Boston city revenue picture faces downside from commercial real estate

A recent report warns that Boston's tax revenue may fall by $1.2 to $1.5 billion over the next five years — the equivalent of the city's 2024 education budget.

Not every analyst concurs with the report's headline number, but there's consensus that the triple-A-rated city is uniquely vulnerable to the national decline in commercial real estate values.

The root of Boston's potential problem, according to the report from the Boston Policy Institute, a think tank that launched in December, is a nationwide phenomenon: as remote work has proliferated, commercial real estate has declined in value. 

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But unlike other cities, commercial property taxes make up more than a third of Boston's total revenue, thanks in part to a Massachusetts policy that prevents municipalities from levying certain taxes.

This is a long-term problem, says the report's author Evan Horowitz, director of Tufts University's Center for State Policy Analysis. 

"The decline in commercial real estate is not a cyclical problem. It is a new normal," Horowitz said. "There's no waiting it out, there's no hoping for it to go away." 

Citing a McKinsey report that projected a drop in real estate values in major cities (Boston not among them), Horowitz's report predicts "a new normal where the city collects $400 million to $500 million less each year than the long-term trend implies, amounting to an annual reduction of roughly 10 percent of total revenues."

By 2029, the report says, Boston will have missed out on $1.4 billion of revenue. If the city's $4.4 billion budget FY 2024 budget were to remain unchanged through 2029, it would leave a hole of about 6% of the city's revenue. 

Elaine Beattie, a strategic advisor for the Boston Municipal Research Bureau,a non-partisan research organization that provides research and fiscal analysis about Boston city government,  said it was hard to be so confident about the numbers: "It's a pretty big jump that they're making," Beattie said.

Forecasting post-COVID is complicated, Beattie said, and real estate values are complicated — the highest-quality Class A properties, for instance, have been performing better than Class B and C, and it's not entirely clear why or whether those trends will continue.

Beattie noted that Boston's economy has been hitting all of its targets for FY 2024 and the city finished FY 2023 with a $192 million operating surplus. 

Nick Ariniello, commissioner of Boston's assessing department, told the Boston Globe that the city hasn't "seen any indications from the real estate markets that would translate into a loss of revenue to the city."

Despite Beattie's questions about the report's methodology, she said commercial property taxes are a relevant subject to study and that BMRB should look into them. 

Greg Maynard, a former campaign manager who founded the Boston Policy Institute late last year, said the report was conservative in its estimates. He declined to disclose who funded the Institute, citing its status as a 501(c)(4) nonprofit. BPI raised roughly $200,000 last year to launch, Axios reported. 

Although the report focused on Boston, Maynard said the city's heavy reliance on commercial property tax revenue is common in Massachusetts municipalities. 

The city has time to change its budgeting structure, Horowitz said, although there has been no action to do so. He sees several avenues the city could pursue. 

Boston could raise residential property taxes. Currently, commercial properties are taxed higher than residential properties, but if the city tries to tax them higher while the industry is under strain, it would risk further damaging the market, according to the report. 

But if Boston wants to make up the difference by raising residential property taxes, the report said, the city would need "a rate increase of 25 percent to 30 percent, pushing residential rates from around 1.1 percent to nearly 1.4 percent."

Massachusetts could direct more aid toward Boston. 

State aid was part of the deal when the commonwealth imposed its "home rule" policy, which despite its name actually constrains the authority of municipalities to levy taxes, Horowitz said. In 2002, Massachusetts' aid made up 30% of Boston's budget, but it shrank to just 12% in fiscal 2024, according to Boston Mayor Michelle Wu's most recent budget. 

Massachusetts's state government could also allow Boston to levy sales and/or income taxes. This has long been a debate within the commonwealth, Beattie said, with opponents of home rule policies arguing that Boston couldn't reap the rewards of its financial success. Now, Horowitz said, home rule limitations also prevent Boston from compensating for financial stress.

HilltopSecurities, in a report published in November, acknowledged the problems facing the commercial real estate sector but concluded that local governments only face a very limited credit impact due to its weakness.

It took a closer look at Boston, noting that the 64% of governmental revenue it derives from property taxes is "very high," with a "moderately elevated" 29% of its assessed valuation from commercial property.

"However, Boston is a "Aaa" rated ("stable" outlook) local government with an available fund balance of about 37% of revenues. This offers a comfortable cushion should near term stress appear," said the report, authored by Tom Kozlik, Hilltop's head of public policy and municipal strategy.

In its last thorough review of Boston's Aaa rating in April, Moody's Investors Service said the city's other strengths outweigh concerns about its commercial property market.

"We expect the strong residential sector to help mitigate anticipated softening of the commercial sector over the next few years as that sector incorporates the impacts from many companies implementing permanent and hybrid work-from-home models," the report said, noting that the city's total assessed value grew by 7.3% in 2023 over the prior year to $212.2 billion.

The office market vacancy rate in the city was 11.2% and the downtown area was up to 13.3% compared to 6.1% and 6.4% in pre-pandemic 2019, respectively, the report said.

One potential future credit challenge Moody's singled out for Boston was pension and other post-employment benefit funding, but the rating agency recognized the city's efforts to tackle that challenge.

"The city's annual pension contributions for the last five years have been significantly higher than the Moody's tread water indicator, which is the amount required to keep the unfunded liability from increasing if all actuarial assumptions are realized," the report said.