New York City is known as a place with low property taxes, thanks to its virtually unique sky-high local income taxes. Yet there is one class of property for which the city’s property taxes are not low – commercial buildings without special tax breaks. While it has many liabilities, the property tax has one key advantage – it is hard to hide the asset being taxed, and difficult for it to move to a lower-taxed jurisdiction. But like trees, commercial buildings do move slowly over decades as new ones are built in some places and not built in others, while old ones are torn down or converted when they become obsolete. Does this have a negative effect on the New York City economy? We may be about to find out the answer.
New office construction has virtually ceased in New York City. From 1981 to 1990, over 50 million square feet of new office space was built in Manhattan. Metrotech in Downtown Brooklyn and the Citicorp Building in Queens were completed at the end of that decade. From 1991 to 2000, on the other hand, less than 4 million square feet was added in Manhattan, and Downtown Brooklyn and Long Island City stagnated. Then 15 million square feet was lost in the World Trade Center disaster in 2001, and since them limited new supply has been balanced by older office buildings converted to residences, for a net loss of space.
When space did get built in Manhattan during the last 15 years, there has generally been a large corporate anchor tenant. And that anchor tenant has generally threatened to move out of the city unless provided with special tax breaks to make new office space in New York City competitive with new and existing space elsewhere. The most recent deals were awarded to the New York Times and Goldman Sachs.
Outside Manhattan, new commercial buildings are exempt from property taxes for years under the 421-b program, but existing properties pay the full rate. While New York City zoning regulations make developers jump through hoops to open large stores in many areas, and have successfully kept new supermarkets out of most poor neighborhoods, when large developments are built they are tax free. Outside Manhattan, the New York City policy is apparently “if they cut a deal let’s subsidize it, but if it isn’t subsidized we’re against it.”
There were plenty of non-public policy reasons for limited office development in the 1990s. The 1980s boom had left the city, and the country, with a glut of office space. Lenders became unwilling to finance new office buildings without extensive pre-leasing from highly creditworthy companies, which generally requires a commitment from a large corporation. It had thus become impossible to add new “speculative” space for small and new businesses in New York City. Demand from those businesses, in the 1990s, was met through the conversion of former industrial space in places like Midtown South. Until recently office rents had been falling, relative to inflation, for more than two decades. Some argue that the internet will, eventually, lead to more people working at home. But in the interim, cheap rents and available space made New York City highly attractive to new entrepreneurial businesses in the 1990s.
Not so today. The World Trade Center disaster happened during a recession, and the businesses displaced from Downtown were readily absorbed elsewhere. It is only now that the loss of that space is starting to bite. The Real Deal reports “vacancy rates plunged and rents soared in the last month of 2006, capping off a record year for commercial real estate in the city…The downside to this boom is that there is precious little space available and little new inventory coming onto the market.” Thus far, soaring rents have not induced firms to leave the city, but they may already have an effect on new firms. So will new speculative space be built? Why hasn’t it been?
After the World Trade Center disaster, property tax rates were increased by 18%. But before and since, the city and state have enacted a series of policies to hand money back to homeowners and, to a lesser extent, apartment owners, leaving commercial property owners with a rising share of the bill. And, some conservative columnists have already pointed the finger at city regulations that discourage buildings, the glacial pace of development at the World Trade Center site, and taxes that discourage new construction.
In my view, the regulatory argument might have been true in the past, but not today. In the mid-1990s, the city was lackadaisical about rezoning areas like the West Side, Downtown Brooklyn, and Long Island City, announcing the policy but taking little action because there was no interest from the real estate community. When the economy soared in the late 1990s, the Department of City Planning began initiatives in these areas, initiatives that took years. By the time policies were approved, the 1990s boom was over. But now zoning is in place to allow extensive office development in all of these areas, in addition to existing commercial centers. At the World Trade Center, redevelopment may have been stalled at one time by the approval process, but in recent years has been stalled by the lack of pre-leasing by large corporations. Indeed, development is moving forward only because government agencies have agreed to lease the space. In short, the private sector has regulatory approval to start millions of square feet of office space tomorrow if it chooses.
There is also an argument against the role of property taxes in the office development dearth. New office space in Downtown Brooklyn and Long Island City remains tax-exempt for years, yet no one is rushing to build office buildings there. Developers are building condos and hotels in the outer boroughs instead. In fact, they are building hotels in Manhattan, and hotels do not get tax breaks or pre-leasing. New condos, which are also being built and financed there, have a diminished tax benefit in the Manhattan core, though they continue to be advantaged in the other boroughs. On the other hand, perhaps the higher tax on office space relative to residences tips the balance in the competition for available sites.
It is possible, therefore, that the office space dearth may be a result of trends in the private sector, not public policy. Large companies may have gotten used to the idea of getting tax breaks in exchange for new building construction, and may be unwilling to pre-lease without them. This may be a game of chicken.
It may also be that the herd of bankers and Wall Streeters, who get paid enormous money to do what everyone else at the country club is doing whether it makes sense or not, are sticking with their collective decision not to finance office buildings in New York without pre-leasing – even though they are willing to finance hotels and condos, the latter to the point where a glut may be coming. Even Larry Silverstein, who has insurance money to play with at the World Trade Center, is not going forward on additional buildings without large corporate tenants. The former World Trade Center, in contrast, had been occupied by thousands of small companies, and the small local offices of large companies from elsewhere.
Meanwhile, the Department of City Planning is waking up to the long term economic threat of a lack of space for entrepreneurs. In a reprise of the 1990s, it will propose lifting limitations on converting space in the Garment Center from light industrial to office (but not to housing, or at least not without variances, loopholes, or self-certified illegal construction). There seems to be no new Class B space, commonly built elsewhere, on the horizon.
As mentioned in the 421a discussion, the value of land also has to be factored into the equation. As long as land has value as a development site, then taxes are not so high as to completely prohibit development. But commercial property taxes may be high enough to make the existing use (a parking lot) more profitable than a potential use (say a new Class B office building), especially if the tax on the building is high relative to the tax on the land (see Henry George). And if one use is more tax advantaged than another (say condos), it is more likely to be built all else equal.
So is the government, with its discriminatory taxes to blame? Or the real estate industry, which lacks the balls to finance and build? With vacancy plunging and office rents soaring, we’re about to find out.
If the City knuckles under and provides more tax breaks for new buildings, then we will have established that not only do its property taxes hit business harder in favor of homeowners, but within business they hit small and new businesses (in existing buildings without tax breaks) harder in favor of large corporations, both in the outer boroughs where they occupy new developments, and in Manhattan where they get special deals. This, combined with the unincorporated business tax, will establish once and for all the hostility of the City of New York to new business and entrepreneurs, and their political powerlessness.
If the City does not knuckle under, new office buildings are not built, rents soar, and job gains stop, then it will be possible to conclude that the real estate industry is responding to high taxes by gradually moving its office space elsewhere. As long as spec buildings aren’t built for new and small companies, large companies do not have to leave the city to reduce employment growth. They merely need to stay put in existing buildings, denying small and new businesses affordable space in the existing buildings they would otherwise leave behind.
If office buildings start popping up, possibly because developers and capital from outside the city move in and do what the local industry will not, then the overall attractiveness of the city will have continued to outweigh the high taxes collected by our state and city governments.
Economic development agencies often credit subsidized office space with "jobs created." But office buildings do not create jobs, businesses do. If there isn't enough office space, however, its absence can reduce employment. Will someone put up a spec office building in this town?