Houston’s 2021 Budget Will Empty Its Rainy Day Fund, Leaving The City Open To Future Shortfalls

Houston Mayor Sylvester Turner presented his proposed fiscal year 2021 budget this week, aiming to close a $169M shortfall exacerbated by the coronavirus pandemic and low crude oil prices.

Amid a range of cost-cutting measures, the budget proposes drawing down the general fund balance by $98M and emptying the city’s $20M Budget Stabilization Fund, also known as the rainy day fund.

With hurricane season approaching and a lack of clarity over how long Houston’s economic recovery could take, there are concerns that this year’s budget could leave the city vulnerable to other unexpected disruptions, and in a position where even bigger budget cuts may be necessary in the fiscal year 2022 budget.

“I think the big hit comes next year and the year after,” Kinder Institute for Urban Research Director Bill Fulton told Bisnow.

Though actions within the commercial real estate industry, including difficulty paying property tax and the closure of retail and hotel properties leading to limited sales and hotel taxes, have contributed to the city’s budget shortfalls, the industry may not feel much direct pain from them. On the contrary, property owners may see reduced property tax rates in upcoming years.

But the budget woes may have an indirect affect on CRE, with property values potentially sliding and the rainy day fund, which was used to help Houston recover after Hurricane Harvey, no longer being available for emergencies. 

Some of the measures outlined in the budget include a $13.7M reduction in contingency funds and furloughing 3,000 municipal employees for a maximum of 10 days, which will save the city about $7M. The budget also proposes deferring five police cadet classes, which will save $13.9M.

The proposed budget for all funds totals $5.1B, which is an increase of 1.2% from the city’s current budget. However, the $2.53B proposed general fund budget, which covers most of the city’s operations, is a 0.9% decrease from 2020. In times of significant economic instability, the city is permitted to draw down the balance of the general fund.

The city council will hold a May 27 hearing on the proposed 2021 budget and consider the budget for adoption on June 3. The cuts will not be implemented before the start of the 2021 fiscal year, which begins on July 1.

Much of the shortfall has been driven by the loss of sales tax revenue over the past couple of months, as businesses were forced to close their doors due to the pandemic.

Prior to the pandemic, the city of Houston experienced a modest growth in sales tax revenue in fiscal year 2020, and anticipated another conservative 2% growth in fiscal year 2021. However, Houston is now facing a cumulative estimated loss in sales tax revenue of about $107M during the 2021 fiscal year, according to city officials.

Fulton said that if the furloughs and layoffs continue for an extended period of time, it means less money in people’s pockets, and subsequently less spending.

“I think you're going to see a decline or stagnation in sales tax for the next two or three years, and that's going to affect the city's ability to support the city budget to bounce back to where it was before,” Fulton said.

“It'll be several years before the city will truly be financially stable, almost certainly past the end of Turner's term.”

University of Houston economist Steven Craig told Bisnow that while a rainy day fund exists for difficult unexpected situations like a pandemic, using all of it could lead to more painful cuts in the future.

“I would be nervous about using the entirety of my rainy day fund, because if he does that, he'll be looking at potentially serious cuts the following year,” Craig said.

“That's taking a chance that's not for sure going to work out.”

A tighter budget means an impact to public safety measures and reduced city services. But commercial real estate development is unlikely to be directly affected by the budget, because Houston’s local government typically has little input or involvement with most development projects beyond things like inspections and permitting.

“Houston is a city where development has been shaped much more by the private sector than many other cities, where the public sector is key," Wolff Cos. Chairman and President David Wolff told Bisnow.

Still, Fulton thinks development activity in the city of Houston will scale back, as developers step on the brakes until economic conditions improve. He pointed to high-end multifamily developments and urban development in neighborhoods around Downtown Houston as two types of developments that could cease for a while.

Commercial real estate could see some potential opportunities come out of another source of the city's revenue — property tax — which could take a hit in the next few years.

Property tax reappraisals begin on Jan. 1, so for the calendar year of 2020, property taxes will remain relatively high and people won’t have a choice but to pay, Craig said.

Those taxes will likely fall in 2021, as economic and job growth slows in Houston, unless something remarkable occurs between now and Jan. 1.

“Even if the sales tax revenue recovers, the property tax revenue is going to take a big hit,” Craig said. 

Unlike other municipalities, the city of Houston must operate under a property tax revenue cap, Turner said in a statement attached to the proposed budget. The property tax cap was introduced in 2004 by voters, requiring the city to collect less tax revenue.

Fulton also anticipates a slide in property values, though he said it could take a while for that impact to be seen in the property tax system. Harris County, which is largely funded by property tax, is in a better position than the city of Houston because it is less exposed to the volatility of sales tax.

“Any agency that is highly dependent on sales tax, such as METRO and the city, is going to have a really hard time over the next two to three years, compared to other agencies,” Fulton said.

Wolff has an even more conservative outlook on how long it could take for the city of Houston to recover.

“I think this downturn in Houston, maybe if you assume nationally it's going to be two years, I'd say in Houston it's going to be four years, because we've got the double whammy of the virus coupled with the energy industry's problems,” Wolff said.

“A lot of those jobs that are lost probably aren't going to come back, as the companies figure out that they can operate with fewer people and cut out middle management.”

Mayors around the U.S. have been lobbying the federal government to allow them to use some of the money received through the CARES Act to backfill lost revenue. The city of Houston received $404M from the act, which is intended for coronavirus-related action.

Fulton is skeptical that will happen, as the current administration is Republican and President Donald Trump has said the federal government should not have to bail out Democratic state and local governments. But Fulton said the federal government will have to do something, given the immense economic damage that has been done to state and city budgets around the country.

“The bloodbath, particularly at the local level, is going to be so huge, that I think the Feds are going to have to do something else. So I think more money will be coming down the pipe eventually, and that money will probably be more flexible, and that will help Houston and other cities — if not by 2021, help them in 2022,” Fulton said.

Craig noted that the U.S. energy sector, which has enjoyed massive returns thanks to the shale boom, may never return to its prior strength. Houston is instead entering a maturation stage, which is a major change from the growth stage the city has been in for a long time.

That will place a higher onus on the day-to-day management of the city, staying within budget and finding effective ways to get things done, because lackluster growth won’t allow officials to paper over inefficiencies.

“We're going to have to get used to last year's spending being about the same as this year's spending, being about the same as next year's spending, instead of always growing in real terms,” Craig said.

“For the next two years, the city is looking to be very fiscally stressed."

Wolff said he also thinks Houston will need to strengthen other revenue streams outside of oil and gas, like manufacturing, to keep the city growing and strengthen its finances.

“Longer term, I think what we have to be facing up to [is] the fact is that the oil and gas business is not going to be what it has been, and I don't think it'll ever recover to the levels that we have enjoyed in the past,” Wolff said.

“To me, it really emphasizes the point as to how we have to diversify our economic and job base and do a better job of economic development.”