Falling commercial real estate prices are hitting local budgets

A couple of weeks ago I wrote about a new study which found that working from home is here to stay. I concluded by noting that:

If this holds for Minnesota, it could have some far reaching consequences. It will lessen house price pressures in the Twin Cities by allowing people to access jobs there while living somewhere else. This, in turn, will make it even harder for downtown Minneapolis to “bounce back.” By making place less important, it will make businesses and workers more mobile. And, finally, it could lead to some surprising results come the next redistricting.

This, of course, is not an exhaustive list of consequences. Another is that as offices are in less demand their rents fall and so, in turn, do their real estate values. And that impacts local property tax collections.

The Star Tribune reports:

Plummeting commercial real estate values prompted by the shift to remote work are causing a trickle-down financial crunch on cities, schools, park districts and other public operations that depend on tax collections.

The reason: more commercial property taxes are going unpaid than at any time since the Great Recession of 2008-09.

Minneapolis, for example, typically collects around 99% of taxes levied. But by the third quarter of 2023, just 97.5% of taxes levied had been collected — leaving $11 million in unpaid taxes.

Initially the impacts of this will be concentrated in some areas:

Some public bodies, like the city, rely less heavily on property taxes to fund operations, so the immediate impact is less severe. But the tax-collection drop is a major hit for the Park Board, which ended the year with a $1.9 million difference between taxes levied and those actually collected. The board depends on property taxes to finance almost 80% of its general fund — and might be a harbinger of what can happen when collections fall short of expectations.

“This is a big reality check,” said Park Board President Meg Forney, who noted the revenue loss comes as the Park Board is working on major capital projects and in negotiations with union park workers looking for higher pay. “So heads up everybody, roll up your sleeves, because we have a big lift here.”

For Minneapolis Public Schools, which is already facing financial challenges as a result of declining enrollment, property taxes represent one-fifth of its operating budget. A 1% decline in its collection rate would be a loss of roughly $1.5 million, said Donnie Belcher, the district’s executive director of marketing and communications. At last year’s collection rate, then, MPS is down nearly $3.5 million in tax revenue.


…the steep and steady decline in commercial property values is a longer-term problem because delinquent taxes are a first-priority lien — meaning they receive payment ahead of other debtors even in the case of a foreclosure on a building.

Tax revenue lost to declining values is likely to be a much bigger problem for municipal coffers. Already, the value of many commercial buildings in Hennepin County has been falling — by double digits in some cases, siphoning tens of millions in tax revenue from state and local budgets.

In downtown Minneapolis, the owners of the IDS Center saw its value fall about $62 million in three years after peaking at $319 million in 2020. The value of the tower, which is current on its property taxes, is only slightly more than what a Florida-based investor paid for the building a decade ago.

Many office owners are already in a precarious position as they struggle to make loan payments and pay taxes on buildings that are no longer worth what they paid for them. Many refinanced their loans on the eve of the pandemic when values peaked and interest rates were at record lows, and now many are coming due again.

Trouble is, values are down significantly and lending rates are higher, causing a growing number of borrowers to default on their loans — and leaving lenders to decide whether to foreclose or buy time with a modification to the loan terms.

That’s what happened recently after the loan came due on the IDS, raising the prospect of foreclosure on the region’s tallest and most iconic office building. After months of negotiations, the owners of the building were recently able to modify the terms of its loan, averting a crisis for building owners, tenants and the city.

A deepening glut of office space is to blame. Office vacancies across the metro rose to a record 13.6% at the end of last year, according to a new report from Colliers. For most of the pandemic, downtown Minneapolis was the epicenter of the problem, but the financial pain is spreading, especially into the southern suburbs. At the end of last year, the office vacancy rate along the Interstate 494 corridor eclipsed downtown Minneapolis.

Much of this is the result of shutting down offices in 2020 in response to the COVID-19 pandemic. But there are other factors at play, too:

The second-largest suburban property behind on taxes is the Huntington Place apartment complex in Brooklyn Park, which owes nearly $383,000 and has been penalized $42,700. It is a 55-year-old building with perennial problems of crime and blight, and leads the county in evictions. The affordable housing provider Aeon purchased the complex in 2020, and last spring the city of Brooklyn Park stepped in to monitor stabilization efforts.

Aeon CEO Eric Anthony Johnson said hiring private security, installing a checkpoint and evicting gang elements have all been working to calm the complex down — but at a cost.

“We prioritized our spending on safety, and not the taxes,” Johnson said. “We are preparing to pay the taxes, and we will pay our taxes, but we wanted to make sure that in no way, shape or form Huntington was being viewed as a place that was unsafe.”

One sympathizes with Mr. Johnson. It is hard to see why he should pay property tax to the local government when the local government won’t provide the most basic service of protecting his property from crime.

The hollowing out of local government tax bases is not, perhaps, something that many of us foresaw when workplaces were shut down four years ago. But remember: the majority of the consequences of any action are unintended.