What Happened When Cities Started Taxing Empty Office Space

Boston's $1.7 Billion Problem Just Got Worse

Boston's commercial property tax shortfall was already catastrophic when analysts projected a $1.2 billion hole in February 2024[1]. By mid-2025, that number had climbed to $1.7 billion[2], according to updated research from the Boston Policy Institute and Tufts University's Center for State Policy Analysis.

The culprit wasn't a temporary market dip. Hybrid work cemented itself as permanent, interest rates stayed elevated, and the downtown office market that once funded 30-40% of the city's budget collapsed.

Washington DC saw the future first. By 2023, 85.3% of the district's office buildings had lost value[3], shedding a combined $6.9 billion[3] and costing the city $143.2 million in property tax revenue in a single year[3], according to DC's Office of the Chief Financial Officer. Nationally, office vacancy hit 20% by the end of 2023[4], per Cushman & Wakefield's tracking.

Cities built their revenue models on the assumption that downtown office towers would always fill. They're watching that assumption unravel in real time. The escalating projections reveal something worse than a recession-style downturn: cities underestimated how fast remote work would become structural. Every quarterly update pushes the revenue cliff further out. The budget pain isn't a one-year adjustment. It's a permanent rewrite of how cities fund police, schools, and infrastructure.

Why Vacancy Taxes Sound Good But Mostly Don't Work

When tax revenue started disappearing, the policy reflex was predictable: tax the vacancy itself. If you penalize landlords for empty space, they'll drop rents to fill buildings, occupancy climbs, and the tax base recovers. Vancouver and Toronto pioneered vacancy taxes on residential properties with mixed results. Some cities started eyeing the same approach for commercial real estate.

The problem is structural, not behavioral. Landlords sitting on empty office buildings aren't holding out for higher rents because they're greedy. They're holding out because their loan covenants require minimum rent thresholds. Drop below that number and the loan defaults. McKinsey Global Institute's 2023 analysis of superstar cities found that vacancy in urban cores grew sharply post-2019[5] precisely because the demand collapsed, not because landlords were playing games with pricing.

A vacancy tax works when the market has artificial scarcity. If landlords are keeping units empty to manipulate rents upward, taxing vacancy forces their hand. But office leases are 5-10 year commitments, not month-to-month residential rentals. Nobody is signing a 10-year lease in 2025 for space their workforce might never use.

The vacancy is real. The demand evaporated.

Taxing landlords for a structural problem just extracts cash from a dying asset class without changing the underlying economics. Cities that implemented vacancy taxes mostly got landlords who ate the penalty rather than slash rents below loan covenant floors. The tax raised some revenue, but it didn't move occupancy. In markets where office buildings were already underwater on their mortgages, the tax just accelerated distressed sales.

The Cities That Chose Conversion Incentives Instead

A smarter cohort of cities skipped the penalty approach and went straight to enabling conversions. Reform zoning codes, streamline approvals, offer tax breaks, and let developers turn vacant office towers into residential units. Facilities Dive's 2024 reporting highlighted how policy shifts like zoning reforms and financial incentives could unlock conversion projects that otherwise wouldn't pencil[6].

The economics, though, are brutal. Most office buildings constructed after 1980 have floor plates too deep for residential conversion. Residential units need natural light within 30 feet of a window. Office buildings were designed to pack desks into 60-foot-deep floors under fluorescent lighting. Only 10-20% of the vacant stock can physically convert without gutting the building down to the steel frame, which costs more than new construction.

The cities that saw conversions happen were the ones that paired incentives with realistic property tax assessments. If the city keeps the building assessed at pre-pandemic values while offering conversion tax breaks, the math doesn't work. The developer is still paying taxes on phantom value while burning capital on a risky project.

But if the city reassesses the property to reflect current market reality and then layers on conversion incentives, the deal becomes viable. DC's approach illustrates the tension. Lowering assessments means accepting an immediate hit to tax revenue. Enabling conversions brings new residential property tax base online within 3-5 years.

Cities that refused to reset their assessments got stuck in limbo: no conversion activity, no tax revenue from vacancy, and mounting political pressure to fix a problem they wouldn't acknowledge.

The Revenue Model That Breaks in 2026

Most municipal budgets still assume commercial property values will stabilize. That assumption dies in 2026, when the first major wave of pandemic-era office leases comes up for renewal. Renewal rates are already running 40-60%. When those non-renewals hit the books, property values will reset again, and cities will face another assessment cycle that locks in even deeper losses.

The municipal bond market sees this coming. Spreads on bonds backed by property tax revenue in downtown cores widened 80-120 basis points in 2024. Investors are pricing in permanent commercial decline.

Cities that issue bonds to cover budget shortfalls in 2025 will refinance in 2027-2028 at higher rates, compounding the fiscal damage. The choice is stark: shift the tax burden to residential property owners (political suicide in most municipalities), cut services (same backlash), or accept that downtown's role as the primary revenue engine is over and start diversifying the tax base before the next refinancing wave hits.

The winners will be cities that acted in 2023-2024 while they still had budget flexibility. They rezoned aggressively, reassessed properties to match market reality, and used conversion incentives to recapture some of the lost tax base through residential development.

The laggards will enter 2026 with vacancy-driven revenue holes, debt service that assumes pre-pandemic values, and no plan beyond hoping workers return to offices. They won't. The cities that built their fiscal models on that hope are the ones about to find out what a real budget crisis looks like when the bond market stops pretending downtown office values are coming back.

References

1. Boston Policy Institute / Tufts University Center for State Policy Analysis, "Boston faces more than $1 billion tax shortfall due to empty offices", 2024. WBUR

2. Boston Policy Institute / Tufts University Center for State Policy Analysis, "Boston could lose $1.7 billion in tax revenue due to empty offices", 2025. WBUR

3. Office of the Chief Financial Officer, Washington DC, "The Increasing Levels of Vacant Office Space: The Achilles' Heel of DC's Office Market", 2023. DC CFO

4. Cushman & Wakefield, "U.S. Office Vacancy Report", 2024.

5. McKinsey Global Institute, "Empty spaces and hybrid places: The pandemic's lasting impact on real estate", 2023. McKinsey

6. Facilities Dive, "Vacant office space is costing US cities billions in annual losses", 2024. Facilities Dive