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Municipal Bonds

Property, water and power impact muni bonds

Municipal Credit Research Team
Experienced sector specialists represent one of the industry’s largest credit research teams dedicated to municipal investing.
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Commercial real estate valuations for office space are declining in some markets, which may affect city property tax revenue. California’s drought restrictions have been eased after record-breaking rain and snowfall, with the governor rescinding many emergency measures. Energy Harbor’s acquisition by Vistra Vision affords investors an opportunity to participate in a newly formed, diverse, larger-scale and 100% carbon-free baseload power generation entity.



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Vacant office space may affect property tax revenues

Property tax revenues across the U.S. were up 6.9% at the end of 2022 versus 2021. This was the largest annual increase since 2009, reflecting the lagged impact of soaring home prices in the wake of the Covid-19 pandemic. Post-pandemic residential valuations have remained steady and bolstered by housing demand.

Commercial real estate valuations, however, are declining in some markets and expected to fall further, with the office sector most at risk. Weekly office attendance in major cities had only reached 50% of pre-pandemic levels as of early March. The national office vacancy rate hit a 20-year high of 17.9% in the first quarter of 2023, well above the pre-pandemic level of 12%.

In general, when governments face projected budget gaps, they can raise revenues, cut spending or draw down budget reserves to close the gap. Looking back to the Global Financial Crisis, which was triggered by the popping of a real estate bubble, residential property values declined dramatically between 2007 and 2008. In most cases, however, property tax collections did not decline, or the decline was not commensurate with the drop in valuation. This is because local governments can easily raise the tax rate to compensate for the declining value of property. The increase in rates requires neither legislative nor voter approval.

Work-from-home patterns and practices continue to shift. As new regional and industry norms continue to emerge, it’s too early to reach conclusions about the long-term demand for office space. Given the lag in assessing property value, which at best is done annually, local governments may not see a downturn in property tax collections for at least another 18 to 24 months. The property tax appeals process further extends the horizon for potential revenue declines.

Even so, investors should consider the impact this trend could have on cities with significant office space. Importantly, the impact of diminished commercial market values will vary widely by city based on local demand, how commercial properties are taxed and how much a given city relies on those revenues.

Weekly office attendance in major cities had only reached 50% of pre-pandemic levels as of early March.


Governmental reliance on property tax revenues varies

The method for valuing commercial assets and assessment practices vary. Issuer-specific factors influence how individual credits will fare. In some cases, rising residential values and the strength of the industrial sector and warehouses will make up for any downturn in office properties. In short, the effect of a depressed office real estate market is not monolithic.

Many cities, like New York City, have already reined in spending levels in current and upcoming budgets in anticipation of a significant U.S. economic slowdown and waning federal pandemic aid. Others, like San Francisco, have set aside reserves specifically to manage through possible tax revenue declines from lower property valuations or an uptick in tax appeals for nonresidential properties. Larger cities generally have more diversified revenue structures, relying on a combination of property taxes, sales taxes, shared income taxes, state aid, fines and other taxes. Some cities, like Chicago, don’t use property taxes at all to fund general operations.

New York City’s property tax system provides stability

New York has the largest office market in the country. According to JLL, New York City’s total office vacancy rate stood at 16.1% in the first quarter of 2023. This rate falls to 11.5% when excluding long-vacant space vacant more than 24 months. While this is below the average 20.2% vacancy rate seen in major U.S. cities, many New York office buildings are being valued lower, raising concern.

Notably, commercial property market values and tax revenues in New York are not determined by property sales transactions. Instead, market assessed values are based on each property’s estimate of income and expenses from the prior calendar year. As such, the 2022 taxable assessed values were slightly lower, despite the higher vacancies and recent decline in sale value.

In fiscal year (FY) 2022, property taxes accounted for 28% of New York City’s general fund revenues, a 6% drop from the prior year, primarily due to the pressured commercial property market. In the near term, strong residential value growth is projected to offset the decline in non-residential properties. Additionally, changes in assessed commercial values are phased in over five years, blunting the impact of valuation changes. This allows the property tax system to provide stability and makes revenues less sensitive to changes in economic cycles. According to the City’s five-year financial plan, property taxes are projected to increase 1.9% in FY24 and remain flat through 2027.

Property taxes accounted for 28% of New York City’s general fund revenues in FY22, a 6% drop from the prior year.


San Francisco vacancies should remain high

San Francisco also has above-average office vacancy rates that reached a high of 26.4% in the first quarter of 2023. The city forecasts vacancies will remain high through 2026. Favorably, the city’s tax base is primarily residential, with office space contributing to only 17% of assessed value.

Nonetheless, city officials are taking steps to mitigate the impacts of weaker assessed values in the office sector. San Francisco had an unrestricted net asset position of $6 billion across all funds at the close of FY22, giving it significant financial flexibility. The city has also set aside $114 million in reserves in FY22 to pay for future tax appeals, although that amount might only cover a portion of possible revenue losses. San Francisco’s mayor recently announced a tax incentive plan offering three years of tax breaks to any company relocating downtown.

In some respects, San Francisco is a bit of an outlier given the predominance of the tech sector, which has embraced remote work to a greater degree than other industries. The city is forecasting budgetary shortfalls in the coming years from tepid revenue growth and the increase in service costs due to an anticipated economic slowdown, higher inflation and higher interest rates. In December 2022, the mayor instructed departments to reduce spending by 5% for FY24 and 8% for FY25.

Chicago shifts the tax burden

Many cities depend more on income taxes or sales tax revenue for operations. High office vacancy rates in those cities will have a more indirect impact on operations. For example, Chicago has historically used property tax revenues to pay debt service and employer pension contributions, not to support general operations. The office vacancy rate in Chicago was about 23% in the first quarter. This won’t lower the city’s property tax revenues in the near term, due in part to a newly enacted state recapture law that allows local governments to recover the total of any taxes refunded to property owners on appeal.

Based on recent real estate market data, Chicago residents’ property tax bills should have decreased in 2022, but instead increased as the tax burden shifted from commercial to residential property as large reductions in the share of commercial assessed value were granted on appeal. The County Assessor’s Office reset the value of over 550 commercial properties in the central business district to the final assessed values set in 2021, which will remain as-is until the 2024 reassessment. The appeals granted to these properties resulted in a reduction of $2.7 billion of taxable commercial value, or nearly 3% of Chicago’s total tax base. This reduction drove residential tax rates higher to compensate, forcing residents to shoulder more of the property tax burden last year (52.8%) than they did the year before (52.1%).

Bright spots emerge in numerous markets

Despite high office vacancy rates in some markets, a wave of distressed sales in the office sector has not yet materialized. It’s still unclear how rising interest rates, and the recent regional banking turmoil, will ultimately affect commercial real estate. Cities with sizable office inventory (especially older buildings) will undoubtedly face some fiscal challenges as office valuations suffer.

But strong valuations for retail, hotel and industrial property offset office property weakness and continue to be bright spots in numerous markets. Office attendance is gaining momentum and many cities, with stronger financial positions than the prior real estate downturn, are already preparing for the impact.

California drought restrictions eased

Governor Newsom recently eased California’s drought restrictions after record-breaking rain and snowfall, rescinding many emergency measures. Water agencies across the state boosted their supplies after a record wet winter ended a three-year drought in much of the state. Through mid-April, total precipitation was more than 140% above average compared to prior years and 28% above the average year-end total with four months left before the next rainy season begins.

Snowpack was 300% above normal levels with the 2022-2023 season having one of the largest snowpacks on record. Only 9% of the state now has moderate or extreme drought conditions, a stark improvement from four months ago when essentially the entire state was in a drought. California’s reservoirs are now filled to 76% capacity, on average. Now that reservoirs and groundwater are replenished, the state’s Department of Water Resources announced that it expects to deliver 100% of requested water through the State Water Project. This is up from the 75% announced last month and well above the 5% allocation in 2021 and 2022. The last time there was 100% allocation was in 2006. The State Water Project delivers water to 28 public water agencies, serving 70% of the state’s population and 750,000 acres of farmland.

Despite these developments, Governor Newsom has not declared the drought over and is keeping 32 of the 81 total emergency drought provisions in place. These provisions include practices such as replenishing aquifers and preparing for future dry periods.

Energy Harbor has operated its nuclear plants at high-capacity levels, grown its retail business and performed well through the economic uncertainty during the pandemic.

Energy Harbor expected to emerge as a zero-carbon power generation company

In April 2018, FirstEnergy Solutions, which was a subsidiary of FirstEnergy Corp., filed for bankruptcy protection under Chapter 11.

FirstEnergy Solutions was a unique corporate issuer because most of its debt was issued in the municipal bond market to finance pollution control and waste disposal facilities for its power plant portfolio. During the bankruptcy, numerous FirstEnergy Solutions bondholders entered into a settlement agreement with former parent FirstEnergy Corp. that resulted in meaningful financial consideration to the FirstEnergy Solutions estate, in addition to several liabilities being assumed by its parent company.

The utility emerged in March 2020 as a new standalone entity named Energy Harbor Corp. For the past three years, Energy Harbor has operated its nuclear plants at high-capacity levels, grown its retail business and performed well through the economic uncertainty during the pandemic. Energy Harbor owns three nuclear power plants and is one of the largest zero-carbon energy producers in Ohio and Pennsylvania.

On 06 Mar 2023, Vistra Corp. announced its acquisition of Energy Harbor. The deal is expected to close in the second half of 2023, subject to closing conditions. Distributions from the deal will represent a meaningful return of capital to investors holding Energy Harbor shares.

The ownership interest in Vistra Vision affords investors an opportunity to be involved at the inception of a more diverse, larger-scale and 100% carbon-free baseload power generation entity well positioned to advance zero-carbon solutions in the energy industry. Though the process has been lengthy, Energy Harbor’s separation from FirstEnergy Corp. ultimately resulted in the creation of a new clean-power generation company with a strong balance sheet and upside potential for investors.

Energy Harbor’s separation from FirstEnergy Corp. resulted in a new clean-power generation company with a strong balance sheet and upside potential for investors.
Municipal-to-Treasury ratios (%)
Longer bonds are performing best in 2023 (%)
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“Rain Won’t End California’s Water Troubles, but Better Infrastructure Might”, Governing, 24 Mar 2023.
US Drought Monitor, 06 Apr 2023.
“Gavin Newsom lifts California drought restrictions after record-breaking winter storms”, The Sacramento Bee, 24 Mar 2023.
California Data Exchange Center, California Department of Water Resources, Northern Sierra Precipitation 8-Station Index, 24 Apr 2023.
“State Water Project to Further Increase Water Supply Allocation”, California Department of Water Resources, 20 Apr 2023.
U.S. Census Bureau, Quarterly Summary of State & Local Tax Revenue.
Nuveen CIO Weekly Commentary, 17 Apr 2023: Containing Concern in Commercial Real Estate.
City and County of San Francisco, Policy Analysis Report, 24 Feb 2023.
Evercore ISI Research, 1Q Office Quarterly.
“Tax Breaks Threaten Remote Work If Cities Start Enforcing Them,” Bloomberg, 21 Feb 2023.
City of New York FY22 CAFR.
New York City Independent Budget Office.
City of San Francisco FY22 CAFR.
City of Chicago OS, 08 Dec 2022.
Cook County Assessor’s Office, “Commercial Property Values Reset in the City of Chicago,” 08 Feb 2023.
Moody’s Analytics, Inc.
Jones Lang LaSalle (JLL) Office Outlook Report, Q1 2023

This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on Please note, it is not possible to invest directly in an index.

Important information on risk

Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments.

This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute

Nuveen provides investment advisory solutions through its investment specialists.

This information does not constitute investment research as defined under MiFID.

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