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A challenge to one of Chicago's biggest draws for companies
Since office buildings typically pass along tax expenses to tenants, new Assessor Fritz Kaegi's approach threatens one of Chicago's biggest selling points for companies: Relative to other major markets, it's a bargain.

Friday, April 12, 2019
Crain's Chicago Business
by Danny Ecker

Cook County's new way of assessing the value of commercial buildings may create a more transparent property tax system, but it could also make it a lot more expensive to lease office space in Chicago.

As new Assessor Fritz Kaegi begins shifting more of the area's property tax burden onto commercial buildings by valuing them based on real market sales and income data rather than the "baffling" method Kaegi says was used by former Assessor Joe Berrios, downtown commercial property landlords are in for tax sticker shock when city properties are reassessed in 2021.

Since office buildings typically pass along those expenses to tenants, the changes threaten one of Chicago's biggest selling points for companies: Relative to other major markets, it's a bargain. The cost of locating here has enticed a parade of corporate relocations from the suburbs and a slew of newcomers to the area, including Bay Area tech companies lured by Midwest engineering talent that is generally more affordable and easier to retain than coastal counterparts.

For now, downtown office landlords are still reveling in a leasing bonanza from record-low unemployment and the longest bull market in U.S. history. Companies moved into more office space in the central business district during the past three months than in any quarter since 2016, according to brokerage CBRE. But higher property taxes will test Chicago's value proposition for employers and challenge office landlords who are uncertain about how much longer the leasing boom will last and face competition from new office buildings.

The sting of Kaegi's increases could be traumatic to downtown properties, if his first round of reassessments is any indication. In Evanston, one of the first Cook County townships to be reassessed under the new system, some office landlords are smarting from assessments that more than doubled in 2019 over 2018. And commercial properties are hit harder than residential ones, as they are taxed on a larger portion of their assessed values.

Willis Tower illustrates the potential pain downtown. The 110-story tower sold for $1.3 billion in 2015, but its 2017 property tax bill shows the assessor valued it at only $579 million. Applying that year's nearly 7.3 percent commercial property tax rate, which was calculated based on revenue needs for the dozen taxing bodies that pulled in money from Cook County property taxes, the tower's tax bill was $31.2 million, county records show.

Based on a $1.05 billion valuation—the portion of the sale excluding personal property, which is not taxable—that tower's tax bill would have been far higher. By applying a hypothetical 5.5 percent tax rate for the 2017 year using publicly available data that accounted for all commercial properties being assessed by Kaegi's definition of market value, a study by tax property law firm O'Keefe Lyons & Hynes estimates Willis Tower's tax bill would have been around $42.5 million, or 36 percent more than it actually was.

"This transition is going to be a bit of a bumpy ride," Elizabeth Gracie, a tax attorney at the law firm, said during a February presentation on property tax changes for brokerage Cushman & Wakefield.

Those tasked with leasing office space in the city downplay the impact of property tax hikes by pointing to Chicago's value relative to other major markets.

A report last year from tenant brokerage Savills comparing the average cost of rent, operating expenses, taxes and utilities for office users in major markets found that downtown Chicago in 2017 came in at a little more than $50 per square foot, lower than downtown Manhattan ($58), west Los Angeles ($63), Boston ($69), Washington ($71) and San Francisco ($80).

That makes Chicago a relative value play, especially for big corporations that can absorb a few extra dollars per square foot in property taxes. The bigger blow could be dealt to small and midsize, privately held companies already in the city that might endure a sudden, more painful hit to their bottom lines, says Savills Vice Chairman Robert Sevim.

Those tenants "will need to be thoughtful about (whether they are) in the right building, should they find a less expensive building, space-manage better, do more with less," he says.

The biggest challenge for tenants trying to underwrite expenses now on a long-term lease is uncertainty, says Cushman & Wakefield tenant broker Steve Bauer. He helps clients run one cost analysis based on how a landlord projects its taxes and another that factors in a potential reassessment, often adding a few extra dollars per square foot for the latter.

"We'd rather it be on clients' radar now than to have them sign a lease and be caught off-guard," he says.

Meanwhile, suburban office landlords in collar counties could benefit from Kaegi's changes. Companies in suburban Cook County office buildings might find better value in other nearby suburbs that are just outside county lines.

That was part of Chicago real estate investor Core Acquisitions' thesis in buying a 100,000-square-foot Deerfield office building last month that will soon be vacated by its longtime full-building tenant.

The property's location just outside Cook's northern border "helps keep tenant expenses down and hopefully attracts them to our building," says Core Acquisitions Principal Bradley Joseph. "I do still believe in Cook, but if you're going to put me right next door to Cook and I can be in Lake (County), I like it a lot."

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