Thursday, July 23, 2020

Pennsylvania’s Budget Issues Loom Large Over Commercial Real Estate

Pennsylvania’s economic woes might just be getting started according to an ominous report filed by its Independent Fiscal Office in early July.

June's tax revenue collections were just $2.67 billion, $545 million short of what the office estimated a year ago. That’s not at all surprising given the shutdown, and the auditing agency projects the coronavirus will probably cost Pennsylvania anywhere from $2.7 billion to $3.9 billion in taxable revenue.

This could affect commercial real estate in myriad ways, the most immediate of which may be a near-term tax increase to fund essential services such as education.

The school system soaks up more than 30% of the state’s budget, and a substantial chunk of the funding comes from property taxes. Elected officials across the state have been open about a property tax increase and recent actions make it clear they were not playing around. Earlier this week, Scranton’s school system recommended a 16% hike to fund local schools through 2021, and multiple school districts in Berks County, Erie and Allentown have also proposed tax increases as well.

Higher property taxes will probably reduce property values and could limit both investment and development. Save for logistics spaces, there’s already minimal development, investment, leasing, or rent growth in markets like Scranton, Reading, York and Harrisburg; and even less in smaller towns like Johnstown, Schuylkill, Beaver City and Carbondale.

Increased taxes could also discourage businesses and individuals from relocating into a market while providing incentive for them to look elsewhere. Residents moving away is a serious problem throughout Pennsylvania, and the latest census data shows that 42 of the state’s 67 counties have lost residents since 2010.

A declining population has an enormous impact on nearly every facet of commercial real estate, and financial distress would probably amplify the problem. The state’s secondary markets are particularly exposed to this risk. A recently released study from the University of Pittsburgh’s Center for Metropolitan Studies indicates that in the southwestern Pennsylvania region alone, 20% of municipalities could become insolvent in 2021.

Tax increases are never popular, but many residents believe these cities have been mismanaged for decades. A 16% tax hike in Scranton to fund schools will probably prove deeply unpopular, as its very public corruption issues appear directly tied into the school system. Its last mayor, Bill Courtright, is awaiting sentencing on federal charges and while in prison he can trade stories with the former mayors of Allentown, Reading and Bloomsburg.

There’s already ample evidence that a large swath of the business community is losing faith in the state’s handling of the shutdown, and local politics are becoming increasingly contentious. Though Democratic Governor Tom Wolf’s approval rating with the public at large remains relatively high, he faced an open rebellion in mid-May, when Republican officials from six counties made it public that they would be ending their lockdown with or without his approval.

Wolf condemned these upstart county officials and business owners as "cowards," and last week, announced that the state would be withholding federal relief funding from Lebanon County. Republicans, who dominate the state legislature, passed a resolution in second quarter directing Wolf to end his emergency declaration, which would reduce the restrictions placed on many businesses. Wolf declined, and an amendment to the state's constitution stripping the governor of his powers as well as a motion to impeach him was introduced shortly afterwards.

There is little chance Wolf will be removed from office, but none of this discord bodes well for the future because the unprecedented financial challenges the coronavirus created will require extraordinary cooperation across the political spectrum to resolve.

Whatever solution the state reaches will have major effects on the Pennsylvania commercial real estate market for some time.

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