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September 25, 2019

Taxed To Death

By Jonathan Zimmerman

Given the enormous budget deficit in Chicago, it comes as no surprise that the Mayor and members of the City Council are turning over every stone imaginable to unearth creative ways to raise revenue over the upcoming years. No industry appears to be exempt from their scrutiny, including commercial real estate. If some of the ideas being tossed around actually come to fruition, the results could be calamitous.

In a recent Crain’s Chicago Business article from September 10, it mentions that among the many ideas being pushed by certain coalitions include restoring and increasing Chicago’s corporate head tax to $16 per month for large companies, instituting a 3.5 percent tax on office leases, a vacancy tax on commercial properties vacant for more than 18 months, and a local income tax on those earning above a certain threshold. Wow, where do we even begin with all of this?

On a macro level, if more and more taxes continue to be implemented, at some point corporations and business owners are going to say enough is enough. Yes, the office market has been on quite a roll the last few years. Firms are relocating to and expanding in downtown Chicago like never before.  Unemployment is low and a healthy supply of new buildings have been and continue to be constructed to accommodate the vast demand. So far, the property tax increases which have been implemented have done little to deter activity. However, if these continue and more are piled on, there almost certainly will be a breaking point.

Proposals such as restoring the head tax will do nothing but suppress future hiring, push firms to automate more rapidly (thereby eliminating jobs), and drive businesses back to the suburbs or out of Illinois altogether. Do not be surprised to see more corporate headquarters going with split locations as a way to circumvent this altogether.

A tax on commercial leases would effectively be another add on charge forced upon weary tenants who already are dealing with having to pay rents at record high levels. Will this force landlords to cut rents in order to maintain occupancy levels, thereby reducing revenue in the process and curtailing sales activity? Might this push more businesses towards co-working, since many of these short-term arrangements are considered flexible memberships as opposed to leases?

The concept of a vacancy tax seems most unfair on many levels, as there are so many factors which go into why a space might sit empty for an extended period of time. Sure, there are instances where an owner overvalues its property or refuses to contribute a market-level improvement allowance and this could fairly be deemed as the main cause of a space not leasing.  However, what if it’s a flawed space that has, for example, little-to-no views or one which is situated way too close to the El tracks?  How can an owner reasonably change that?  What if high crime levels in the immediate area are scaring tenants away? What if the market tanks or an economic downturn ensues? The city is really going to punish these landlords at a time when no one is renting space?  Are they supposed to give spaces away to avoid paying this tax, or just chalk it up as another cost of doing business in the City of Chicago?

If the City ends up instituting these taxes, it makes one wonder what other charges could be on the horizon.  If the much-debated LaSalle Street tax is implemented, would the trading floors at the CBOT Building quickly become a ghost town? Advances in technology make it no longer necessary for trading firms to be in Chicago proper. If the tax on high end services goes into effect, could this ultimately include real estate brokers?  Might there one day be an additional tax placed on commissions?  Who knows, this could be the beginning of the end of the brokerage industry.

It cannot be disputed that we have a major problem and everyone collectively has to share the pain to get Chicago out of this massive fiscal abyss. There is a staggering amount of inequality in this town that needs to be addressed for Chicago to have a viable future. However, if the approach continues to involve taxing every industry and person in sight, we will suddenly encounter more serious problems than what we are faced with today. Mayor Lightfoot has said her priorities for the upcoming budget are to seek “reasonable options that relieve the financial burden on those least able to afford it while not driving businesses out of Chicago.”  In theory, this sounds ideal. In practice, it is much tougher to implement.

An endless string of property taxes increases in conjunction with a city income tax and taxing employees, leases and vacant spaces will have a detrimental effect on downtown Chicago commercial real estate. Businesses will stop growing here, leasing activity will decline, and rents and property values will take a tumble. The domino effect will slow down construction, architects will have less work, foreclosures will be on the rise, and more and more brokers will find it tougher to survive in the industry. Might this be the beginning of the end?  Let’s hope common sense ultimately prevails.