San Francisco Feels a Tax-Base Chill With First Drop in 25 Years
(Bloomberg) -- For the first time in more than 25 years, San Francisco is forecasting that its property tax base will fall -- a decline that reflects the tough straits of the city that is among the hardest hit by the pandemic downturn.
That tax base, the real estate values the city uses to calculate taxes, rarely drops even in the worst of times, thanks to a quirk in California law dating back to 1978. Not even the dot-com bust or the 2008 financial crisis was capable of nudging it lower.
But the virus that drove out residents and kept tourists away will likely make this downturn different. The city controller’s office estimates that San Francisco’s commercial and residential property tax base fell 0.46% over 2020, a decline that would translate to a $7.8 million drop in revenue for the fiscal year beginning in July.
That’s not so big as to threaten the creditworthiness of San Francisco, which sold bonds Tuesday. But the mere possibility of a decline in that tax base is a big switch for a city that benefited from a years-long tech boom that seemed to mint new millionaires every day.
It’s those techies -- from companies such as Uber and Salesforce and Twitter -- that may make San Francisco more vulnerable to a prolonged pandemic downturn than perhaps every other major city in the country. Given the option to work remotely, many of them have decamped to cheaper spots like Lake Tahoe and suburban Sacramento, and some are showing little desire to return to their Bay Area offices soon. If this shift drives down demand for office space and homes enough, it’ll sink property values so much that the city’s bottom line gets hit even more.
“San Francisco’s almost got a state of emergency in its economics,” said Ken Rosen, professor emeritus at the Haas School of Business at the University of California at Berkeley who focuses on real estate. With an expected fall in commercial property values, “there’s no question that’s going to make the city have very tight budgets the next few years.”
Residential and commercial property owners in California will start receiving notices this July on the values of their properties as of Jan. 1, 2021 -- the first assessment to fully factor in the pandemic.
The massive shift to remote work has emptied offices around the country, leaving landlords grappling with vacancies and a potential drop in values. Yet high-cost cities such as San Francisco and New York face more pain because they have so many people who can readily work from just about anywhere. Professionals in both areas are showing signs of leaving.
The Bay Area has endured decades of booms, busts and natural calamities. San Francisco’s reserves and diverse sources of revenue have helped it weather previous downturns, and to maintain its high credit ratings even as the pandemic hit the city.
Supporting those ratings is its $300 billion property tax base, which since at least the state constitution change in 1978 had been growing steadily every year except for two in the mid-1990s. The amendment allowed counties to increase property tax rates only slightly from year to year, and assessed valuations only rose if the real estate had been sold or built upon during that year.
The upshot of that rule across the state is that valuations for property tax purposes are often well below market prices. Local governments may miss out on revenue increases in boom times as a result, but they also have a cushion in downturns, because falling market prices often aren’t severe enough in aggregate to go below the rock-bottom valuations that tax authorities use.
This time will probably be unusual. During the city’s recent boom years, a sizzling real estate market resulted in a significant number of properties changing hands, meaning the city’s appraised values for buildings were closer than usual to the market prices.
Then came the pandemic. San Francisco’s overall office vacancy rate in the first quarter of this year shattered the previous record high hit during the dot-com bust at the turn of the century, according to CBRE Group Inc.
Companies including Salesforce have said employees can continue working remotely even after the outbreak eases, and many seem inclined to do so: a third of employees in the Bay Area don’t plan to return to the office as often as before, a poll released on April 13 showed.
With that decline in demand, office rent and occupancy are expected to fall 22% this year, according to a report by research firm Green Street in January.
Workers moving away also potentially cut into the value of apartment buildings that investors once considered blue chip. San Francisco’s effective apartment rents dropped almost 15% last year, according to Moody’s Analytics, the worst among top markets. The home of 880,000 last year suffered the greatest increase in net population outflows from its urban neighborhoods among large U.S. cities.
“If a more permanent shift to telecommuting occurs, it’s obviously going to have long-term implications for property tax well beyond the coming year or two,” said City Controller Ben Rosenfield. “That’s really where the big risks would lie in our property tax base.”
With $636 million in aid from the federal government’s stimulus providing a buffer, the city has time to see how office work and tourism return, said Rosenfield.
Still, San Francisco likely can’t count on a quick return of the boom that propelled its economy. Over the last few years, commercial development represented up to 40% of the annual growth in its tax base, and multifamily residences accounted for nearly half of the increases, according to Moody’s Investors Service. That activity is now slowing, and the outlook for office space is hazy.
“Historically, offices have been a huge generator of revenue in San Francisco,” said Megan Elliott, who manages a team of residential and commercial property appraisers for the city.
Pointing to Salesforce’s high-profile cancellation of a lease, Elliott said, “if that kind of thing continues to happen, it’s going to leave us all wondering what do we do with that space now and what kind of value does it have?”
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