As we start the new year, it is important to reflect on what happened in 2023 so that we know where commercial property taxes are going in 2024. While it was a busy year, three trends stand out. They indicate that property values should decrease in 2024 and that the market is going through a realignment. Property owners should watch assessments carefully to make sure they are being fairly valued and to look for opportunities to gain tax savings and possible refunds.

1. Cap rates are increasing, which lead to values decreasing.
   
   In 2023, cap rates increased across all sectors. Higher risk property types, such as office buildings, saw greater increases than lower risk categories such as industrial and multi-family. But even industrial and multi-family buildings saw upward cap rate pressure. In 2021 and 2022, many industrial and multi-family properties traded with cap rates in the 5.5% range, indicating a relatively safe investment. In 2023, the cap rates rose to a range of 6.5–7.5% or higher, reflecting increased volatility and risk for investors. As a result of the increased risk, property values in 2024 should decrease.
    
2. Office landlords should factor higher lease-up costs to fill vacancies, which negatively impacts value.
   
   New and renewing tenants typically receive some level of tenant improvements. If the tenant wants more expensive improvements, landlords frequently accommodate them and spread the expenses over the lease's duration, leading to an increase in the base rental rate. However, office space is broadly available and competition for new tenants is intense. As a result, some landlords are offering more tenant improvements without passing on the additional costs, while at the same time absorbing rising construction costs. This suggests that in 2024, as lease-up costs to fill office vacancies increase, property values will decrease.
    
3. Fewer sales in 2024 could potentially lead to more over-valuations.
   
   The volume of commercial real estate transactions is down across all sectors. One reason for this is that buyers and sellers may have different pricing expectations. To illustrate, consider a scenario where a seller bought an industrial property in 2021 for $10 million and has a $7 million mortgage. The seller may want at least $10 million to cover the debt and not lose equity. But a buyer today may offer only $8.5 million because mortgage rates are much higher and the property would not cash flow appropriately at a $10 million sale price. The $1.5 million gap will likely result in no sale.

We anticipate that 2024 will see a lower volume of sales until the market adjusts to realign the expectations of buyers and sellers. From a valuation perspective, this is significant. One of the primary ways that assessors determine value is comparing property to similar properties that recently sold. With fewer sales, assessors may lack reliable comparisons. Property owners will want to work closely with their counsel to make sure that their properties are being fairly assessed.

Final Takeaway

Property taxes are based on valuations. As we anticipate lower values in 2024, property owners should diligently review their assessments to make sure they are paying only their fair share and watch for opportunities to obtain tax savings and potential refunds.