Facing Billions In Budget Shortfalls, Cities Scramble For Solutions

City coffers have dwindled since the pandemic, with tax revenue of all kinds taking a hit in the new world the coronavirus created. But as new property valuations roll in, cities are confronting deep dents in their budgets and have limited options for fixing them.

Across the country, falling asset values are only now beginning to weigh on the local governments that rely on property taxes to fund day-to-day operations.

Cities managed to stave off an immediate collapse of revenue, instead creating a slow-moving crisis that some localities are preparing for while others deny it exists, setting up conflict with property owners now asked to shoulder more of the burden.

“We're just in this post-Covid world where people work remotely, interest rates are higher, and therefore these properties are worth less and will continue to be worth less,” said Evan Horowitz, who heads the Center for State Policy Analysis at Tufts University. 

Cities’ reliance on commercial property tax varies widely across the country, according to a report from the Tax Policy Center, a lobbying group backed by the Urban Institute and Brookings Institution. 

Boston leads the nation by a wide margin at 33% of city revenue on average from 2013 to 2022, 10 percentage points ahead of second place Knoxville, Tennessee.

Dallas relies on commercial property taxes for 21% of its budget, while Atlanta, Austin, Houston, Miami, Washington, D.C., and Denver all get at least 10% of their revenue from commercial property tax. 

In Chicago, where commercial property taxes account for the lowest proportion of the budget in any major city at just 7%, elected officials are weighing a rate increase to plug a $1B budget shortfall.

Depending how far valuations fall, the average American city can expect tax revenues to fall between 0.9% and 3.2% by 2031, according to a Tax Policy Center analysis of 47 U.S. cities.

While a small percentage of total revenue, the lost taxes add up for cities with multibillion-dollar budgets. Property taxes, including residential, account for roughly a third of all local government revenue, according to the Tax Policy Center.

Some cities are more prepared than others for what’s coming.

In Boston, where a third of city revenue comes from commercial property tax and roughly another 50% from residential taxes, officials can see the wave coming, but they’ve done little to prepare.

Horowitz published a report in February pointing out that a 20% to 30% decline in office values, a reasonable estimate given the steep discounts at which offices in the city are trading, will create a cumulative budget shortfall between $1.2B and $1.5B from 2025 to 2029.

His research caught the attention of city officials, but he said politics hampered any near-term solution.

“It is a strategic decision to delay as long as they can, to maintain spending and boost the short- and medium-term political fortunes of those who run the city,” Horowitz said. 

“They’re kicking the can.”

Boston Mayor Michelle Wu faced an industry revolt when she proposed raising commercial property taxes in April. 

The city, like many others, is governed by tax laws that limit options to increase revenue. There is an upper limit in Boston to the spread between residential and commercial property taxes charged, and the city is at that limit.

Wu tried to lobby the state to temporarily expand the gap in an effort to avoid raising taxes on homeowners but was rebuffed by the legislature. The city is already running out of options. 

“Any kind of meaningful solution, in Boston in particular, is probably going to involve some mix of substantial new taxing authority or substantial new state aid, combined with spending cuts,” Horowitz said.

The city is already contending with office owners angry about the current fiscal year’s tax assessment, arguing that the city is unfairly valuing their property at a time when the office sector faces an identity crisis that has pushed vacancy in Boston to 20.7%, the eighth consecutive record high, according to Newmark. 

The long process of appealing a valuation starts with a separate local government office but can eventually end in court. While the city had previously been amenable to negotiating down tax payments, Horowitz said officials had issued near-blanket denials of appeals this year in an attempt to delay any hit to revenue.

Landlords and attorneys in New York City have alleged that local officials are following a similar playbook by overvaluing offices and forcing more appeals. 

Office owners balked in January when city officials announced that, despite buildings trading for less money, their property value had in fact gone up. 

Officials at the city’s department of finance said taxable assessed values would go up across all office classes for the 2025 fiscal year. Trophy buildings were worth 3.4% more, Class-A properties rose 3.0% and Class-B offices saw a 2.6% bump. 

Like in Boston, more New York City landlords are taking to the appeals process to fight for a reduction in their tax bill. Benjamin Williams, an attorney at Rosenberg & Estis, counts himself among a growing cottage industry of lawyers suing the city over appraised values. 

“The biggest change I've seen is the amount of people who have properties that will sink or swim depending on if I can get the property tax cuts,” Williams said. 

There are good reasons for the disparity in a city’s assessed value versus what an owner feels their property is worth, multiple sources told Bisnow. For one, most cities' appraisals are a lagging indicator that uses past leasing, revenue and availability data to determine future values. In New York, city models also allow a certain level of vacancy and factor a parcel’s highest and best use into the valuation regardless of whether the property is being used that way.

Williams acknowledges the city’s limitations, but said he believed that local officials are deliberately pricing properties higher than what they’re worth because they don’t want to confront the reality of declining revenues. 

“They're being unrealistic, and they know what they're doing,” Williams said. “They are trying to prop up the city's revenues, balance the budget however they can, and they’re just girding for the future battle. The city's going to be on the hook for huge refunds.”

The Tax Policy Center projects New York's overall budget shortfall because of falling office values would range from $3.8B to $5.3B by 2031. 

New York City is partially shielded from office value deterioration because its tax base is much broader than other cities, with commercial property taxes accounting for just 12% of revenue on average from 2013 to 2022, according to the Tax Policy Center. 

Still, the Citizens Budget Commission, a nonprofit think tank focused on tax policy across the city and state, estimates all tax revenue will grow by 2.6% per year — with a 2.1% annual increase in property taxes — while the city budget is expected to expand by 3% annually. 

That gap will need to be filled either by raising revenues or cutting services, a politically fraught choice that could delay decision making.

“There's some serious risk to the city,” said Ana Champeny, vice president for research at the Citizens Budget Commission. “The city budget office is aware of this, the fiscal monitors are aware of this. But there is still a push to provide services to New Yorkers in need and a reticence to cut any program, even when it's ineffective.” 

As New York officials get a better understanding of the scale of the shortfall the city is facing, San Francisco is executing on a plan that was spawned around November 2022 when Ted Egan, the city’s chief economist, issued a report warning lawmakers that falling office values could leave the city with a $200M loss of revenue by 2028.

Egan warned that office vacancy in the city could top 31% by the end of 2023, dragging down office values and draining city coffers. Office vacancy in the city at the end of the most recent quarter was 37%, according to CBRE. 

“Things have pretty much turned out the way we thought,” Egan said in an interview. 

San Francisco, like Boston and New York, has limitations on how much and how fast appraisals can change, and it relies on its own appeals process to settle valuation disputes. After the 2022 report, city officials opted to set aside more money for future appeals, effectively lowering overall revenue from property taxes. Egan declined to specify the amount the city saved to cushion its future budget.

The city — which gets around 10% of its annual revenue from commercial property taxes, according to the Tax Policy Center analysis — shored up its property tax reserves but has still struggled to recover from a pandemic-era decline. 

“The forecasts that are going into our models look like real pain to me for office and hotel owners in San Francisco, but they just don't look as painful for us from a property tax point of view,” Egan said.

Mayor London Breed is facing a $790M deficit over the next two years, and recent negotiations over the record $15.9B budget threatened cuts to programs for child care, food insecurity and violence prevention programs, the San Francisco Chronicle reported.

The original budget proposal included $95M in budget cuts, but the city’s Budget and Appropriations Committee restored $59M in spending — including to the threatened social services — before passing it along to the full board of supervisors for final approval.