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11th Hour Anti-Competitive Warehousing Tax: A Big Loser for Owners of Industrial Properties

Thursday, August 1, 2013  
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By Stephanie Wolf, NAIOP Minnesota

 "Minnesota’s warehouses are under attack.” That’s how Jonathan Lamb, president of Lake Superior Warehousing Company, Duluth, describes the new 6.875% service tax on Minnesota warehouses that, barring repeal, will take effect April 1, 2014. "In an industry with single-digit profit margins, Minnesota warehouses cannot afford to be the target of a new service tax,” said Lamb, who is also president of the Minnesota Warehouse Association.

The new tax imposed by the 2013 legislature also represents a threat to the state’s developers and owners of industrial and warehouse properties, according to Kaye Rakow, Director of Public Policy for NAIOP Minnesota, the commercial real estate development association.

"Our members are deeply concerned about the potential impact of this new business sales tax on their tenants who provide third party warehousing services, businesses which operate with slim margins and compete across state lines with similar service providers in nearby states with lower overhead costs, such as Wisconsin,” she said.

Chris Willson, Senior Regional Director for First Industrial, a Chicago-based REIT which owns more than 4.5 million square feet of industrial space in the Twin Cities, shares her concerns. Willson calls the almost 7% increase in costs a "huge issue” for some of his tenants, and, therefore, for First Industrial. He estimates as much as 10% of his firm’s total Minnesota portfolio—or 450,000 square feet of space—is at risk if the tax goes forward.

"This tax may not only impact our fulfillment and third party logistics tenants (known in the industry as 3PL’s). Other companies may also find themselves covered by the law’s vague language,” Willson said.
Most contracts covering these fulfillment and third party logistics services are short-term, 12 to 24 months at most, and can be terminated easily. "Third party logistics firms are typically nomads,” Willson explained. "All they need is just racking and space in which to put it. They are extremely cost-sensitive. Therefore they will move from one building to another, even to pick up another nickel, if their relocation costs are minimal.”

First Industrial tenant Skybridge Americas, based in Greenfield, is typical of the fulfillment firms who are also subject to the new tax. The firm leases 100,000 square feet and employs anywhere from 30 to 130 people, depending on the season, providing warehousing and distribution services for a number of well-known national marketing firms.

"This tax presents a real risk for our business,” said John Turner, Skybridge’s Vice President of Product Fulfillment, "especially since most of our non-Minnesota-based clients are all in a position to give us short notice of moving out, and can certainly do so quickly if there is a material change in terms.”

The Warehouse Association’s executive director John Hausladen calls the tax an "anti-competitive blow to Minnesota-based warehouses that compete within the multistate region.” Skybridge Americas’ Turner agrees. In fact, he said it’s particularly troublesome for his own company right now, "because we are actively looking for new clients outside Minnesota, and this tax will make it harder to compete within the region.”

Pat Mascia, Senior Vice President of Duke Realty, voices the concern of many NAIOP members who lease space to affected tenants. "This will have a big impact,” he said. "In fact, because of the bill’s ambiguities, some of our tenants don’t yet know and can’t determine whether they will be affected.” Mascia’s firm owns and manages 4 million square feet of industrial space in the Twin Cities.

"There are layers of these types of services in many companies, so just where and how the tax will impact them is difficult to predict. However, most of whom can cure their problem by simply moving across the border to Wisconsin,” Mascia said.

Steve Dorff, Property Manager at Meritex, owner of a million square feet of industrial space located in Rogers, Savage and Eagan, added another concern for the commercial real estate industry: client firms of some of the 3PL’s could choose to lease their own warehouse space directly and simply hire workers to handle the services end, "thereby not paying a tax at all and leaving vacant the warehouse space they previously leased.”

David Kordonowy, president of Steiner Development and also president of NAIOP’s Minnesota Chapter, is particularly worried about the precedent set by the legislature’s singling out of the warehousing segment of the commercial real estate industry for a special tax. "NAIOP’s 750 members have major concerns that taxing third party logistics firms could lead eventually to broader taxation of all users of office, warehouse and industrial space,” he said. "Equally troubling is the general uncertainty this raises for our members about where Minnesota is headed in terms of taxing business in general.”

"Costs matter, and so does uncertainty, for Minnesota’s business decision-makers,” Kordonowy said.
During the last legislative session, NAIOP joined with the Minnesota Chamber of Commerce and other business groups in successfully opposing over $3.6 billion worth of new business-to-business (B2B) taxes—legislation that would have impacted virtually every business transaction in the state. Despite their efforts, the warehousing tax and two other new B2B taxes—one on purchases of telecommunications equipment and another on repair and maintenance of business equipment—all resurfaced in the waning hours of the session and were passed with the omnibus tax bill.

Of the three new taxes, the tax on storage and warehouse business services is the one that most directly affects the commercial real estate industry, since it applies to all business related storage and warehousing activity, other than agricultural products and refrigerated storage.

Where did these new taxes come from? Economist Ed Lotterman, writing in the St. Paul Pioneer Press, said they "arose at the end of the session like a fiscal Lazarus from the tomb of a broader application of an intra-business services sales tax, first proposed by Gov. Mark Dayton and then dropped by him when it became apparent that they would not pass the legislature.” Lotterman bluntly describes them as "bad policy,” because they add further complications to the state’s "crazy quilt” tax system, and because they are arbitrary and hence unfair. "Why tax warehousing, but not parking lot patching or payroll administration?” he asks.

Lotterman also cites the "tax competition” between states. "Minnesota is cursed in that its major metropolitan area, in contrast to say, Idaho, Colorado or Arizona, is right on the state border. This means that there is much more potential for taxed businesses to move 20 miles or so east and escape payment.”

If allowed to be imposed, all agree that the tax will also become a significant factor in deterring construction of new warehousing facilities in the state. Willson says he has already heard of a 300,000 square foot facility planned for construction in southern Minnesota that has been put on hold. Red Wing Shoes President Dave Murphy has publicly announced that his firm is delaying construction of a new $20 million distribution center in Red Wing. And given the ease of serving all of the metro area from Wisconsin, with even faster, easier access when the new Stillwater bridgeis completed, warehousing and fulfillment companies are likely to find welcoming arms in our neighboring states’ counties bordering the St. Croix River.

The Minnesota Warehouse Association is taking no chances. According to Hausladen, his members are moving ahead, drafting legislation to repeal the tax, which it plans to introduce at a "launch event” July 30 at the Radisson Hotel Roseville.

"We are thankful that implementation of the tax has been delayed until next April,” he said, "but the problem is that businesses are making decisions now about where to place inventory and what kinds of contracts they are going to sign for future warehousing services. Because it is so important to their business planning, the sooner it gets fixed the better it is for everyone.”

"Other states, including Maryland, Massachusetts, Florida, and Michigan, quickly discovered that taxing warehousing services is a job-killer and repealed similar taxes within months of enacting similar legislation,” he added. "We must take immediate action to do the same here in Minnesota.”