The standard commercial lease involves a rent that incorporates current property taxes (for which the landlord is legally responsible). It also allows to landlord to automatically “pass on” any increase in those taxes to tenants through rent increases. To economists the age-old question of tax “incidence” is whether the landlord has enough market power to do this? If not, as rents rise, vacancies develop, and NOI actually can drop. The wise landlord tries to figure all this out in advance so as not to have to “eat crow”.
Recent research is able to answer this question with far better precision than any previous work.[i]The research relies on data from Massachusetts where commercial property taxes have a number of unique features. Since 1978, cities and towns have been allowed to effectively set separate tax rates for residential, commercial and industrial property. Only about one third of the Commonwealth’s 351 communities choose to discriminate this way, but those that do tend to have much higher commercial rates, that vary from neighboring towns, and sometimes change quite significantly over time. All this variation provides a perfect environment in which to study the impact of commercial taxes on rents. With CBRE’s building level rent data we can examine over time as each community changes their commercial rate how the office rents in individual buildings within that town respond to the change.
Without getting into detail about the actual econometrics of this research, the results showed conclusively that rents rise after tax changes sufficiently to fully absorb 80-90% of the change in landlord tax payments! This estimate is highly significant statistically.
Hopefully this research may make towns think twice about the practice of trying to extract as much revenue as possible from commercial and industrial property. Local municipalities have often treated such property as fair game in the search for revenue that does not come from voting local residents. If raising commercial rates in turn increases the tax burden of local business tenants (and not landlords), might it not:
- reduce new business development
- then curtail local job and wage growth
- and eventually reduce the local land values that underpin resident house prices?
Commercial property taxes are not necessarily “free money”. By excessively raising commercial property taxes, cities and towns might be biting the generous hand of business that helps to support them and the services they provide.
Lyndsey Rolheiser, “Commercial Property Tax Incidence: Evidence from the Rental Market”, MIT PhD Dissertation, Center for Real Estate, 2017.