Shawn Massey, CCIM, SCLS

Are Property Taxes in Memphis and Shelby County STIFILING the retail growth of our city? Watch out Suburbs!

In the wake of the perceived financial windfall of $63+ million dollars annually to the city as documented in a recent newspaper article, this money is from when Memphis City Schools surrendered their school charter last year, and the City of Memphis not having to pay this staggering apportionment amount to the city schools each year going forward.

When the Memphis City Council voted a year or so ago not to pay the city schools I was extremely disappointed.  They made a promise to the city schools and failed to live up to that promise until they were forced to by the court and an outpouring of community support for the school system.  I personally do not think the city should be involved in school funding, but this is not the topic of this blog post.  The City Council made a promise, levied a tax on the residential and commercial properties which they collected and then did not use it for the purpose in which it was collected.

Now we as a city have a glowing opportunity to give back this tax savings to the residential and commercial property owners including the retail tenants who pay this additional property tax in addition to their base rent each month.  I am also of the opinion that the county government will need to increase their tax rate to make up for the cities withdrawal to the school funding equation.    I am hoping that the merger of the two school systems which I am in favor of (if they do it right and I have confidence that they will) will be able to operate much more efficiently and not need to levy an additional tax to make up for the city portion.

Now I read in this article that the city wants to use this money specifically for other city needs.  Mayor Wharton outlined in his “State of the Union” address that he wanted to use the money for early childhood education, raises for those employees who are underpaid and numerous other worthy projects in our great city.  I think all of these should be funded from cost efficiencies, increased sales tax collections and not on the backs of our city property taxpayers and retailers who have been shouldering the load for too many years.  If you have not figured it out by now I am very pro retail and very pro Memphis!

The way retailers typically pay rent is a payment of monthly base rent and a pass-through from the property owner of the pro-rata share of additional charges that include common area maintenance, property insurance and real property taxes from both the City and County.  These latter additional charges are usually variable and the largest portion of these charges is always property taxes for both our city and county.  Memphis and Shelby County have the highest property taxes in the State of Tennessee and significantly far greater than our adjoining states and surrounding suburbs.  It is not uncommon that the property taxes can increase a retailer’s total occupancy cost from 25% to 50%+.

There is significant statistical evidence of the inverse relationship between an increasing property tax and a decrease in new non residential development.   Therefore, any increase in property tax or having the highest property tax in an area hurts our economic competitiveness in the retail world.  It has become cheaper for a retailer to setup in the adjoining suburbs or across the state lines.  Retailers can only pay so much total occupancy costs (rent & additional charges) in relation to their sales before they start working for the developer and city.  The City of Memphis is effectively making it easier and cheaper for a retailer to do business in North Mississippi, West Memphis, Arkansas and the adjoining suburbs than in our city.  The high county tax rate does not help the equation against our neighboring states!

The City of Memphis is the economic center, cultural center and education center of the Mid-South.  Our city and county has an over reliance on property taxes which most economists would agree is a regressive tax.   This continued  reliance and dependency on increasing the property tax rate to fund our cities and county needs is driving retailers to close up shop, negotiate a rental concession to make up for dramatically increasing property taxes or not consider a Memphis or Shelby County location in the first place.    This in turn is driving up the retail vacancy rate, lowering the effective real value of these retail properties and decreasing new retail development.   Owners are consistently looking to lower their property tax assessments due to lower effective rent numbers today than in years past.  The overall effect in turn is a shrinking tax base versus economic growth.  For example, for every dollar in property tax increases will property result in the Landlord having to provide an equal rent concession to existing tenants (or lose them when their lease comes up for renewal) or lowering the asking rents accordingly.  How does this effect value?  The typical way a commercial real estate project is valued is by using the net rental income and dividing it by using a market capitalization rate.  For example:

Reduction of $ 1 PSF in net rent                 – $ 1.00  divided by

Retail Market Capitalization Rate                        9%         (typical  retail cap rate for A type property) Equals

Reduction in Real Value                                   -$ 11.11

Therefore, every $1 increase in property taxes leads to the landlord lowering his effective rental accordingly of an equal amount and therefore decreasing the properties value by $ 11.11.   If this doesn’t sound like much to you, then  multiply it by the $63 million and the number is a staggering, almost $700 million dollars in lost real estate value.   This loss of real estate value will put many developers upside down on the required bank requirements.  Property owners may no longer meet bank required DCR (Debt Coverage Ratio) and a LTV (Loan to Value) ratios of their banks causing many to provide significant additional equity funding or simply sending the property into foreclosure.  Just look at the number of retail properties that have been foreclosed upon in Memphis and Shelby County and sold well below their previous valuation.   Many more properties will be foreclosed upon in the upcoming months.  The amount of property taxes collected on these properties will be significantly reduced and again lead to budgeted shortfalls for our both our city and county.   The $63 million discussed in the beginning is just the tip of the iceberg to the higher property tax rates.

Is the slowing of retail development in Memphis entirely to blame on the high property taxes of our city and county?  The answer is a resounding NO, as the country goes Memphis goes and both have been in a recessionary period since 2008, suffered from a period of easy money and overbuilding for the decade beforehand.  These and numerous other factors beyond our cities control and have led to the decline in new retail development.   What our city leaders have control of is reversing the trend for retailers to shy away from our city and provide true economic opportunity retail growth for our city and county by lowering our property tax rate.   This can be done first by giving back the $63 million to our property owners and retailers and then going a step going further in reducing the property tax rate to be competitive with our peer communities.   This will provide economic growth by spurring retailers to locate in our city, allow owners to increase effective rental rates and allow property values to be raised back to pre 2008 levels.   The city will then collect far more in a broad based sales tax as more retailers will be located in our city limits.  Increasing property values even at a lower property rate will cause overall property tax collections to be higher and will spur new retail development in the city limits which will increase the city and county coffers to cover all those good causes of the Mayor and city council.

I hope that the citizens of Memphis will step up and let our city council, county commission and mayors know what will promote true economic and retail growth in our city and county.  The suburbs should be concerned with what effect increase property taxes may have on the their retail property tax base, especially if they choose to operate their own school systems and need to increase property tax rates to fund the additional costs.  They may actually acquire the same problem that has affected the City of Memphis.

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Shawn Massey, CCIM, SCLS is a partner with The Shopping Center Group a 3rd party retail real estate advisory firm in their Memphis office, an adjunct professor in the graduate real estate program at The University of Memphis and a co-founder and Chairman of the Board for the Memphis Business Academy charter schools (K-12grade) in the Frayser area of Memphis.  

For all your retail real estate needs (tenant representation, landlord representation and property, investment & land sales) I hope that you will choose The Shopping Center Group and me to represent you and your business.  We understand that representation is a privilege and that you have a choice!

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