Could a slowdown in the Philly real estate market impact the city budget?

Philadelphia Mayor Cherelle L. Parker is getting ready to unveil her first budget proposal, and she may have less cash to work with than anticipated.

A slowdown in Philadelphia’s real estate market over the last year following national interest rate hikes is likely to have an impact on the city’s coffers, with a recent analysis showing revenue from the city’s realty transfer tax down 26% compared with projections.

That means that the city expects to bring in about $110 million less in transfer taxes than initially projected by the end of the fiscal year in June.

Officials say the decline in revenue is not an immediate cause for alarm for the city’s more than $6 billion budget. That’s because, combined with larger-than-expected returns from other taxes, the revised overall revenue projection for this fiscal year is $5.94 billion, just $68 million lower than anticipated.

But the assessment, included in a quarterly report released this month, comes as Parker administration officials have already warned that the city is working in an uncertain economic climate. An unprecedented amount of federal relief funds allocated to the city during the pandemic will be exhausted by the end of the calendar year. Inflation remains a factor, and it’s unclear whether or when the Federal Reserve will cut interest rates.

Those elevated interest rates mean the resale market for homes has slowed as owners hold on to mortgage rates secured during the pandemic that are 3% or less.

“From an existing supply, there’s just an extreme lack of inventory on the market right now for people to buy homes,” said Devin Tuohey of the Concordia Group.

He said the decline in the tax is also a result of local policy choices, such as the halving of the value of the 10-year real estate tax abatement, which has slowed new construction.

“Then there’s been a lack of new inventory that’s hit the market as compared to the last five or six years when townhomes were being built everywhere throughout the city,” said Tuohey, who is treasurer of the Building Industry Association.

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The 3.278% tax on real estate transactions, which is typically split between property buyers and sellers, has long been more volatile than other revenue streams. It was expected to generate less than $400 million this year — far below the city’s taxes on wages and businesses.

In fact, the wage tax is the city’s biggest revenue driver, and it’s projected to generate about $77 million more than expected this fiscal year.

And there’s some sign that the reduction in revenue from the real estate transfer tax is slowing. Projections were worse in the first quarter of the fiscal year, which ended in September.

“Philadelphia is a place that has lots of different taxes, and there’s movement in some of the others,” said Marisa Waxman, executive director of the Pennsylvania Intergovernmental Cooperation Authority, the state board that oversees city finances.

» READ MORE: The city budget has been a source of pain for past Philly mayors. Under Jim Kenney, it’s been a bright spot.

Waxman, who was the city’s budget director under former Mayor Jim Kenney, said the city is still projected to have healthy cash reserves that allow it to absorb some revenue volatility. The city ended last fiscal year with nearly a billion dollars left unspent, making for the highest fund balance ever recorded.

“That net decrease in tax revenue doesn’t immediately spell disaster,” she said. “We do have tools in place to weather this.”

City officials project a much more modest fund balance by the end of this fiscal year. According to the most recent quarterly report, the city expects to end the year with a $504 million fund balance, or about 8% of revenue. That exceeds the city’s goal for its fund balance to be at least 6% of revenue.

PICA officials have said the Parker administration should revisit tax growth rates in order to set realistic revenue targets for the coming year.

Tuohey said that from the real estate industry’s perspective, there are tweaks to local policy, such as zoning changes or the strengthening of the tax abatement, that could be made to encourage construction and bring in more revenue from the transfer tax. A tax abatement change is likely not politically palatable in City Hall; City Council voted in 2019 to reduce the tax break.

For immediate relief, he said, the biggest change needed is outside the city’s control. If and when interest rates come down, the effect on new construction may not be immediate — but resales of existing homes should rebound quickly.

“If the rates start decreasing, we should see a significantly higher uptick in resales, which will obviously help the transfer tax situation,” Tuohey said. “That’s the really direct correlation when rates go down: Folks will think much more seriously about selling out of a 3% mortgage.”