals Could Wallop U.S. Cities

'A lot of owners and operators have what they perceive as significant data to support a 40 percent or 50 percent reduction'

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For big city landlords and office owners, seeking to shave a few dollars off tax bills might as well be muscle memory. On March 1 of this year, there was a line down the block in front of the Municipal Building in Lower Manhattan to file property tax appeals.

“In New York City, 99 percent of owners appeal,” said Steve Thompson, a commercial property tax expert at tax consulting firm Ryan. “Most commercial owners are acutely aware that this is their largest annual operating expense, and it becomes like spraying for pests. If you don’t do it every year, it can snowball and become a huge problem.”

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This year, the appeals came with a lot more angst. Amid steeply declining office values and open questions about the future of this sector of commercial real estate, tax appeals and efforts to reduce tax burdens have become more frenzied. Thompson’s clients, which include Fortune 1000 firms and large real estate investment trusts, have petitioned for significantly lower tax assessments: 40 percent to 50 percent in New York City and San Francisco, and even 75 percent in Washington, D.C. In his two decades of work, he’s never seen owners dig in their heels and be so combative.

“A lot of owners and operators have what they perceive as significant data to support a 40 percent or 50 percent reduction, and they’re not going to be shy about going to court and getting that,” Thompson added.

A true disconnect in valuations — cities currently value office properties much higher than buyers and sellers — means that expected years of appeals seeking to bring those values back in line will unexpectedly eat away at municipal income. In New York City, many Class B office buildings actually saw increases in assessments this year, despite increasing vacancy and sublease activity.

In New York, for instance, property owners can appeal tax assessments going back five years, so it’s likely owners will continue to dispute current valuations as future sales provide legal backing for their arguments.

“New York City doesn’t have a real firm grasp on what this means in terms of revenue exposure,” said Thompson. “The city is trying to do budgets year after year, and they have no real idea of how much money they’re going to be giving back.”

New York City is far from alone. This doomsday scenario has been sketched out by municipal financial authorities and watchdogs nationwide. One key issue remains that the tax systems in question, which vary considerably across cities, do share a propensity to look backward and not forward. 

Most utilize an income method of value assessment, due to the unique nature of office properties. The income method looks at past income and expenses, divides that by a capitalization rate, and figures out a taxable assessed value. By comparison, residential property values, like the ones you see on Zillow, are calculated based on recent sales of comparable nearby homes, a method with more constantly updating data points.

Assessment is an art, not a science, and assessors have to complete this task on a mass scale, often using computer-aided appraisal tools to quickly and perhaps roughly compute what’s owed by whom. But with office owners struggling to keep up with all sorts of payments, lowering tax burdens becomes that much more important, since higher valuations and taxes mean higher bills and a harder time getting valuations to a point where failing properties can be sold and recapitalized. Uncertainty around tax rates and modeling for future payments also adds an additional question mark to the financial morass making new sales more challenging. 

“At some point, if you’re using the higher inflated value, the pigeons come home to roost,” said Joseph Cioffi, chair of the bankruptcy, creditors’ rights and finance practice group at Davis+Gilbert in New York City. “There are problems that are being masked until the valuations and the assessments come in line.”

A so-called tragedy of the commons situation — wherein individual owners will try to lower their tax burdens through public means, in turn bringing down overall valuations — remains hard to fix. And the speed with which this drop occurs means city budgets could slowly die from a thousand cuts. In Philadelphia, the Centre Square office complex, owned by Nightingale Properties and Wafra Capital Partners, successfully negotiated a valuation cut from $326.6 million to $250 million, both saving the owners and costing the city $1.2 million in taxes.

One of the challenges of higher tax assessments, at least in the opinion of owners, is the volatility it injects into previous deals and financing. If the market sees a property being worth less than the city does, it creates dueling data points that can become a basis for future disputes, said Cioffi. That in itself might be a reason owners might not be as aggressive in tax appeals, he said, since they don’t want to lose controlling rights over loans. 

Interest in the doom loop decline of commercial property tax tends to focus on New York City and San Francisco, for good reason. The former is the largest commercial real estate market in the nation, and the latter became the poster child, fairly or unfairly, for urban decline during the pandemic. But other cities and major real estate players may actually have a much more troubling and hard-to-fix problem. 

Boston depends on commercial property tax more than just about any major city in the country, due in large part to a state law that restricts what kinds of taxes municipalities can levy. Roughly a third of the city’s tax income comes from commercial buildings. Once traditional office towers start seeing their values slip, it’ll ripple across the market, said Evan Horowitz, executive director of Tufts University’s Center for State Policy Analysis. He predicts $500 million less coming into Boston coffers when this situation plays out. 

“You can’t put this on the feet of any Boston administration, they just don’t have any choice,” Horowitz said. “This is very foreign territory for Boston politicians. The city has not had a tax problem to speak of in 20 years.”

In Atlanta, the system of appeals and appraisals has been found to be very tilted toward property owners. An analysis by Georgia Tech School of Public Policy researchers led by professor Brian An found owner appeals were successful 62 percent of the time between 2011 and 2022, leading to $654 million in lost tax revenue. Owners can, in effect, appeal in perpetuity. 

Thomas Brosy, a senior researcher at the Tax Policy Center, sees a number of potential scenarios — increasing commercial or residential tax rates to cover lost income, jacking up income and sales taxes, or cutting city services — which would all have debilitating impacts on the price of assets and the attractiveness of cities for companies. Pittsburgh, for instance, faces sharp cuts for schools and public services due to ongoing revenue losses triggered by office value decline, and that pain is just starting.

These assessment formulas could be fixed legislatively, said Ryan’s Thompson, but cities haven’t been focused on this problem, hoping that values would bounce back. He foresees more and more of these appeals going to court, beginning in the fall, which will lead to battles between tax and assessment experts from regulators and owners. Owners in New York City have until Oct. 25 to file with the city Law Department, setting off a string of court cases that Thompson assumes will begin to reset many office values further downward. 

The movement toward this new normal in city finances will be a dribble, not a flood, said Horowitz. But once it’s set, it seems unlikely to revert to the past. 

“You can find examples where a city faced a sharp revenue shortfall for a couple of years,” said Horowitz. “But I don’t know of an American city that’s seen a persistent 10 percent falloff in revenue.”