Lowered valuations for Midtown Manhattan real estate could have a devastating impact on the city’s budget, real estate executives are warning — and there are no indications anyone in the mayor’s office sees it coming, they say. 

Between market uncertainty, slashed rents, and low occupancy rates in fully leased buildings, even a much wider return to work as Covid ebbs will not mean a return to the pre-pandemic Midtown of 2019. That may be gone forever.

The problem at hand has to do with the valuations of commercial real estate buildings in New York. Many are poised to slip in the near future, and some already have.

Most buildings have two valuations: that set by the market value and that set by the city for tax purposes. If the market value changes, property owners can appeal the city’s valuation in an attempt to lower taxable value.

Lower valuations by the banks incentivize property owners to appeal the valuation that the city uses for tax purposes. If a large number of landowners successfully appeal, it could affect the city budget.

Nearly a third of the city’s annual revenue comes from property taxes, and while new construction in the other four boroughs could compensate, lower valuations of buildings in the city’s key business districts could have a serious impact on the city’s bottom line.

The 2022 adopted budget already accounted for a downward revision of $2.57 billion in property tax revenues, 2.6 percent of the city’s total budget. Whether this was an accurate estimate will become clear by the end of the budgetary year this summer.

The 2023 preliminary budget has a more bullish outlook, expecting an increase of $839 million in revenue. The Citizens Budget Commission says that could be hampered by slow growth.

“The economic recovery has been sluggish and structural changes in commuting or travel could hamper tax revenue growth,” a commission report reads.

Opinions differ on the effects of new valuations, with some pointing to the city’s own valuation process and reserves as bulwarks for any possible budget shortcoming.

“I don’t think they are being overly optimistic but I do think there is significant risk,” a researcher at the budget commission, Ana Champeny, told The New York Sun. “They are really keeping the long-term prospects very low.”

On the other hand, some in the private sector believe that regardless of whether the changes in commercial real estate affect the city’s budget, there is “something brewing” in the real estate market.

“The eviction moratorium has been lifted, interest rates are going up, vacancies are at an all-time high, rents are down 25 percent. Something’s going to happen,” the CEO of Okada and Company, Christopher Okada, told the Sun.

The mayor’s office did not immediately respond to a request for comment.

Manhattan commercial rents, both office and retail, were beaten down during the pandemic and will probably stay low for another five to seven years, Mr. Okada said.

“I would say that we are at a 25 percent rent decline — 30 percent if a landlord is not willing to upgrade their space and do construction for the tenants,” he said.

This is backed up by both anecdotal and statistical evidence.

Take the building at 15 W. 39th St., which was renting for an average of $45 a square foot before the pandemic but now rents for slightly more than $30 a square foot.  The story is similar for 224 W. 30th St., where office space was renting for an average of $42 a square foot before Covid and now rents for about $32 a square foot.

The Real Estate Board of New York noted the trend in retail spaces last year, saying average retail rents were down more than 50 percent in some districts.

Retail real estate on Broadway between Houston and Broome streets has seen a 62 percent decline in asking rents since the 2015 peak. Taking rents — what occupants actually pay — were down even more.

“Brokers have cited that there is a 20% average difference between asking rents and taking rents,” a report from early 2021, nearly a year into the Covid pandemic, reads. Although rents demonstrated some recovery, the trend continued throughout the year.

The fall report for 2021 pointed to a prevalence of “discounted rent” and a general lag in the recovery of office corridors. The report also noted that retail rents remain low compared to 2019 levels.

Discount rents have stuck around for years at this point, and they are expected to stay comparatively low in the near future.

“It takes two years to get to the bottom, here we are in 2022. Historically, it’s five to seven years to the top,” Mr. Okada said.

The change is not necessarily due just to lack of demand, but rather to fundamental changes in the way that offices are being used.

One of the issues is office utilization. Even fully leased buildings are not seeing anywhere near the level of utilization — the actual number of workers in a building — as before the pandemic.

“We would not think that average utilization will ever be back to the same levels — this is gone,” an analyst relations manager at Locatee, Raphaël Morgulis, told the Sun. “You need to really look at what your people are actually doing with your office.”

Mr. Morgulis also pointed out that offices are more often used intermittently now and act as showcases for companies. A decreasing number of employees use offices as places for focused work — another reason fully leased buildings may sit empty.

While fewer workers means fewer consumers to power the recovery of New York’s business districts, it’s potentially only the beginning of the problem.

Making note of what apparently is a long-term change in the value of buildings, banks will look to adjust the valuations of buildings to match the new market environment. 

With increasingly uncertain market conditions, high inflation, and rising interest rates, banks could end a practice of leniency regarding loans affected by the pandemic, according to Mr. Okada.

“It comes down to the banks. A lot of banks have been very very friendly with extensions and mortgage modifications, keeping interest rates where they are, but in 2022 we are supposed to have increased interest rates. Eventually the banks will get tired of just kicking the can down the road,” he said.