18 August 2023
Tax-increment financing — almost always called by its acronym, TIF — is a tool typically used in cases where a city expects large increases in property tax valuation. A city subsidy thus represents an “investment” in a project that might not otherwise take place, and the return comes along with higher tax assessments and payments in later years.
Last week, though, the St. Paul City Council, technically acting as the Housing and Redevelopment Authority (HRA), approved a TIF district that allocates $26 million to help a developer convert an office tower into apartments. It’s an interesting turn of events for the tax policy tool, because the taxable value of the building does not theoretically represent an increase, as office buildings are generally worth more in taxes than apartments. But a new post-COVID world, where downtown patterns are being upended, changes the urban playbook. As companies empty out office buildings, cities might have to throw around more money to make downtowns more adaptable.
The problem of tax rates
In theory, this case of St Paul TIF might reduce the city’s overall tax capacity, which flies in the face of what the policy is meant to do. This happens because, under Minnesota state law, commercial property is taxed at a higher rate than residential property: 2% for the former versus 1.25% for larger apartments, with lower rates for designated affordable homes. That means that the overall tax value of a converted office building will often decrease under an office-to-residential conversion.
In reality, the theory has been thrown out the window. As most people know, there’s been a radical shift in demand for office space following the COVID pandemic. Many white-collar jobs have transitioned to working from home, at least part time, and nobody can predict the demand for office buildings in the coming years. That leaves most office towers in limbo, a big problem for a city like St. Paul, where commercial real estate demand was already low.
Enter local developer Sherman Associates, which had spent years working on plans to convert a 40-year-old, mixed-use office tower into residential use. As I’ve written before, adding residential to central business districts long focused on office space is the simplest solution for the post-COVID downtown turn. The new Landmark Towers project, located right on popular Rice Park, is a good example of that. It draws on historic tax credits to add funding to the project that would add around 180 new apartments to the core of St. Paul.
Overall, the project will cost around $90 million, but through the recently approved TIF district, the city of St. Paul will offset about a third of that cost with up-front bonds, paid off later in increased tax revenue. The “increment” is expected to be paid off in about 30 years, by 2051, though those predictions can vary depending on how assessments change in the future.
Meanwhile in Minneapolis
Office valuation in Minneapolis’ downtown is also seeing a lot of change — see also the sale of the LaSalle Plaza (where I once worked as an office temp) — but its much larger tax capacity and economic footprint means it has a lot further to fall. The pace of change is likely to be more gradual, and might not be much worse than the overall commercial real estate market throughout the metro. According to reports from the Downtown Council — the private organization that all but runs downtown Minneapolis — there’s also a “flight to quality,” where some offices are moving into downtown Minneapolis.
That hasn’t stopped planners in Minneapolis from trying to get ahead of the curve.
“We’re right at the beginning of looking at this as a problem, as we’re coming out of the pandemic,” said Erik Hansen, the Minneapolis Community Planning and Economic Development (CPED) director, who views recent changes as part of a larger trend. “Even though the pandemic accelerated the changes in the office market, the apportionment of office space to an employee has been being reduced for a number of years now.”
When asked about conversions in downtown Minneapolis, both Hansen and Mayor Jacob Frey point to the in-progress conversion of the Northstar East office building on Marquette Avenue. There Sherman Associates (again) is transforming office space into 216 apartments, paid for in part using affordable housing tax credits.
St. Paul and Minneapolis are not alone in these efforts. With the goal of revitalizing what are today often underpopulated parts of downtown business districts, almost every other city on the continent is trying to accelerate the shifts toward residential conversation.
But there’s a lot of different angles, and some are more aggressive than others. Calgary, Alberta, with a metro population of 1.4 million, has long been the oil production capital of Canada. But as that industry faced steep declines over the last decades, it’s led to a large shift in office demand in downtown Calgary. As a result, city planners have been using policy tools to incentivize residential conversions, creating a city fund that offsets costs once a housing conversion is completed. That policy already allowed them to convert over 2 million square feet of office space to residential uses since the pandemic began, a blistering pace. According to their mayor, Jodi Gondek, “the secret sauce, if you will, was creating a fund for the private sector to tap into.”
Similarly, downtown Boston has been aggressive in subsidizing their own shift, reducing property tax rates by up to 75% for up to 30 years. The catch is that the conversion would have to start quickly, under construction by late 2025, in order to qualify. The aim, under Mayor Michele Wu, seems to be to use the city’s policy levers to help fill in the gap in street vitality created by the shift to work-from-home in downtown Boston. (Incentivizing short-term results also seems like a good idea for elected officials, in general.)
So far, Minneapolis doesn’t have similar policies in place, but Planning and Economic Development Director Hansen doesn’t rule them out in the future.
“When we get to the more complex tools of using the tax base to help incentivize the conversion we’re not, we don’t know enough about the position yet,” said Hansen. “We’re still a little ways away from knowing if there would be additional new resources.”
Drawing on the work done by Mayor Frey’s Vibrant Storefronts work group, which issued a report earlier this summer, CPED is still in data gathering mode. According to Hansen, they are working on tallying the supply and demand figures, to get a sense of how large the shift in office space use will have to be.
Similarly, there are other changes that might help smooth the coming transition.
“[We] are looking at how to case manage a building owner who comes in and says they are interested in converting to residential,” Hansen said. “What kinds of things would they need to do with the regulatory and permitting system?”
Conclusion
There hasn’t been this dramatic of a shift in the fortunes of American downtowns in at least a half-century, not since the eradication of rail transit in the vast majority of the country. In some ways, the pending post-COVID transformation is even more profound, as the entire concept of daily commuting has been upended, likely for good.
Still, the prescription that planners are recommending to themselves is not a new idea. For example, famous mid-century urbanist, Jane Jacobs, loathed downtown Manhattan, referring to the area as a “great blight of dullness” because it was composed almost entirely of nine-to-five office space. Neighborhoods where one narrow use predominated, Jacobs argued, were anathema to vibrant cities that thrived on density and diversity.
Instead, Jacobs pushed for city neighborhoods with a balanced mix of office, commercial and residential uses, attracting people all through the day and at night. You can levy the same criticism about the central core of downtown Minneapolis, where the skyway shops and streets empty out after 4 p.m. (and often much earlier).
“Workers and residents together are able to produce more than the sum of our two parts…,” Jacobs wrote. “It is important to understand that numbers, in themselves, are not an equivalent for people distributed through time of day.”
This is almost exactly what the recipe calls for in 2023. The only question remains whether cities will just slowly evolve in that direction, or if they can kick-start the process with a few fiscal levers.
Given how much tax revenue is at stake, and how many empty office buildings loom over the half-deserted sidewalks, downtown leaders should not sit on their hands. St. Paul is probably doing the right thing using tax policy to boost residential projects, even if the TIF district adds more liability to the city’s general fund. Expect to see more projects like this in the future, as empty buildings downtown aren’t doing anybody much good, other than the eternally circling pigeons.