A Ghostly Commercial Sprawl Drains Municipal Funds

Empty offices, malls, and factories blight U.S. communities just when they most need commercial real estate revenues the sites once provided

For governments grappling with a fierce economic downturn, urban sprawl is turning out to be far less of a problem than empty sprawl. Across America the skeletal remains of millions of square feet of commercial real estate have produced a sharp decline in tax revenues. This is forcing government to deal with an upsurge in business properties that are no longer productive.

While home foreclosures have been a central problem in America's real estate crisis, nonperforming commercial properties are playing a major role in roiling municipal finances. The most populous state, California, faces a $42 billion budget deficit, coupled with a state law that prohibits an increase in property taxes—the primary source of state revenue. A combination of federal stimulus money and severe budget cuts are likely to be the state's only short term option. "They do triage," says Robert Lang, co-director of the Metropolitan Institute, a development think tank at Virginia Tech, of budget writers.

By and large, many vacant commercial properties will remain that way until credit markets ease and business regains some confidence in the economy's outlook. Commercial real estate listings at LoopNet.com (LOOP), rose 16% to 651,000 in the fourth quarter of 2008 from a year earlier, said Mike Manning, a vice-president of the San Francisco-based commercial real estate site.

Afflicted Suburban developers

In Sacramento, a city that boomed when times were good, concern runs rampant about the effect of empty and abandoned commercial real estate. Four blocks from California's General Assembly, where lobbyists have typically swarmed for office space, demand is soft. A building owned by Los Angeles-based realtor CB Richard Ellis Group (CBG) is 50% vacant despite floor-to-ceiling windows, a newly renovated interior, and a stone's throw to the Capitol stairs. "If we had listed this in 2006, there might be ten different groups interested," Senior Vice-President Ken Turton says. "Today there's three or two."

Fourteen miles south, in suburban Elk Grove, more than a third of the town's office space sits empty. A 107-acre mall, the Elk Grove Promenade, was highly touted for years as a major economic bonanza but now sits on hold indefinitely. The Promenade's financially troubled developer, General Growth Properties (GGP), owes the city $400,000, according to the Sacramento Bee. Its stock now trades at 35¢ per share, down from 44 last May.

Optimism is hard to muster these days—even for Steve Czarnecki, executive director of the Elk Grove Economic Development Corp., who says it's his job "to put things into positive context." Elk Grove's gross tax receipts fell a cumulative 15.3% in the second and third quarters of 2008, compared with 2007, largely a result of the implosion in commercial real estate. In 2006 the Elk Grove Saturn (GM) dealership and a Circuit City store were on the city's list of top 25 sales tax producers. The bankrupt Circuit City electronics chain, which turns off the lights nationally March 8, dropped off the list in 2007. Both properties now sit vacant: The Saturn car dealership is shuttered and stained with graffiti.

Cleveland's "bizarre retail landscape"

Property taxes are Sacramento County's largest source of revenue, followed by sales taxes, and static property dries up both streams. Buildings appraised three years ago, at the height of the speculative boom, are being reassessed at lower rates. At this point many cities and states would welcome flipping—the rapid turnover of property—as such transactions produce revenues.

Elk Grove's most recent third-quarter sales tax update is a grim read: "Local government budgeting will be the most challenging it has been in decades." The city will lean for savings on "enterprise" services such as trash pickups, bus transit, and water drainage, city finance director Rebecca Craig says.

While excess space has accelerated development problems in such places as suburban Sacramento County, Cleveland is suffering from urban issues, too. The Rust Belt city is attacking problems that include factory properties located among potentially prime urban residential areas and exurbs that were built with urban planning models from the 1930s. "It's such a bizarre retail landscape," says Terry Schwarz of the Cleveland Urban Design Collaborative at Kent State University.

Cleveland has an estimated 3,300 vacant acres (5.15 sq. miles), and about 15,000 vacant properties, 12,000 or which are residential. The city's 40 square feet of retail space per capita is among the nation's highest, says Schwarz. (The national average is 19 square feet.) As the population migrated outward, developers kept building, creating redundancies between downtown and exurban stores. "Retail follows those populations out," Schwarz says. "It doesn't mean that the older stuff disappears, it just functions less well."

Some urban sites bear toxic risk

Scattered among empty retail space and office buildings are former industrial sites such as the 22-acre Midland Steel Products factory west of downtown Cleveland. The plant stopped producing vehicle frames for Detroit six years ago, and the city saw tax receipts from the site plummet. Midland had been paying about $277,000 annually in property and income taxes. Since 2004, the city has reaped only $22,000 per year from the property.

The city's Industrial-Commercial Land Bank, a division of the Cleveland Economic Development Dept., has razed what was left of the building, cleaned up the site, and is scouting a buyer. "It's extremely expensive to do what we are doing," says Nate Hoelzel, manager of Cleveland's brownfields programs, which deals with former industrial sites that bear environmental risks. On top of the loss in tax receipts, the Midland Steel site has cost the city nearly $300,000 per acre to clean up.

Since 2006, Cleveland has razed 2,300 structures and the private sector has demolished an additional 900. Like Sacramento County, Cleveland receives significant federal money through Neighborhood Stabilization Program Grants, funds that can be used to demolish structures and redevelop vacant properties. With an overstock of retail space in most American cities, the immediate future is likely to keep vacant property stagnant and municipal governments stumped for solutions. "I am an accountant," says Craig, the Elk Grove finance planner. "I don't use the word creative and finance in the same conversation."

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