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Is Boston Ready For The Budget Crunch Its Struggling Office Buildings Are Expected To Cause?

Boston is heavily dependent on its office buildings, with property taxes from the sector generating more than one-fifth of the city’s total revenues this year. As those buildings decline in value and show signs of distress, they could endanger Boston's fiscal health.

Office buildings in Boston, a city facing its highest vacancy rate since the Great Recession.

The city’s office vacancy rate has reached its highest level in more than a decade as tenants continue to give back space, and high interest rates and frozen credit markets have made it harder for struggling owners to avoid foreclosure. Real estate leaders and appraisal experts told Bisnow they expect a significant drop in office valuations that could cause a larger hit to the city’s budget than the government is projecting.

"If people can't get their buildings tenanted up to the capacity that it once was, then they look to a diminution in value, and then property tax abatements, and then that's going to land in the city’s lap ultimately,” Greater Boston Real Estate Board CEO Greg Vasil said.

The city’s budget department projects that its property tax revenues will increase from $2.94B this fiscal year, which ends June 30, to $3.1B in fiscal year 2024, accounting for 72.4% of its total revenues. That growth includes about $60M in added tax revenues from newly constructed buildings, meaning it still projects a large increase in revenues from the city’s existing building stock.

Of next year’s projected property tax haul, it said 58% will come from commercial, industrial and personal property tax. Its projections don’t specify the expected revenues from the office sector, but a city spokesperson told Bisnow that in FY 2023, the city brought in $882M, roughly 22% of its total budget, from office buildings.

City budget officials, in a report on Boston’s 2024 revenue estimates, wrote that growth in property taxes can be volatile and dependent on the local and national economies, “as evidenced during the Great Recession.”

“Any significant decline in property values can present a problem for cities as dependent on the property tax as Boston,” the budget officials wrote in the report.

Because of the state’s taxation structure, Boston Chief Financial Officer Ashley Groffenberger said it is unlikely Boston will see a significant loss in revenue from property taxes in the near future.  

“However, the City of Boston is carefully monitoring the impacts of remote work on our local economy, including on our residents and businesses," Groffenberger said in a written statement to Bisnow

Office buildings in Boston and across the country are expected to lose a significant amount of their value in the coming years, an issue that has already created budget crises in other struggling coastal cities. Nationally, the decreased demand for office space is expected to result in a 35% decline in office values by the end of 2025, according to a report from Capital Economics.

Boston real estate experts said the city won’t be immune from that loss in office values, and the city government may have to rely on other tax avenues — like raising residential rates — to make up for the decline from office.

Although Boston has yet to see this fully play out, other cities have begun to see it affect their budget forecasts. In Washington, D.C., officials in March reduced their tax revenue projections by $464M due to the decline in the city’s office values and transaction volume, and this led the mayor to make “tough choices,” including reducing funding for D.C.’s main affordable housing tool.

Other cities like New YorkSan Francisco and Milwaukee are also facing huge budget deficits due to falling commercial property valuations. A report from Standard & Poor's released this week found that cities still have time to avoid worst-case fiscal crises if they can prepare properly and benefit from rising residential values.

Thomas Jensen, executive director of Boston Appraisal & Consulting LLC, said he expects Boston’s Class-B and C office properties to see their tax assessments slashed by around 40% to 50% of 2021 levels as vacancies continue to rise and cash flow shrinks.

Jensen said he doesn’t think the city is fully prepared for the loss in property tax revenue that will occur in the office sector.

“When things crash, it's almost like the same cycle where people first are in denial. They're like wishful thinking,” he said. “And then when they realize it's going to get worse before it gets better, they realize that it hit the fan. Then they still have partial wishful thinking. Then they finally come to the realization that ‘OK, we're in over our heads, and what do we do? What are our options? Is there any way to get out of this?’”

The city's fiscal year 2023 property tax rate for commercial, industrial and personal property stood at $24.68 for every $1K of value.

Industry leaders like NAIOP Massachusetts CEO Tamara Small said they have already started to see property value declines with assets on the market now.

“We've definitely seen that there have been some dramatic changes,” Small said of office values. “There are properties that were purchased, say, in January 2020 and now on the market in 2023 saw a big decline in value.”

One such property is 179 Lincoln St. in the city’s central business district. It sold for almost $156M to Blackstone in January 2020, but the investment giant put the property back on the market this year, and it is expected to sell for somewhere between $80M and $90M, the Boston Globe reported.

However, part of the challenge with determining how far property values will fall is the lack of sales in the office market this year. According to CBRE, only one office building had traded hands in Boston this year as of Wednesday. That deal, the $56M sale of 11-19 Deerfield St., was between Boston University and Related Cos. as part of an agreement to settle a court dispute, the Boston Business Journal reported.

For comparison, Boston recorded $908M of office sales through the first six months of last year, according to CBRE. This sharp decline in sales volume will also likely lead to a reduction in transfer tax revenues this year. 

Small said she expects to see more examples of property values dropping as owners face maturity dates for their loans in the coming months. 

“The industry is very concerned about the debt maturities and the future of particularly Class-B and C space and what it means for Boston in particular,” Small said.

In the first quarter of 2023, office vacancy in the city stood at 18.8%, matching the peak of the Global Financial Crisis, and the city experienced a net occupancy loss of more than 5M SF over the last year, according to Colliers’ Q1 office report. The Class-B segment, which totals 17M SF, had a vacancy rate of 25.8%, and it has experienced a 13% decline in asking rents, figures that signal a likely decline in values.

“People are concerned because they look at potential tenants and the amount of space they're going to take,” Vasil said. “We know that if tenants are coming in and vacancies are rising in those spaces that ultimately that's going to lead to a lower number in terms of value for that building.”

Vasil added that some landlords have begun filing abatements to try to get their property taxes down as they struggle with rising vacancy and shrinking operating income. 

Landlords with sinking values that are hoping to avoid foreclosure are looking for help from banks, but many aren't lending a hand. In the wake of banking turmoil and increased pressure from regulators to reduce commercial real estate exposure, lenders have begun to avoid putting money into office buildings. Small said she worries many office owners won’t be able to secure financing to hold onto their assets.

“If you can't get the financing and you can't make it work, then you're going to start to see foreclosures,” she said. “You're going to start to see owners hand keys back to the bank, and that's not great for any city."

179 Lincoln St. was put on the market and is expected to sell for much less than what owner Blackstone paid for it in 2020.

Similar issues exist in other major markets. Monday Properties last month missed a payment on part of its $841M loan backed by seven high-rise buildings in Arlington, Virginia, ahead of its June 9 maturity date, and the loan was transferred to special servicing. 

In Los Angeles, two office buildings went into receivership in April and May after owner Brookfield failed to make payments. This happened because the buildings weren't generating enough cash flow to keep up with building operations and debt.

In February, Columbia Property Trust defaulted on a $1.7B loan backed by a portfolio of office buildings in four cities, including Boston’s 116 Huntington Ave., which stands right across the street from the Prudential Tower.

In order to fill the budget gap from falling office values, Jensen said Boston and other cities that have benefited from low residential tax rates due to their strong commercial sectors are likely going to raise rates on homeowners.

“Now that commercial is dropping, that reliance on commercial real estate tax revenue is going to diminish tremendously,” he said. “They’re going to be forced with no choice to revisit residential tax rate.”

The pain facing office owners is being exacerbated by a wave of incoming debt maturities that have begun to crash, with $189B in office loans set to mature nationally this year and another $117B next year, Aaron Jodka, director of national capital market research for Colliers, told Bisnow.

Jodka said that the wave of maturities and the office leases set to expire in the next two to three years will create more issues for Boston’s office market.

“I don't believe this will be a 'six months and everything's OK' environment,” Jodka said. “I do expect distress to be, unfortunately, an aspect of our marketplace for the years to come.”

Boston is still in a wait-and-see period, as it takes time for the city to make new property assessments and respond to owners’ requests for lower tax payments. But Small said that any decrease in the values of existing properties could be exacerbated by a slowdown in development, reducing the number of new buildings entering the tax rolls in the coming years.

“It's a little bit early to know for sure how bad it is going to be, but I don't think it's going to get better with time,” she said.

UPDATE, JUNE 29, 6:15 P.M. ET: This story has been updated with a statement from Boston Chief Financial Officer Ashley Groffenberger.