Of all types of property, the values of office buildings may be the most adversely affected by the pandemic. Accordingly, owners of office buildings should carefully monitor their real estate tax assessments to make sure the valuations reflect the new post-COVID economic reality.
There are four main factors in the valuation of office buildings for real estate tax purposes:
- income
- vacancy and collection loss
- expenses
- capitalization rates.
All four factors have deteriorated post-COVID.
First, office building revenue is stagnant or declining. The exodus of workers from office buildings to remote locations has significantly lessened the demand for dedicated office space. With employees working remotely, many companies have realized they can function as well as before while occupying much less space and, as leases that were originally executed 5 – 10 years ago expire, those tenants choosing to renew may be doing so at flat or lower rates with a smaller area.
Second, owners are facing the problem of an increased amount of vacant space as companies continue to downsize, move out of state, or simply expand their remote workforce, considerably decreasing the need for physical space.
Third, building expenses have skyrocketed. Rapid inflation has helped to propel insurance and general property maintenance costs, which have surged upward by more than 15% since 2020. Lingering COVID-19 health concerns have led to enhanced cleaning protocols and upgraded air filtration systems, which have likewise raised expenses.
Lastly, the increase in mortgage interest rates has reduced property values by increasing the cost of financing. That, together with greater risk, has resulted in overall capitalization rates increasing 2 – 3 basis points over the past year. Higher capitalization rates generate much lower appraised values.
For property tax purposes, buildings must be valued for the upcoming year according to their current use and condition. The large shift in lease renewal rates, occupancy percentages, expenses and capitalization rates have or will result in a drop in market values of 10% – 40% over pre-pandemic market values. Most municipal taxing authorities have responded to this valuation apocalypse in the same manner as they have with any other issue affecting their tax base — they have simply ignored it. Consequently, property owners must be vigilant in challenging assessments to ensure current taxes are based on this new valuation reality — which can make the difference of several dollars per square foot in taxes.
Forchelli Deegan Terrana’s tax certiorari practice group has over 200 years’ collective experience in property valuation appeals. Please contact us for any property valuation assistance.
This article was published on the New York Real Estate Journal’s website on April 11, 2023.