The Pandemic's Ripple Effect: How Declining Office Values Are Shifting Property Tax Burdens in the U.S.

The real estate fallout from the COVID-19 pandemic, like the 2008 Great Financial Crisis (GFC), has lagged behind the broader economy. However, the current situation differs due to three main factors:

1. Inflation is now a primary concern, unlike post-GFC.

2. The pandemic has dramatically shifted office labor practices.

3. Housing was the main contributor to the 2008 crash, whereas office space is the current focus.

With the Federal Reserve projecting higher interest rates for longer, office values have begun to erode as companies fail to bring employees back to the office en masse. This trend is unlikely to reverse, leading to distress, receiverships, short sales, and value resets for office buildings nationwide.

The impact on property taxes, however, is more complex and localized. Since the US government doesn't levy property taxes directly, and each state has different tax codes, the effects vary significantly based on state, county, and local policies.

In Minnesota, particularly in the Minneapolis-St. Paul metro area, the situation provides an illustrative example. This region houses over half of the state's population and the majority of its office inventory, with Hennepin County leading in total office square footage.

As office values decline, the tax burden is shifting. Suburban residential property values have increased dramatically, causing homeowners to bear a larger share of local taxes. Additionally, Minnesota's State General Property Tax on commercial properties is redistributing the tax burden among different commercial asset classes.

Minnesota's property tax system centers on the concept of Net Tax Capacity (NTC), which determines the taxable portion of a building's value. The process works as follows:

1. State and local governments set their levies (required tax revenue).

2. The total NTC for each jurisdiction is calculated.

3. The tax rate is determined by dividing the levy by the total NTC.

4. This rate is applied to each building's NTC to calculate its tax due.

This system ensures that governments meet their revenue needs, but it also means that tax rates fluctuate annually in response to changes in levies and property values.

As office values decline and residential values increase, this system is likely to result in a shift of the tax burden. Commercial property owners may see some relief as their properties' values decrease, while residential property owners, especially in suburban areas with rising values, may face higher tax bills.

The long-term implications of this shift remain to be seen, but it's clear that the pandemic's impact on office use and real estate values will continue to ripple through local economies and tax systems for years to come.