Can landlords really pass higher property taxes on to tenants?

Nov 2, 2018, 12:45 PM by Bill Wheaton

A standard commercial lease will incorporate a share of the building’s property tax costs into the rent. In this way, landlords can automatically pass tax increases on to tenants through rent increases. But do landlords always have the market power to do this—to keep the tax “incidence,” or burden, on the tenant? 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.”

Some recent research has been able to address the question with far better precision than any previous work.[i] The research uses data from Massachusetts, where commercial property taxes have a number of unique features. Since 1978, cities and towns have been allowed, effectively, to 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 differ from those in neighboring towns and sometimes change quite significantly over time. All the variation provides a perfect environment in which to study the impact of commercial taxes on rents. Using CBRE’s building-level rent data, we can examine how individual buildings’ office rents respond to changes in their respective communities’ commercial rates over time.

Without getting into detail about the econometrics of this research, the results showed conclusively that, following tax increases, rents rise sufficiently to absorb 80-90% of the change in landlord tax payments! This estimate is highly statistically significant.

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. In their search for revenue that does not come from local, voting residents, municipalities have often treated such property as fair game. But if local business tenants shoulder the burden of higher commercial rates, rather than the landlords, might that 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.” In excessively raising commercial property taxes, cities and towns might be biting the generous hand of the business that helps support them and the services they provide.

[i] Lyndsey Rolheiser, “Commercial Property Tax Incidence: Evidence from the Rental Market,” MIT PhD Dissertation, Center for Real Estate, 2017.

Deconstructing CRE

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