‘That Needs To Stop’: Top D.C. Developers Blast City Leaders For Proposed CRE Tax Hikes
D.C. appears on the verge of raising taxes on commercial real estate and property transactions, upsetting many of the city's top developers who say the tax will hurt small businesses and worsen the office market.
Mayor Muriel Bowser introduced the tax hike in March in her proposed budget as a way to generate more revenue to fund affordable housing. Her plan would reverse a commercial property tax cut passed last year, and it would raise the deed transfer tax on property sales of over $2M.
D.C. Council Chair Phil Mendelson said Monday he opposes the tax hikes and plans to bring forward a measure to prevent them from becoming law, but he said he does not expect to have the support of a majority of the council.
Several top developers, lenders and researchers, speaking Wednesday at Bisnow's D.C. State of the Market, decried the tax increases, saying they could harm a commercial real estate industry that is vital to the city's prosperity.
Jemal, speaking in the event's keynote conversation with Dochter & Alexander Retail Advisors co-founder Dave Dochter, said the taxes will end up being passed on to small retail businesses. Many retail deals are structured as triple-net leases, meaning the tenants pay the property taxes, and the higher costs could make it challenging for small businesses to stay open.
"There does become a level where it becomes unaffordable," Jemal said. "When you hit that sour spot, it’s bad."
EagleBank Chief Real Estate Lending Officer Tony Marquez also highlighted the effect on retail tenants, saying small businesses need to speak up to help the city understand where the impact of the taxes will be felt.
"If you think you’re taxing the real estate owner, think about a retail operator that has a triple net lease, the taxes go up, guess who pays for that tax? It’s the operator, the creator of jobs, the small businessman," Marquez said. "The owner of the restaurant is the one that’s really paying for it. Those are the folks we need to activate as an industry to go to comment on the impact of that on their ability to create more jobs."
Abdo Development CEO Jim Abdo said the commercial real estate industry helps the city in good times and during bad economic periods, but the city's leaders often punish developers and commercial property owners when they need a politically easy way to raise taxes.
"This industry tends to be low-hanging fruit for the people in the council, and they go back to this well pretty often," Abdo said. "We can't continuously be a low-hanging fruit for them to say, 'Ah, we need more tax dollars, let's just go to this community.' That needs to stop."
The D.C. office market has been struggling, and increasing the tax on property sales could make it worse, DSC Partners co-founder Doug Donatelli said. He added it has been difficult to get investors to buy properties when they do not see a strong leasing environment that could allow them to raise rents, and higher taxes will make deals even harder to pencil.
"A number of transactions didn’t trade last year because it’s a terrible time," Donatelli said. "You could argue that the commercial real estate market in D.C. is in a downturn. Our vacancy rate is well above 10% and it's trending up. This is not the time to impose new taxes, especially not on the trading of properties."
Donatelli said some new office developments are succeeding, but many existing office buildings that would be able to fill up in a stronger market are being left with large blocks of vacant space. He cited the example of 1101 New York Ave. NW, where Wednesday's event was hosted on the vacant sixth floor.
"This is a perfect example," Donatelli said. "We're in a great building. This space ought to be leased. There are lots of buildings just like this all over [the] city that have the same situation."
JLL Managing Director of Research John Sikaitis quantified the impact to the city's bottom line of commercial properties that fail to trade because of the soft office market. He said nine buildings valued at a combined $1.9B have been removed from the market since the start of 2018 after the owners were unable to find a buyer at the price they sought. Those trades would have created an additional $50M in revenue for the city, he said.
"They have lost $50M because of the softness of the office market and demand essentially shooing investors away," Sikaitis said.
He said the city should take proactive steps to improve the office market, such as more aggressively courting West Coast technology companies. While Northern Virginia landed Amazon HQ2, he said most of the office market impacts will be felt in the nearby Arlington County submarkets, and the District needs to take action to court new technology companies.
"We have to have tools in our toolbox for owners and developers to incentivize those companies that are first movers to come to this market," Sikaitis said.
The D.C.-area office market is sharply divided between new buildings and old buildings, The Meridian Group Chief Investment Officer Gary Block said. New projects like The Boro that create walkable, mixed-use environments where employees want to work are seeing "monster leasing," he said, but older properties are not so fortunate.
"For the obsolete buildings, the ones who aren’t new, are old, are not in a regionally significant walkable urban place, they don’t have amenities, it’s horrible," Block said. "It's binary. You have winners and you have losers."
"The existing buildings are flat, there’s very little if any rent growth here," Carr said. "It's a gun fight for every tenant in terms of lots of concessions. It's hard to make money today with existing buildings, but you can create value if you can find those unique places to develop."