Vacancy Taxes in Commercial Real Estate: Solution or Unintended Consequence?
The Proposal
I live in Santa Monica, CA. There has been much concern over the vacancies that we have been seeing in the Downtown submarket, including the Promenade. Like many cities policymakers continue to search for ways to address empty storefronts, underutilized office buildings, and declining business districts. One proposal that is frequently talked about is the implementation of a commercial vacancy tax—a tax imposed on property owners whose commercial space remains vacant for an extended period of time.
Proponents of the tax argue that
Vacancy taxes encourage productive use of real estate and revitalize struggling business districts. Critics contend that such taxes only serve to punish owners for market conditions beyond their control and may ultimately discourage investment.
“As with most governmental real estate policies,
the reality is much more nuanced.”
A commercial vacancy tax is an additional tax levied on owners of commercial properties that remain vacant for a specified period, often after six months or a year. The goal is to motivate landlords to lease, sell, or repurpose unused space rather than allowing properties to sit idle.
These taxes have been discussed or implemented in various forms in cities facing persistent vacancies, particularly in retail corridors and central business districts struggling with post-pandemic occupancy challenges.
Benefits include:
1) Encourages active leasing efforts
2) Revitalizes Business Districts
3) Increases Tax Revenue
4) Discourages Speculative Holding
5) Supports Small Business Occupancy.
Let’s discuss these in detail.
Encourages Active Leasing Efforts
One of the primary arguments in favor of vacancy taxes is that they incentivize landlords to actively market and lease vacant space. Rather than holding out indefinitely for premium rents, owners may become more flexible on pricing, lease terms, tenant improvement allowances, or concessions to attract tenants. The results could be faster absorption of vacant inventory. What this doesn’t take into consideration is that most owners are already incentivized to actively market and lease their vacant spaces. Most are currently already paying for a mortgage, as well as the property taxes and maintenance (expenses that many times are covered by a tenant)
Revitalizes Business Districts
It is true that vacant storefronts and empty office buildings can negatively impact surrounding businesses and property values. When vacancies cluster in a district, they often create a perception of decline that discourages customers, investors, and prospective tenants. By encouraging occupancy, vacancy taxes may help maintain vibrant commercial corridors and support economic activity. Business districts must look to also maintain the type of tenant, ie: if a vacancy tax makes a landlord desperate to find a tenant, they may bring in tenants that do not align with the business district.
Increases Tax Revenue
Municipalities often view vacancy taxes as a potential source of revenue. Funds generated from vacancy taxes can be directed toward economic development initiatives, infrastructure improvements, small business incentives, or public safety programs designed to strengthen commercial districts. The key here is to make sure that any vacancy tax that is put in place is specifically and ONLY used for these purposes.
Discourages Speculative Holding
An argument some communities make is that some investors acquire properties with little intention of immediate leasing or redevelopment, instead waiting for appreciation. A vacancy tax may discourage this practice by creating a carrying cost for leaving space unused, encouraging more productive deployment of real estate assets. Unfortunately, the reality is that, although there is no exact percentage of investors that purchase for speculative holding, the estimate is that it is extremely rare, and accounts for less than five percent (5.0%) of all investments.
Supports Small Business Occupancy
In some markets, landlords may become more willing to negotiate with local businesses, startups, and entrepreneurs if prolonged vacancies trigger additional taxes. This flexibility can potentially increase opportunities for smaller tenants that might otherwise be priced out of the market.
There are also potential drawbacks of a commercial vacancy tax, some of which are: 1) Market conditions are not always within the owner’s control; 2) Increased financial pressure on property owners; 3) May reduce actual investments in some markets; 4) Difficult to administer fairly; 5) May encourage short-term, or lower-quality leasing decisions. Let’s delve into these a little deeper.
Market conditions are not always within the owner’s control.
The biggest criticism of a vacancy tax is that vacancies are often caused by broader economic conditions, or changes in public policy. An owner cannot force a business to lease space during a recession, period of rising interest rates, or sector-specific downturn. Office landlords in many markets, for example, continue to face elevated vacancies due to remote work trends. Taxing these owners will likely not create demand where none exists, it will only increase the pain they are already feeling.
Increased Financial Pressure on Property Owners.
Commercial real estate owners already face substantial expenses, including mortgage payments, insurance, property taxes, maintenance costs, and capital expenditures. A vacancy tax adds another financial burden, potentially creating distress for owners already struggling with reduced cash flow. In extreme cases, it may accelerate defaults or foreclosures. Additionally, many commercial loans have a lease approval covenant. What this means is that if an owner leases the property at a lower rental rate then what was agreed to in the covenant, they would be in default of the loan, and potentially face foreclosure.
Could Reduce Investment in Certain Markets.
Investors evaluate risk when deciding where to allocate capital. Markets with aggressive vacancy tax policies may become less attractive compared to neighboring jurisdictions without such taxes. Reduced investment could ultimately hinder redevelopment efforts and economic growth.
Difficulty to Administer Fairly
Determining whether a property is truly "vacant" can be challenging. Many times a property may appear vacant, but the tenant has just “gone dark” but is still paying rent. In this scenario, the tenant still maintains occupancy rights even though the property appears vacant. Additional questions that often arise:
What qualifies as active marketing?
Should buildings undergoing renovation be exempt?
How are partially occupied properties treated?
What about properties being repositioned for a new use? (especially if the permitting process from the city is onerous and time consuming)
Administrative complexity can create disputes and increase compliance costs for both owners and municipalities.
May Encourage Short-Term or Lower-Quality Leasing Decisions
To avoid taxation, some owners may accept tenants that are not financially strong or operationally suitable for the property. While this may temporarily reduce vacancy, it can increase turnover, collection issues, and long-term instability. A fully occupied building is not necessarily a successful building if the tenant mix is unsustainable and high turnover undermines the main reasons for a vacancy tax.
The Office Market Challenge
The vacancy tax debate has become particularly relevant in the office sector. Many downtown office markets continue to experience elevated vacancy rates due to hybrid work arrangements and reduced space requirements. In these situations, vacancy is often the result of structural shifts rather than landlord behavior.
Critics argue that taxing office vacancies may simply penalize owners during an industry-wide transition, while supporters believe the tax could encourage office-to-residential conversions and other adaptive reuse projects.
The key to all of this is to find a balanced approach. Rather than imposing blanket vacancy taxes, some policymakers are advocating for targeted solutions, including:
Tax incentives for tenant improvements, to attract new tenants.
Conversion incentives for obsolete office buildings.
Streamlined and reduced cost permitting processes.
Small business leasing grants.
Redevelopment tax credits.
Flexible zoning policies.
These approaches focus on creating demand and facilitating occupancy rather than penalizing vacancy alone.
In conclusion, the thought process is that commercial vacancy taxes are designed to encourage productive use of real estate and revitalize struggling business districts. In theory, they can reduce long-term vacancies, stimulate leasing activity, and generate public revenue. However, they also risk penalizing owners facing legitimate market challenges, increasing financial distress, and discouraging future investment.
The effectiveness of any vacancy tax ultimately depends on local market conditions, the design of the policy, the support of the municipality to bring in tenants, or reposition the assets, and whether it addresses the root causes of vacancy. For many commercial real estate professionals, the question is not whether vacancies should be reduced—but whether taxation is the most effective tool to achieve that goal.
What Now?
Vacancy challenges affect property owners, tenants, investors, and entire communities. If you're evaluating a vacant property, considering redevelopment opportunities, or looking for strategies to increase occupancy and asset performance, I'd be happy to discuss your situation. Every market is different, and finding the right solution often starts with a conversation. I’d love to hear from you on what you think, or if there are better alternatives to increasing occupancy in high vacancy areas.
Written by: George Pino