Manhattan’s Broadway, one of the most famous avenues in the world, is a shopping mecca that bustles with energy. Or it used to. The stretch between 48th and 57th streets looks like it was hit by a neutron bomb. Along those nine blocks, only one store has been open recently; it sells drones. Excluding a few bank branches and fast-food outlets, the rest of the storefronts are boarded up.
What happened? Amazon and other digital retailers happened, that’s what.
Manhattan is not the only victim. While Amazon’s popularity has pushed its stock market value to more than 700-billion, it is cutting swaths through main streets from Los Angeles to Rome and gutting suburban malls. Last year saw record retail defaults in the United States, and 2018 could set another record, according to S&P Global Ratings.
Why should you care? Because the ease of online shopping may come at an unexpected price: watching your property taxes go up. They may not have gone up yet because of the Amazon effect, but Amazon is just getting started. The CEO of one of the world’s top real estate companies, who did not want to be quoted by name, says he thinks governments will be forced to raise property taxes to overcome the inevitable tax shortfall from the ailing retail sector.
In North America and Europe, the traditional retailing industry isn’t just a huge employer, typically ranked second, third or fourth, but it is also a huge spinner of property taxes. When retailers go bust, their tax payments collapse, too.
How will city and regional governments make up the lost revenue? The obvious targets are residential and office real estate.
If your city’s property tax is a percentage of assessed value, the rate might rise. Or land transfer taxes might go up. Or both.
Governments will not allow themselves to go broke while Amazon chomps its way through the retail landscape.
Retail everywhere is under pressure.
Last year, Bill Ackman, CEO of the Pershing Square activist hedge fund, which took baths on large investments in shops and malls, pronounced the traditional department store dead.
The numbers suggest he is not exaggerating by much, and the wildly overbuilt American retail market is more vulnerable to implosion than those elsewhere.
PwC has estimated there is 24 square feet of retailing space per person in the United States. The European figure is a mere two to five. Another survey puts Canada at 14 square feet. The U.S. retail glut is partly due to private equity funds, which bought chains like J.Crew, loaded them with debt and expanded them to pump up sales. Now those overextended chains are in trouble as Amazon comes on strong.
Challenger Gray & Christmas, a U.S. employment firm, reports that retailing is now the top job-cutting sector. In the first three months of this year, retailers slashed 56,500 jobs, almost 50 per cent more than the same period in 2018. In recent quarters, retail job losses have exceeded gains, according to the U.S. Bureau of Labor Statistics. And the pace of store closures may be far from peaking out. In 2011, Amazon and its smaller e-commerce competitors took just 5.1 per cent of total American retail sales. Today, they account for 10 per cent.
City and regional governments everywhere must be getting worried. In the United States and Canada, property tax is paid by the owner of a property, not the tenant. When a shop goes vacant, the landlord still has to pay the tax, in theory.
In practice, owners often cut deals with governments to reduce or suspend the tax payments until that property is reoccupied. In Toronto, until recently, owners of vacant stores could apply for property tax rebates. But the program is a cash drain, and the city is winding it up.
In the United Kingdom, the government tax loss when a store closes is particularly nasty, because the so-called “business rates” charged on commercial properties are hefty. The tax is usually about half of the value of annual rent, and it raised 29-billion the 2016-17 fiscal year, equivalent to 4.5 per cent of the total national tax take. Governments bill tenants, and if the tax isn’t paid, the action is taken against the occupier, not the landlord. If there is no tenant, no business rate can be charged.
The trouble is that the alternative to granting tax relief is tax default, which leaves governments with nothing. Cutting deals with mall owners will continue as more retail chains shrink or go bust, as Sears Canada and Toys “R” Us have.
If traditional retailers continue to be ground down, no government is going to raise income taxes to fill the hole that would be a vote killer. But property taxes are a different matter. Notice how they never go down, even in the best of times? With traditional retailers on their way out, watch property owners pick up the tax slack.