All those empty office buildings could spell trouble for you and me
This year around Valentine’s Day, my daughter and I took a stroll through Downtown Crossing, past an ice-sculpture throne and a long line of people waiting to sit on it with a free red rose. Only a few weeks later, we visited a pop-up amusement park on Boston Common, complete with bouncy houses and Dunkin’ Munchkins. It was mobbed.
City leaders are clearly pushing hard to bring excitement back to Boston, to make it more family-friendly, to compensate for vacant offices and dark storefronts. They know they can’t let Boston become San Francisco, where many families, stores, and office workers have decamped for the suburbs.
But the magnitude of the post-pandemic problem may be larger than we can yet imagine. And the solutions may have to be far more radical.
What’s the problem? Taxes fund services, and Boston’s tax base is facing a serious threat.
While most of us think of the pandemic as a thing of the past, the changes wrought by COVID will take years to ripple through commercial real estate.
Boston’s office buildings currently have a vacancy rate of about 20 percent. But because commercial real estate leases often run for 10 or 15 years, lots of folks who want to reduce their office footprint haven’t done so yet. Lots of building owners haven’t yet grappled with mortgages they can’t pay. Lots of banks haven’t yet encountered owners who throw up their hands and turn over the keys to buildings that no one wants. But all these things may come to pass.
“It’s a slow-motion dynamic,” says Andrew Nelson, a real estate economist and former chief US economist for Colliers International. “It takes a while to play out.”
Even if employers typically trim their space by only 10 or 20 percent, that will still be a huge hit to the market, Nelson warns. “The vacancy rate is basically the highest it’s ever been, and this is at a time when office employment [rates are] at a record. What’s going to happen when we finally have a recession or a slowdown?”
“The pain is going to get worse,” he argues. “There’s no question.”
That pain will be felt by multiple groups: owners seeing the value of their buildings take a hit, city leaders watching tax revenue from commercial buildings plummet, and residents enduring diminishing services. It’s also possible that residential property tax rates, which are lower in Boston than in many surrounding cities and towns, will have to be raised to make up for declining commercial tax revenue.
As the Globe’s Catherine Carlock reported in May, a building near South Station that sold for $156 million before the pandemic may now sell for less than $90 million. That’s a tough break for a city that would far rather assess taxes on a $156 million building than on a $90 million building.
Multiply that loss of revenue by dozens of downtown buildings — and others scattered across the city — and you can start to see why the woes of commercial real estate will not stop at the Financial District’s edge. They will ripple out, making less money available for schools, safety, transportation, and all the other things the city wants to fund.
“Boston is one of the cities . . . that is overreliant on property tax as its major source of revenue,” says Jim Rooney, president of the Greater Boston Chamber of Commerce. If the value of commercial real estate plateaus or diminishes over the next few years, “that worries me.”
Indeed, nearly 74 percent of the city’s 2022 revenue came from property taxes — the bulk of that from commercial real estate. Nationally, the average is closer to 50 percent.
Will Silverman, managing director at Eastdil Secured, a real estate investment bank, recently told the Financial Times that some buildings in New York City “are selling for less than the value of the land they sit on.”
And Boston is even less “back in the office” than New York and many other big cities. The private equity firm Apollo reported in April that cellphone activity in Boston’s downtown in the fall of 2022 was at 54 percent of pre-pandemic levels. Not as bad as San Francisco (31 percent), but considerably behind San Diego (99 percent), New York (74 percent), Los Angeles (65 percent), and most other cities that Apollo analyzed.
Pam Kocher, president of the Boston Municipal Research Bureau, says her “biggest worry is if the majority of people that used to come into the city full-time stay with reduced schedules, or if companies go fully remote to keep talent.” She notes that the city has historically relied on “new growth to drive revenue,” an approach that may not hold up very well going forward.
So what happens if a reduction in taxes forces a reduction in services? You can start to see the contours of a downward spiral.
If, for example, Boston has less money to support public schools, that may drive out residents, further reducing the school-age population.
Already, there are about 20 percent fewer children in Boston’s public schools than there were in the early 2000s. And that decline sped up during the pandemic, according to the Boston Schools Fund.
Will Austin, the CEO of the fund, argues that “Boston was in a really unique position for a long period of time from the Great Recession up until the pandemic, where the city went through pretty unprecedented economic growth. You could look back on those years and say that the expansion in commercial real estate really drove the municipal budget.”
Austin notes that “we haven’t gotten to the point yet where loans start to default, because it’s too early. But it’s not hard to see that coming down the road.”
He says Boston’s public schools are unusually reliant on money from the city itself, which provides nearly 80 percent of funding. Public schools in Chicago, by contrast, get nearly half their funding from the state and federal government.
Even elsewhere in Massachusetts, schools typically draw on more diverse sources of income. New Bedford schools, for example, get only about 15 percent of their funding from the city itself, while Marlborough schools get about 50 percent from the city.
Beyond that, pandemic-era money for schools will soon evaporate. “I don’t believe in predicting the future,” Austin cautions. “But I do believe in extrapolating from math. And the math here is very difficult.”
Everyone I talked to thought it was crucial for Boston to plan for tough times, even if those times don’t ultimately materialize.
But contending with tough math isn’t enough. As finances constrict, it will become ever more important to maintain services that make people want to live and pay property taxes in Boston: schools, public safety, beautiful common spaces.
Office buildings that can’t attract tenants may need to come down and be rebuilt as residential (conversion is often not an option), spawning a new generation of coffee shops, unique retail, and restaurants.
Certainly, there’s a lot to be said for increasing the housing stock — especially in a state experiencing a massive housing crunch. And building new walkable neighborhoods wherever possible would allow thousands more people to live right near work, instead of crawling along I-93 for hours every day.
But such a transformation will be messy and is unlikely to happen on its own. Fundamentally reshaping the city is going to require huge amounts of risk-taking and creativity.
“It’s the kind of leadership that the mayor talks about,” says Austin. “Big, bold generational leadership. And I think it’s highly likely that’s going to be needed.”
Nelson, the real estate economist, says that although he worries a lot about the road ahead for commercial real estate, he remains bullish on Boston’s capacity for reinvention. “We’re not smart enough to know what the next great thing is going to be,” he says. “But the dynamic cities — like Boston — figure it out.”