Jesse Tollison
Commercial operating costs in Minneapolis-St. Paul over the past five years have seen dramatic growth due to increasing tax bills. The current average operating cost per sq. ft. per year across office, retail, and industrial buildings is up 17% year over year. Office operating costs are at $13.19 per sq. ft. per year; operating retail space costs $9.25 per sq. ft. per year; and industrial has jumped up to $4.19 per sq. ft. per year. Over the past two years alone, office operating costs are up 12.1%; retail is up 9.7%; and industrial a whopping 41.7%. As a portion of total operating costs, industrial properties have the least common area maintenance (snow removal, elevator maintenance, lobby cleaning, etc.), so fluctuation in their tax bills have a greater impact on their total operating costs.
The typical commercial lease in office, industrial, and retail properties is called a “net” lease. In net leases, rent is structured in two parts. First, the tenant pays a base rent that is set out in the lease itself. Second, the tenant pays operating costs according to their proportional share of the building. For example, a tenant occupying half of a building’s square feet pays 50% of those costs. Therefore, increases in property taxes not only impact building owners but also impact the cost of rent for businesses within those properties.
Despite market distress existing mainly in office product, the growth in operating expenses occurs across office, retail, and industrial properties because the state lumps them together into the commercial tax base.
Since the COVID-19 pandemic, office values in Minneapolis-St. Paul have plummeted. They peaked in 2021, and since then the total value of office assets in the Minneapolis metro have fallen 15.1%, or $5.4 billion, which has an impact of about $108 million on the tax base. In that same period, industrial and retail valuations grew a combined $4.6 billion, about $800 million shy of compensating for the decline in office values. This phenomenon has created a property tax environment where commercial values are stagnating despite there being pockets of stable, high growth commercial assets. Without overall growth in the commercial tax base, increases in the tax levies create larger tax bills for all commercial assets.
Put simply, Minnesota property taxes are calculated by dividing the total property tax levy (how much money the governments need) by total tax capacity (how much taxable value exists in the governments’ jurisdictions). This tax capacity number (or tax base) is derived from the assessed values of each property. Commercial properties are classed at 2% of value, so they’re responsible for funding a greater portion of the governments’ levy than other types of properties. For comparison, apartment properties are classed at 1.25% and most single-family homes are classed at 1% of value. What the state of Minnesota considers “Commercial” properties by and large includes office, industrial, and retail properties, so when office values fall, tax bills go up across the board of commercial real estate.
Sources: CoStar, Minnesota Commercial Association of Realtors, REDIComps
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