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Sabrina Faas, owner of Bayswater Tea Co., is photographed across the street from her store in Vancouver, on Nov. 8, 2019. Small business owners have been hit with tax increases that include the air space above the building because of rising land values in the area.Rafal Gerszak/The Globe and Mail

Aftershocks from the housing boom are sweeping over small businesses in the urban cores of Vancouver and Toronto as soaring land values drive up assessments and, in turn, trigger annual increases in property taxes running into tens of thousands of dollars.

Those higher taxes are a significant hit on the bottom line of retail businesses operating on slender profit margins. For some, it means the prospect of closing.

The years-long rise in prices for residential real estate is at the heart of the problem. Land values soared, not just for housing, but for commercial properties as well. Higher home prices also led municipalities to take steps to expand the supply of housing, including changes to zoning that allow residential uses in formerly commercial areas.

Together, those two factors set the stage for steep and sudden increases in official estimates of the “highest and best use” of a property, and in tax bills. Assessors use the principle of highest and best use – the building and improvements of a property that create the highest value – based on a number of considerations, including market demand and legally permitted uses. The key point is this: The highest and best use may not be the building that currently exists.

In areas with rapid growth, such as the urban cores of Toronto and Vancouver, the highest and best use could be a condo tower or townhouse development, which means the owners of such properties face much higher assessments, and a much higher tax bill.

Vancouver’s Kitsilano neighbourhood is full of one- and two-storey retail storefronts that give the neighbourhood a throwback appeal, making it home to precisely the sort of businesses that are most vulnerable. Sabrina Faas, owner of Bayswater Tea Co. in Kitsilano, says the annual tax bill for her three-person business has climbed by nearly $10,000 since 2016, one more financial burden to shoulder. In essence, her 1,265-square-foot shop is being taxed as if it had a residential building atop it. Or as, Ms. Faas puts it: “I’m paying for air.”

Ms. Faas estimates she would need to increase her revenue by more than $25,000 to cover that additional cost. But she has limited room to raise prices, so most of the higher tax bill will come out of her bottom line.

Five kilometres to the east, The Beaumont Studios faces even starker consequences. Founder and executive director Jude Kusnierz says her not-for-profit business renting space to artists may have to start winding down. The tax bill skyrocketed to $110,000 in 2019 from $46,000 four years ago; the studio’s financial plan forecasts another $18,000 increase in 2020. Ms. Kusnierz says she hopes Vancouver city council will deliver some tax relief, but without it, the business that expanded over 15 years and grew into a second building will have to close.

The softening of the B.C. real estate market in the past two years temporarily reduced the upward movement of assessments in Vancouver, says Paul Sullivan, senior partner at the real estate consulting firm Burgess, Cawley, Sullivan and Associates Ltd. But he says land values would have to plummet drastically for the tax increases to roll back.

And now, the real estate markets in Toronto and Vancouver have rebounded, meaning the upward pressure on assessments will resume.

In Toronto, veteran restaurateur Frédéric Geisweiller has run headlong into the tax distortions the highest and best use principle can wreak. Mr. Geisweiller, one of three owners of Le Sélect Bistro in the city’s downtown, has watched condos sprout up near the restaurant and its property tax bills skyrocket.

When the bistro moved to Wellington Street 12 years ago, the property taxes were just $31,276. By 2016, that had risen to $60,131. But over the next three years, the bill nearly doubled to $116,000 – and that was after City of Toronto put a cap in place in 2018. Without it, the bistro would have had to pay $150,028 in 2019.

Mr. Geisweiller says he welcomes the city’s efforts at tax relief, but they aren’t nearly enough. In the low-margin restaurant business, Le Sélect Bistro would need $1.1-million in additional sales to offset even its reduced tax bill.

Toronto’s 10-per-cent cap on yearly increases just delays the day of reckoning, he says. The bistro’s property tax bills, already unaffordable, will continue to rise. “There is no end in sight,” Mr. Geisweiller says.

Without tax relief, he says, Le Sélect Bistro will have to close after more than four decades in business, putting its 80 employees out of work.

Brian Kelcey, vice-president of policy and public affairs for the Toronto Regional Board of Trade, says he believes hundreds of Toronto businesses face the same magnitude of tax increases as Le Sélect Bistro. Lawvin Hadisi, press secretary for Toronto Mayor John Tory, said the surge in property taxes is “solely and directly” attributable to increases in assessments by Ontario’s Municipal Property Assessment Corporation. MPAC says it calculates assessments based on permitted uses, and on land-use policy set by the province and municipalities.

The problem is even more widespread in Vancouver, with more than 4,000 commercial properties facing tax increases of at least 10 per cent in 2019, with some seeing bills triple, says Aaron Aerts of the Canadian Federation of Independent Business (CFIB).

In British Columbia and Ontario, business groups are pressing their provincial governments to give municipalities the fiscal flexibility to deliver long-lasting tax relief. In Toronto, Mr. Kelcey, councillor Joe Cressy and others are asking the Progressive Conservative government to allow the city to exempt properties from a highest-and-best-use assessment unless the owner has an approved development permit – a clear indication a new structure is planned.

In British Columbia, a coalition that includes the CFIB, Vancouver and other municipalities is pushing the New Democrat government to pass legislation that would allow local governments to establish a new class of property taxes to shield small businesses from the impact of rising land values.

Both provincial governments have promised to study the issue. In its economic update this week, Ontario said it will seek input on measures to “enhance the accuracy and stability of property assessments.”

In the meantime, small businesses across Toronto and Vancouver will have another year of punishingly big tax bills.