Property Taxes in Boston - notes from Feb. 12, 2004 ABN meeting

See also:
Why are residential property taxes so high? Action you can take now - 2/12/2004
Questions for discussion: Property Tax Issues - 2/12/2004 - 2/12/2004
New Tax Legislation (1/16/2004): "Chapter 3 of the Acts of 2004: An Act Relative to Property Tax Classification in Cities and Towns"

Notes from meeting, February 12, 2004
"Property Taxes in Boston"

Speakers:
Rich Carlson, Assessing Department, City of Boston
John Avault, Research Department, Boston Redevelopment Authority

Property taxes have historically been manipulated to benefit homeowners who make up a primary constituency for local politicians, especially mayors. They accomplished this by over-assessing commercial properties whose owners typically don't live and vote in the cities where they own property. As a result, there was a landmark case regarding property taxes in 1975 known as the Sudbury Decision. This case established that every property must be assessed at its full and fair cash value.

Over the intervening years, legal precedent and common practice have determined that residential properties must be assessed at the current market value of the property. Commercial values, on the other hand, are assessed essentially on the net income that they produce under a practice known as "fee simple" valuation.

Over the last several years there have been several forces at work driving residential property taxes upward.

  • Housing production has been too low to keep up with demand caused by job creation, immigration and small-household formation; the scarcity of housing leads to rising costs as white-collar workers, yuppies and suburban empty-nesters bid up prices in the city.
  • Low interest rates also allow buyers to shift more of their housing budget toward the purchase price.
  • The classification laws that set commercial tax rates (tax dollars collected per $1,000 of assessed value) higher than residential rates also put a floor on the proportion of the total levy that must come from residential properties and a cap on the proportion that may come from commercial properties. No matter how much commercial construction is added to the tax base, homeowners as a class must pay at least 30%, and per the new legislation, no less than last year's 32%; and commercial properties can't be asked to pay over 170% of the total they'd pay if the rates were equal. So even if residential market values fall, the rates will be raised to bring in the residential portion of the city's tax levy. And no matter how many large commercial towers are built, the whole commercial class can't pay more than its cap; the residential rates or assessments will rise to make up the difference.

The current "crisis" is being driven by the fact that residential values continue to skyrocket while commercial values stagnate or decline due to rising vacancy and falling lease rates in the economic recession.

There are roughly 500 "Class A" large office buildings which drive commercial office prices with the highest rents generating corresponding higher than average tax revenues. Among this "Boston Fortune 500" are an elite 68 downtown office towers. There have been some reports of rent increases and sales value increases among these elite buildings, but Mr. Carlson attributes this to a short term "flight to quality" in a severely depressed market. This phenomenon has been even more pronounced in so-called "Class B" offices, which are older, smaller buildings. These spaces were renting for upwards of $40 per sf just a few years ago and have since fallen to about $25 per sf in the current market as tenants take advantage of the opportunity to lock in lower rents in premium buildings.

As noted, commercial properties are valued on a "fee simple" basis. This practice of assessing commercial property is, according to Mr. Carlson, universal throughout the United States and other economically advanced countries. Despite the City's efforts to increase commercial assessments, the courts strictly enforce uniform application of fee simple valuations. The alternative is a "lease fee" valuation, which amounts to valuing the property based on a bundle of financial rights including such assets as name-brand cache, superior management and long term leases. The City is prohibited by law from using this valuation method.

Mr. Carlson explained that even if a building just sold on the open market for $100 million, if a neighboring building, built at the same time, with the same physical characteristics, has a fee simple valuation of $25 million, by law, they must both be valued the same, or $25 million. As an example of the disproportionate effect that dramatic changes in lease prices can have on commercial valuations, consider the following example:

An office rents for $40/sf with $10/sf in expenses. The net lease income is:
$40-$10=$30/sf.

Assuming a 10% interest rate, the property is valued at 10X or $30 x 10 = $300 /sf.

Now imagine that the price for the space drops 50% to $20/sf. The effect on the valuation is magnified as the net income drops to:
$20-10 = $10/sf

and the valuation becomes $10 x 10 = $100/sf.

Thus a 50% drop in lease rates translates to a 67% drop in the assessed value of the building. Of course, this works in the opposite direction if office space appreciates, which is what the city has assumed in negotiating the current property tax regulations.

An additional issue is the reduction in aid to the cities from state and federal sources. During the 1980's when Proposition 2 1/2 was cutting city levies, only 35% of Boston's revenue came through property tax. This has risen to 58% for the 2004 fiscal year. Boston raises a greater percentage of its budget through property tax than any other major metropolitan area in the country because other cities rely more heavily on sales, services and wage taxes to generate a portion of their income.

Boston arguably is not receiving its fair share of state aid, since it is the region's major economic engine, but bears the costly service obligations of a poorer population, and the expenses of city infrastructure, services and amenities used but not paid for by commuters, tourists, shoppers, and tax-exempt institutions. Boston has 10% of the population, but provides 17% of the regions' jobs and generates 23% of Massachusetts' income. However, we have 20% of the state's poor, 20% of our housing is subsidized housing, the median income is about half that of the surrounding suburbs, and we receive only 8% of lottery money.

The recent State legislation requested by Mayor Menino temporarily raised the cap on commercial properties to moderate somewhat the jump in residential taxes; however, the cap will fall during the subsequent 5 years, ending below the current 170% level. The rise in homeowner taxes will continue, however, as long as net commercial incomes remain low (which could be a long time given the growing loss of white-collar jobs due to outsourcing). As there is no cap on the residential portion of the levy, residents (owners and landlords) will continue to pay more every year as the Proposition 2 1/2 levy rises.

The legislation, responding to the Mayor's acknowledgment that this cap increase is a band-aid and that the whole Boston tax system needs an overhaul, requires a one-year study by the State Department of Revenue of the whole tax structure of each municipality, including development tax break programs (which the ABN meeting did not get to discuss). The speakers mentioned, however, that this study may not be funded.

The State DOR plans to hold public hearings for input before the study starts. Boston's hearing will be in May. We should attend and urge that the study be supported, and contact Mayor Menino to request that the City supply all the information DOR will need for the study.