U.S. cities face continuing challenges from remote work, including declining commercial property values, struggling public transit systems and the possibility of weaker tax collections.
A credit-rating agency said that trifecta could put new pressures on municipal budgets. The report S&P Global Ratings examined how the trends could effect big cities across the country.
When the COVID-19 pandemic hit, it radically changed how and where employees work. The effects from the pandemic continue and evolving workplace policies have hit the urban cores of many large cities.
“The COVID 19 pandemic dramatically accelerated remote work trends, increasing work-from-home frequency by the equivalent of about four decades of pre-pandemic growth,” according to the S&P report.
Public transit ridership cratered during the COVID-19 pandemic and ridership recovery has been slow. As passengers abandoned public transit during the pandemic, many systems were kept alive by more than $70 billion the federal government gave transit agencies throughout the country in relief packages. That federal money is expected to run out in the coming years. Some transit agencies are already looking at new tax proposals to fill the gap amid the slow recovery. For example, the Chicago area’s Regional Transportation Authority’s five-year strategic plan calls for consideration of 11 tax and fee hikes. The transit agency said the tax increases were necessary to prevent the collapse of public transit in the Chicago area.
The S&P report said that some cities are better-positioned to handle these challenges than others.
“Despite the challenges facing commercial real estate due to [return-to-office] trends, we do not expect a broad-based decline in general obligation credit quality among large U.S. cities, particularly those with a foundation of strong credit characteristics and the capacity to proactively manage emerging risks. For those facing significant disruption, several potential stabilizers could either blunt or slow the direct budgetary spillover from [return-to-office] stagnation, which we expect will create some room for budgetary accommodation,” according to the report. “We also find that the pace of downtown recovery is not following a one-size-fits-all formula: Factors such as location, local unemployment, industry composition, and commute times point to different cities having markedly different recovery paths. We believe that cities that don’t see RTO trends moving in the right direction are more susceptible to a downward spiral of a reduction in both tax revenue and attractiveness of downtowns and are at the greatest risk of experiencing pressures to credit stability.”
While S&P Global Ratings remained optimistic about the short-term outlook, the longer-term outlook is unclear.
“Although we believe that most large cities are equipped to meet near-term challenges if they are proactive in identifying potential revenue shortfalls and formulating timely solutions to sustain structural budgetary balance, significant outyear uncertainty remains, given that conditions in the commercial real estate market are still evolving,” the S&P authors wrote.
Office vacancy rates mean fewer people are spending time and money in city centers.
“WFH Research finds that downtown spending has decreased by $2,000-$5,000 per person annually since the start of the pandemic,” according to the report. “Although such figures point to what should be weaker city revenue collections, we’ve still observed strong revenue performance overall.”
Those office vacancy rates could grow.
“Cushman & Wakefield expects national vacancy rates will increase through 2023 and peak in 2024, before beginning a comeback that will depend on location-specific factors such as the pace of local jobs recovery,” according to the report.
An influx of federal money during the pandemic helped fill the coffers of the nation’s largest cities, which could provide a financial cushion.
“In the past decade, the largest U.S. cities have enjoyed strong economic growth, despite near-panic circumstances that prevailed at the onset of the pandemic. The last three fiscal years were characterized largely by revenue overperformance and strengthening balance sheets across the 15 U.S. cities discussed here,” according to the report. “Many also still have significant federal stimulus money on hand that, while in most cases must be earmarked for spending by the end of 2024, offers some additional near-term flexibility. Heading into the current fiscal year, most large cities were at a financial and, in some ways, economic high point, which provides some cushion to manage the near-term budgetary volatility that could accompany pressured valuations or tax appeals from commercial property owners.”
While office vacancies could create challenges for municipal budgets, residential real estate accounts for about 60% of revenue in most cities, according to S&P.
“Despite falling office valuations, it’s possible that stability, or even growth, in other areas could countervail at least some of the expected losses from underperforming office properties, given the relative size of the residential tax base compared with commercial,” according to the report. “It is also worth noting that there’s significant segmentation within the office market itself, so that stable demand for newer, higher assessed Class A office space may blunt the losses expected from the older buildings with high vacancy rates.”
Most cities have the ability to raise taxes.
“Many cities are not subject to property tax rate caps, or, they may be levying well under their statutory cap,” according to the report. “This means that a drop in the assessed value for commercial real estate does not result in a direct loss of tax dollars, but rather shifts the tax burden to other classes of taxpayers – including residential properties, which are almost universally the largest segment of the tax base.”
But large cities may be reticent to hike taxes.
“Many cities will see a tax shift to residential that could, among other things, exacerbate the home price affordability issues that have become endemic in cities for some time,” according to the report. “Along with this shift, policymakers could be more reluctant to raise property taxes, given that doing so would directly affect voting homeowners and renters. And considering the prevalence of dollar- rather than rate-based taxation against a backdrop of near universally high housing costs, we believe tax-shifting could become a greater long-term concern in many areas.”
