Taxes and their impact on Retail Leases


May 17, 2016

  • Property taxes are slated to go up from $22.5 $27.7 billion in 2020E a 5.34% CAGR

  • Taxes are phased in at 20% of the change over a five-year period called a: Transitional Assessed Value.

  • There is still a future -$2.74 Billion USD gap in the NYC budget, which doesn’t account for a drop in assessed/market value.

  • Increasing costs to a building’s revenue, means landlords’ will see a drop in capitalization rates for their buildings—this is only remedied with the increase in rental prices and cutting costs. This could happen upon the increasing of rates, future economic slowdowns, etc.

 

The Monument International Group, at Oxford Properties, is a commercial real estate group that has been successful in working with tenants and landlords creating harmony in Brokerage. However, in the recent past an interesting change has happened regarding the proportional share of real estate tax increases by a new tenant—landlords have been getting more and more aggressive.

 

As tenants’ leases begin to mature, and newer inventory replaces the older, we begin to see a phenomenon that not only prices out certain tenants but forces landlords with “older inventory” to ask for more of the tenants share in taxes—this in turn prices many businesses out of the market. Forcing them to shut down or move; such as: a hat store or a $0.99-cent store in Midtown, Manhattan.

 

The city's overall revenue from property taxes, which accounts for 30.9%% of the City’s total revenue by 2020E (reference), is slated to go up from $22.5 billion in the current fiscal year of 2016, which ends June 30, to $23.8 billion in the upcoming year to $27.7 billion in 2020E (reference), a 5.34% CAGR (compounded annual growth rate, for each year until 2020E).

 

Let’s look at a real example: 533 Third Avenue will be our sample (Source of Dataset). The landlord asks for the tenant to assume 25% proportional share of the tax increase on the retail space; and, this is not so bad, as we have seen this number go as high as 50%. We assume current lease terms were in places 10-years ago to see their potential historical impact on the retail space’s rent—historically the proportional share of taxes was: 0.5% to 7%. As we look at historical numbers and then project them into the future, we get the following:

      533 Third Ave

533 Third Ave

Cash Flow Model Focusing on Possible Tax Situation. Top model is based on historical data from NYC Dept. of Finance.       1/1

As we can see, this is rather unsustainable. Furthermore,  the numbers are so aggressive in certain areas; such as the East Village, where taxes in one of our studies jumped 58.24% from 2015/2016 to 2016/2017 (147 Ave. A Link to Tax Bill). Encouraging the landlords to push the costs onto the tenants as much as possible, where the retail space became the main solution—we can see this in our previous article, where retail rents rose at a CAGR rate of 12.53% since Q4-2012 to Q4-2015: Shop 'Til You Drop--Manhattan's Growing Retail Market. Realistically though, if the landlord bought the building in the 1980/90’s, he is still in a very profitable situation. However, recent buyers at 3%-6% cap-rates will be holding at a loss; especially if the loan-to-value (“LTV”) was significant.

 

  • DEFINITION: One thing to note is that tax increased are phased in through: Transitional Assessed Value, which is the phase-in of changes to Actual Assessed Value. New York State law requires that changes to Assessed Value are phased in at 20% of the change over a five-year period. The Transitional Assessed Value represents all of the changes that are being phased-in for each coming tax year.

Why is this happening? The Credit Crisis, has impacted the city more than we realize:

  • The City needs MONEY! City revenues plummet in 2009/2010

  • More demand for City services

  • Federal and State aid declines

  • City services are cut; taxes are raised

  • Aggressive unemployment and traditional sectors were adversely affected.

Recently, the mayor promised not to raise taxes but this did not stop the city’s finance department to raise “assessed values” of buildings aggressively; as we see on the model above, they have doubled since 2009.

 

What will be the impact?

  • Building expenses will go up, reducing NOI, which in turn lowers cap rates for landlords.

  • Landlords will try and pass the cost onto the tenant, putting further pressure on business revenue, which also reduces taxable income for the City, as EBITDA margins get smaller.

    • In many ways this doesn’t matter to the city, as the business will pay their tax through the property tax, passed on from the landlord—through the executed lease.

    • This is a government solution for business’s maximizing pre-EBITDA expenses to reduce tax liability.

  • Many businesses’ will start to get prices out of the market—only economies of scales will provide protection (opening up multiple stores) but this is not guaranteed.

  • Price inflation of goods will continue at stores.

  • Super structures, with diverse portfolio of: commercial, residential and hospitality will reduce the tax burden but it will only increase assessed values, adversely impacting older building owners with uncompetitive buildings.

  • Solution could be for tenants to ask for shorter lease terms but tenants will not be encouraged to build out their spaces.

  • More leases in older inventory will come attached with Demo-clauses.

  • eCommerce will become more popular, as companies will limit retail locations, trying to maximize quality at fewer retail locations and pushing for greater internet sales.

The assessed value of property is expected to rise by 22.9% by 2020, and from looking at the city’s budget plans for Fiscal 2017, the proportional dependency of Real Estate taxes is expected to increase, from 27.6% to 30.9% of the cities total revenues, and there is still a     -$2.74 Billion USD gap in budget. Furthermore, like a tech company, we see a hockey stick approach and never a doubt that prices will never go down if rates go up or the economy is adversely impacted.

 

To answer your questions: Should you rent a retail store if your business requires it, YES! Should you rent an office, YES! The personal questions of should you buy an apartment, the answer is still YES! Because you can offset the taxes from your own taxes or pass the pre-EBITDA expenses.  However, rising rental rates are not tax deductible for most New Yorker’s making money via a W-2.  Businesses will need to adjust expectations and make changes to their expense ratios, evolve the focus of what the retail store is and set a clear focus on what their product is, if businesses are to survive.             


 
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