THE
INCIDENCE OF REAL ESTATE TAXES
ON OFFICE RENTS
IN THE
GREATER BOSTON AREA
by
THEODORE SYLVAN
SUBMITTED TO THE DEPARTMENTS OF
ECONOMICS AND
URBAN STUDIES AND PLANNING
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS
FOR THE DEGREES OF
BACHELOR OF SCIENCE IN ECONOMICS
and
MASTER IN CITY PLANNING
at the
MASSACHUSETTES INSTITUTE OF TECHNOLOGY
June, 1985
Massachusettes Institute of Technology 1985
Signature
of Author...................................-
Department of Urban Studi
-......
and Planning
May, 1985
.. .t
Certified by.................
Professor William Wheaton
Thesis Supervisor
Accepted by.....
or Philip Clay
Profe
Chair an, MCP Program
(/
MAS3SACHUSETT N
OF TECHN0LOGY
JUL 111985
.11
UE
THE INCIDENCE OF REAL ESTATE TAXES
ON OFFICE RENTS
IN THE
GREATER BOSTON AREA
by
THEODORE SYLVAN
Submitted to the Departments of Economics, and Urban
Studies and Planning on May 22, 1985 in partial
fulfillment of the requirements for the Degrees of
Bachelor of Science in Economics
and
Master in City Planning
ABSTRACT
Area was
Data on 160 office buildings in the Greater Boston
collected as
used in regressions
in order to measure the
tenants. Variables
incidence of real estate taxes on office
number of floors; number
for
were: building age;
controlled
in
an office
buildings
of square feet per floor; number of
number of highways
number
of
nearby subway
lines;
park;
through the town; and percentage of college educated people in
no
linear
model
showed
the surrounding area. A simple
taxes to
tenants. A non-linear
significant passing on of
simultaneous equation which takes account of the dependence of
unexpected results;
taxes on gross rental rates demonstrated
rents were found to fall with increased taxes.
this study.
The resultant of two forces is being observed in
First is the passing on of increased taxes to tenants. Second,
suburban towns tend to lower their tax rates as rents increase
because
their expenditures can be supported with a lower tax
rate
if
property values are high.
In
the cities
(i.e.
Boston,)
where
budgets are strained, the second force should
not operate. In the Boston suburbs, though, the
second
force
apparently dominates the first.
Thesis Supervisor:
Title:
Prof. William Wheaton
Professor of Economics and Urban Studies
Page 1
I. Introduction.
Property
and
municipalities
tax
a
rates
body of literature exists
substantial
and
postulating the incidence of these taxes on owners
of
between
greatly
vary
users
real estate. Data on 160 office buildings from 20 towns in
the Greater Boston Area will be used to
differential
property
test
the
impact
of
tax levels on office rents. A positive
taxes
impact implies that higher
are
passed
on
to
office
renters.
The incidence
property
tax,
has
of
been
taxes
on
property
in
1956
on
the
the
the subject of numerous theoretical
papers and empirical studies since Charles
(1)
values,
locational
Tiebout's
article
decision making process of
individuals. Peter Mieszkowski(2,3) formalized the theoretical
arguments regarding the incidence of the property tax
late
in
the
1960's and early 1970's. From that time, two theoretical
camps have evolved, the traditional or old view
and
the
new
view.
Under the traditional theory, the
essentially
a
profits
tax
and
is
born
property
by
tax
is
the owners of
Page 2
is
capital. Capital is immobile and the amount of land in use
the
Because
fixed.
output remains
factor
constant.
production is constant,
in
mix
markets
Assuming
are
in
already
an owner will not be able to raise the price for
equilibrium,
his output and will therefore bear the full cost of the tax.
Holding capital and land in use constant
assumption
realistic
to
not
a
new view allows for the
The
make.
is
mobility of capital, but not land, so the tax on land falls on
Most
landowners.
tax
property
papers
which
postulate
fictitious
national
is borne by all owners of capital in the
short run. Local differences from
passed
a
this
"national
rate"
are
partially to consumers of products in the long run
on
since the capital-labor mix is modified over time so that less
capital is used in high tax areas.
The final theoretical model presented in this
will
assume
paper
complete mobility of capital and land use, and a
general equilibrium framework for solving for
incidence
will
be used. With land considered a variable factor, theoretically
land
taxes
can
be
shifted to tenants to a degree dependent
upon the relative price elasticities of supply and demand
land,
just
like
in
the
familiar
for
case of an excise tax on
cigarettes.
Measuring the degree to which commodity
the
substitution
of
capital
prices
and
for labor reflect property tax
Page 3
brokerage firms.
in the Boston area through major
tax rates controls for other variables
The
approach
in
taken
have
taxes
effect
while allowing for observation of the
rents.
office
for
index
Creating a hedonic price
includes
which
rents
available
readily
is
data
rent
However, office
levels would be very difficult at best.
on
real estate tax
estimating
incidence will be to develop a simultaneous equation model and
regress office rents on the control variables.
space
of
foot
will
indicate
demand
elasticity
the
landlords and tenants, which approximates
the
burden between
relative
the
square
per
taxes
The resulting coefficient (c) on
of
If demand is perfectly elastic, then c is
curve.
zero and the landlord
pays
the
full
burden;
a
completely
inelastic demand curve would imply that differential taxes can
be
completely
passed on to tenants and c would be one.
on current theory, c should
empirical
results
be
one.
and
zero
between
Based
The
will contradict the theory presented, lead
to speculation on causality and suggest future paths of study.
Knowing the elasticity of
rent
payment
they
can
recover.
information can sway the decision of whether to build in
a town with low rents and low taxes or
taxes,
to
is valuable to office developers in that it enables them
to predict how much of their tax
This
respect
with
demand
helping
high
rents
and
high
suppliers to maximize and eventually equalize
rates of return across all jurisdictions
in
a
market.
Town
Page 4
officials
tax
can
rates
collections.
on
indirectly
market
calculate the /affect of changes in
value,
thereby
estimating
total
Page 5
II.
Capitalization Theory.
Property taxes
payments
to
a
in
municipal
the
United
government
States
are
of a percentage of the
value of the land and improvements on private property.
real
estate
is
subject
annual
While
to property taxes, other capital is
generally not taxed in this country, although some
states
do
have certain wealth taxes. The valuation which the tax bill is
based
on
is made by a local town assessor using various (and
sometimes mysterious)
Massachusetts,
methods
Proposition
for
2
arriving
1/2,
a
at
values.
In
voter referendum, has
required cities and towns to assess property at
"full
market
value." Furthermore, the total take for a municipality may not
amount
to
more
than
2.5%
of
the
town's total valuation,
although different rates may be used for different classes
of
property.
in
The
five
official
Massachusettes
are:
industrial
personal.
and
classes
residential,
Office
of
property
commercial,
space
is
office,
included in the
commercial class.
Property is generally valued in the market place
its
fair
market net rental stream, assuming that the current
use is the highest and best
applied
by
a
discount
or
use.
To
the
capitalization
income
stream
is
rate, and the market
Page 6
value is obtained. "Fair market" net
income
current
than
because
is
income
rather
used
income is often below
current
market due to old leases made early in a bull
Rarely
market.
in history have long term leases been at above market rentals,
and
for the past several years rents have been rising in most
areas.
from
Net rental income is derived by deducting
the
gross rents all annual expenses related to running a building.
This
in
applies
theory to owner-occupied buildings as well,
though the net rent is an
imputed
real
are
there
If
one.
estate taxes to be paid on the property, then these reduce the
net
income
figure. The capitalization rate is market driven,
interest
that is to say it is based upon current
amount
the
capital being directed into real estate and future
of
expectations of supply and demand in
The
rates,
market.
particular
the building is thus its net income divided by
of
value
the
the capitalization rate.
As an illustration, assume
foot
office
building
is
rented
that
at
a
100,000
square
$23.50 per square foot
(psf.) so that gross rents are $2.35 million. If expenses
are
$3.50 psf. then the net rent is $20 psf. or $2 million. If the
market
expects
a capitalization rate of 8% then the value of
the building would be $250 psf. or $25 million ($20/.08 psf.)
Now assume that a property tax is
levied
upon
the
Page 7
building in the amount of $2 psf. This would reduce net income
to
$18
psf. and value would fall to $225 psf. from $250. The
imposition of a property tax
value
of
the
land
has
significantly
reduced
the
and improvements, by ten percent in this
example. The $25 psf. reduction
in
value
is
equal
to
the
capitalization of $2 psf. at 8%. (Smith, p. 177)
The example above illustrates how real estate
are
capitalized
into
the
value
of
the property taxed. It
should be remembered at this point that this
means
the
whole
story,
but
illustration of tax incidence.
taxes
is
not
by
any
rather a very short run static
Later
on
we
will
see
that
theoretically some or all of the property tax may be passed on
to renters in the form of higher rents, thereby mitigating its
effect
on
the property owner. Furthermore, no distinction is
made here between land owner and capital owner, though
theory
indicates that disparate incidences on these two parties occur
or can be imputed.
The U.S. system does not impose flat per square foot
taxes on property; rather property is taxed as
value.
This
simultaneity
percent
of
makes the after tax calculation of
value slightly more difficult and is shown
formula:
V = (N-tV)/c
where:
a
(1)
by
the
following
Page 8
V = value
N = net income after expenses only
t = tax rate
c = capitalization rate
solving (1) for V yields:
V = N/(c+t)
(2)
Equation (2) states that the value of a property
its
net
stream
income
capitalized
at
is
a rate equal to the
taxes
no
market capitalization rate in the presence of
plus
the tax rate. Of course, only overall capitalization rates are
observed
in
the
market
with the tax rate already added in.
Equation (2) also says that no matter what the
from the previous example and a 100% tax
would
have
rate
is,
will always have some value. Taking the numbers
property
the
tax
a
value
equal
rate,
the
building
to $20/1.08, or $18.50 psf. This
compares rather unfavorably to the $250 psf.
value if no
tax
levied, however as t goes to infinity, V only approaches
were
zero.
The
past
several
paragraphs
have
explained
and
derived a formula for the capitalization of property taxes. It
assumes
without any thought that real estate tax incidence is
entirely on the property-building owner.
be
to
develop
the
step
will
theory of incidence more fully as it has
evolved from a static view
incidence model.
The next
into
a
general
equilibrium
tax
Page 9
III. Property Tax Incidence.
Property
incidence
tax
at least since the 1890's, but not until Tiebout's
economists
article in 1956 did the theoretical work
contribution
main
Tiebout's
to
large
a
variety
of
up.
heat
to
begin
the field was on the demand
side, where he showed that consumer's of property
amongst
by
discussed
been
has
could
shop
and benefit packages from
tax
different municipalities. Each consumer was free to choose the
tax/benefit package that gave him the
confined
most
Tiebout
utility.
himself to residential consumers, but the concept is
generalizable
to
any
entity
in
engaged
for
searching
a
location. A firm would clearly prefer to locate in a town with
lower
taxes
and
wider,
better
paved
roads leading to the
office building it intends to occupy, cateris parabis.
The Old View.
On the actual incidence of property taxes,
there
evolved
however,
a traditional view that the portion of the tax
attributable to land fell entirely on the
land
owner,
while
the tax on improvements could be shifted to consumers. Land in
itself
has
value
because
it
is
scarce,
highly
unique
Page 10
derived
value
Land
non-reproducible.
locationally and virtually
is
the difference between the cost of constructing
from
and
site
the highest and best use allowed or feasible on the
the capitalized value of that use. Property taxes are supposed
to
on
separately
assessed
be
the
itself and on the
land
improvements to the site.
completely
fixed
property tax, nor can
the
the
factor,
a
escape the
cannot
landowner
is
land
view,
traditional
the
Because, under
prior
it be passed on if the market
to
This point
implementation of the tax was in equilibrium.
is illustrated by the graph in figure 1. The supply of land is
fixed and therefore vertical;
for
destroyed
neither
factors
other
they
as
optimal mix for their needs.
view
the
then,
imposition
demand curve to D'.
changed (the
landowner
demand
must
now
equilibrium
the
nor created.
Demand, D,
to
substitute
flexible as users of land are free
however, is
it
is
land
price,
no matter what
wish in order to obtain the
From the land owner's
of
point
of
the tax lowers the effective
While the actual equilibrium price has not
curve
pay
has
not
shifted
D),
from
the
part of his rent in taxes. Thus the
owner's perceived rental price is reduced by the
full
amount
of the tax since his supply curve is completely inelastic.
The story is different
improvements.
in
the
case
of
taxes
on
Here the traditional view holds that capital is
mobile and that a local tax will drive capital away
from
the
Figure 1
Landlord
Rent
After
Tax
Page 10A
Supply
.1
1
Demand
R'=R-T
Land in use
Change in taxes per square foot is
completely absorbed by Landlord.
Figure 2
Lanlor' d
Rent
After
T axes
Supply
R
Demand
R-T
R'>R-T
Space
Change in taxes per square foot is
partially passed on to Tenant.
Page 11
amounts of capital will raise the market rents
Reduced
area.
for buildings, passing on some of the tax burden
The
renters.
to
graph in figure 2 shows the supply, S, and demand, D, for
owner.
structures from the point of view of the building
analysis
elasticity of building
the land market in that the
of
that
from
differs
supply
The
is
Therefore,
positive.
the
extent to which the real estate tax is passed on is a function
of
relative elasticities of supply and demand just as in
the
the familiar case of a sales tax on cigarettes.
The New View.
In recent years a
property
taxes
has
new
view
of
incidence
the
of
emerged, pioneered by such economists as
Mieskowski, Aaron, Musgrave and Netzer. The analysis begins by
postulating the imposition of a uniform national
forms
of
land
and
tax
on
all
capital. Because both land and aggregate
capital are assumed to be constant in the short run, owners of
these factors will have to bear the entire burden of the
The
reasoning
the case
of
tax.
for this resultant incidence is the same as in
land
under
the
old
view:
commodities
with
perfectly inelastic supplies bear 100% of the taxes imposed on
them.
The
new
view
analyzes
the
long
run
effect
of
Page 12
on
taxes
property
aggregate
substitution of capital for other factors of
a
of
imposition
greater
the
its
than
factors of production
achieve
the
production.
The
national tax on capital will, in the short,
optimal
will
price
factor
run bear on the capital owner. But with the
capital
and
formation
capital
of
marginal product, over time other
substituted
be
production
mix.
for
capital
to
In the long run then,
increased taxes will reduce the aggregate amount of capital in
existence. However, the factor price of capital will still
be
higher at the long run equilibrium point than initially. Since
before any taxes are imposed, the world is assumed to be using
an
optimal mix of factors in production, the resultant change
in this production mix must be suboptimal and the supply curve
must shift such that higher prices are needed
same
level
of
output.
to
the
induce
Thus real estate taxes are partially
shifted to consumers through increases in product prices.
If city A imposes a
national
property
tax
the
of
top
on
some capital will leave city A and be added to
tax,
all other cities and towns. In equilibrium, the after tax rate
of return to capital must be equal across
all
jurisdictions,
so when city A imposes an excess tax, the return on capital is
reduced
and
capital
begins to flow to other areas where the
after tax return is higher. As capital flows out
its
supply
is
being
of
city
A,
reduced, and since the demand curve is
negatively price elastic with respect to quantity,
the
price
of capital in city A rises until the return to capital reaches
Page 13
the national level and the outflow ceases.
In figure 3, effective supply shifts to
either
S'
due
to
a change to suboptimal production methods or increased
local taxes in one jurisdiction. The new equilibrium price
is
greater than the initial price, so that some of the tax burden
has been shifted to consumers.
The New View has come
theory
full
circle
to
the
excise
of the old view for taxes on capital. Its contribution
however is to remove the analysis away from the simple
supply
and demand graphs into a deeper micro-economic analysis of the
problem. In order to fully analyze the incidence of a property
needs not only a demand function, but also the
now
one
tax,
relevant production functions to
curve.
The
New
arrive
at
the
new
supply
View allows for long run variable levels of
capital, but not land.
This subject will be broached next.
Land as a Variable Factor.
The idea that the total land in use may not be fixed
has been developed by Aaron. While the total
of
physical
supply
land is fixed, except for certain natural phenomenon, land
filling and regrading, the amount of
given
use
may
land
dedicated
to
any
be affected by the level of taxation for that
Figure 3
Page 13A
Tenant
rent
s'
Supply
R'
RDemand
Space
Factor mix is changed, supply of space
is reduced and rent increases to partially
pass a tax increase on to consumers.
Figure 4
Tenant
Rent
Supply
s'
RR'.
Demand
S
S'
Land in use
Reduced taxes in the city lead to an
increase in the supply of urban land,
lowering rents.
Page 14
surrounded
use. In Aaron's example, a city that is completely
by
farm land is postulated. At the moment, all markets are in
equilibrium so that the supply of land and capital in the city
receives a market rate of return. If
were
return to capital and land would increase
the
lowered,
rate
tax
property
the
and
because tax payments would fall. As the amount of capital
land
in
increases,
use
a
declines until
new
the rate of return to these factors
equilibrium
is
reached
at
a
point
somewhere above the initial market rate (see figure 4.)
While the possibility of expanding the capital stock
would be well accepted by most, expanding the stock of land is
One
not generally thought possible under conventional theory.
must
then
realize
that
the
farm land in this
surrounding
illustration represents an untapped supply of
for
available
land
addition to the city's stock. That total farm land in use
declines is a consequence of the increased
to
relative
urban
cost
use after the tax cut.
of
farmland
The presumption
is
that after the tax cut some farm land becomes more valuable as
urban land since the after tax rate of return
has
increased
on
urban
land
while that on farm land has remained the same.
The amount of farmland incorporated into the city is
tempered
by the price elasticity of demand for capital and land.
If the amount of land available in
any
given
area
for any given use can vary with the tax rate, then part of the
burden
of
a property tax can be shifted to the users of land
Page 15
and structures. Landowners should be no different from capital
shift
owners in their ability to
customers.
land
However,
the
use
regulations
variations in the amount of land given to
thereby
forcing
tax
incidence
upon
Unfortunately, this study cannot show the
of
land
taxes
burden
tax
a
can
to
restrict
particular
the
relative
their
use,
landowner.
incidence
on landowner and building owner, but only the
final incidence of land and building taxes on office tenants.
Page 16
IV. The Model.
on
gross rents should bear a direct relationship
typical
its
are
buildings
to the tenants of the buildings then the
on
part
in
passed
paid
taxes
If differentials in
to
The
taxes.
unit in an office building is the square foot, though
definition
exact
not
is
as
pure
as
it
seem.
may
if we consider gross rents per square foot
Regardless,
real
different
across buildings that pay
estate
(psf.)
taxes
per
square foot but have similar quality characteristics, then tax
incidence
can
be
estimated by regressing gross rent psf. on
taxes psf. The resulting linear equation would be:
R =
a + b*X + c*T
where R is the gross rent, X is a matrix of quality variables,
T is the tax psf., and a,b and c are constants.
The constant, c, represents the extent to which real
estate taxes are reflected
increase,
a
fraction,
c,
in
gross
would
rents.
fall
If
T
were
to
on the tenant in the
building. Thus if c is greater than zero, some portion of real
estate taxes is passed on to the tenant. If c were
zero
less
than
then increased taxes would result in reduced gross rent,
Page 17
meaning that an excess burden would be placed on the landlord,
while if c were greater than one, the landlord would
actually
be predicted to realize increased profits as taxes rise. Since
both
of
these
seem
possibilities
far
one would
fetched,
strongly expect to find c to be between zero and one.
appropriate
This linear specification would be
taxes
if
estimation
bore no relationship to property value.
system
However, the very nature of the property tax
that
taxes
be
for
to value.
related
dictates
Furthermore, as mentioned
above, Proposition 2 1/2 in Massachusetts requires 100% market
valuation for tax purposes. Since value is a function of gross
rent, simply using taxes per square
to
equivalent
variable
is
equation
since
specification
model for rent,
taxes
problem
are
foot
as
an
independent
having rent on both sides of the
function
a
of
value.
This
can be fixed by solving the structural
resulting
in
a
non-linear
equation.
resulting model to be estimated appears on the next page.
The
Page 18
Structural taxation model:
R = a+bX+cT
(1)
T = Vt
V
->
=
(R-E-T)/d
T =
((R-E)t/d)/(1+t/d)
Substitute T into (1):
R = a+bX+c[(R-E)t/d]
(1+t/d)
->
R =
a+bX-[cEt/(d+t)]
----------------
(2)
[1-(ct/(d+t))]
where:
=
=
=
=
=
=
=
Gross rent psf.
Taxes psf.
Tax rate.
Value.
Expenses psf.
Matrix of building qualities.
discount rate.
a, b, c = constants.
R
T
t
V
E
X
d
Page 19
In the preceding equation, the incidence of the
is
still
explained
by
property
the coefficient, c, of the taxes per
square foot. The expected value of c would be the same
the linear case.
tax
as
in
Page 20
V. Analyzing Real Estate Tax Incidence for
the Greater Boston Office Market.
The
insurance,
total
real
number
estate
of
and
workers
in
1984.
predominantly
increasing
in
These
office
demand
the
finance,
other service industries in the
United States has increased from
million
in
3
in
million
industries
buildings.
employ
1955
their
Coincident
11
to
workers
with
this
for additional office space, the supply of
space has expanded to 3.5 billion square feet from 1
billion.
New construction has been at record volumes for several years.
(Wheaton.)
The office market in Greater Boston has been one
the
of
hottest in the country over the past decade. A tremendous
rejuvenation has occurred in Boston through the
young
professionals
into
the
city.
migration
Office employment has
expanded, with several new buildings having been
1975.
Growth
of
built
since
in the suburban office market has ridden on the
catalyst of the
high-tech
industry
which
has
concentrated
around the inner-belt highway 128.
If demand is stable in a market, office supply
decline
for there to be a passing on of a tax increase in the
form of higher rents.
slow,
must
so
a
change
Depreciation of real estate
in
the
is
fairly
tax rate will put the market
in
Page 21
disequilibrium for
expanding
years.
several
of
presence
taxes on office buildings becomes much more accelerated.
capital
and
are
supply
land
an
the long run incidence of property
market,
office
the
In
fluid
Both
with respect to taxing
jurisdictions. If demand is increasing on the order of 3 to 4%
per year, changes in tax rates
supply
need
only
remain
are
stable
quickly
passed
The
on.
for rents to begin rising,
passing tax costs on to tenants in a fairly short time.
If different jurisdictions have different tax rates,
then developers of office space will adjust the volume of
so
construction
that the rate of return on buildings will be
equalized over all municipalities. The amount of land
for
new
in
use
office space will be varied in the same way, meaning that
taxes on
land
increased
will
land
be
taxes
partially
will
lead
passed
on.
developers
Furthermore,
to
attempt to
increase the density of floor space per unit of land as
taxes
increase the factor price of land.
The rapid growth in of
office
market
therefore
the
dictates
Greater
that
equilibrium. Thus when estimating the
taxes,
the
results
or
other
incidence
of
property
should yield the full extent of the long
areas
of
imputed
extent
prices
tax
incidence
in
where real estate is substantially
owner-occupied is difficult because
factor
Area's
it be near long run
run shift of burden. Analyzing real estate
industry
Boston
and
the
a
lack
of
of
data
on
capital-labor
Page 22
substitution in the production mix. However, studying a rental
market can provide the necessary data for assessing
incidence
on tenants.
The rental office market in Greater Boston
this
opportunity
accessibility
brokerage
of
firms
to
determine
good
market
provides
tax incidence because of the
data.
At
least
two
major
provide a very complete survey of the office
market, including asking rents, vacancy rates, size, number of
floors, location and age. Furthermore, the fact that this data
is available to both renters and owners should make the market
very efficient.
Data on land and building tax assessments and
the town tax rates are available from local town
these
can
be
derived
a
building's
tax
halls.
payments
From
and its
effective tax rate (taxes divided by capitalized value.)
The question we seek
incidence
of
property
taxes
to
answer
is,
on
these office buildings? If
what
is
the
property taxes are thought of as part of annual expenses, then
an increase in taxes, say per square foot, is paid in cash
the
by
landlord. The only way to shift this burden to the tenant
is for the landlord to raise the gross rent. Thus the relevant
question to be
answered
becomes,
to
what
extent
does
an
increase in taxes per square foot get passed on as an increase
in
gross rents? An econometric model of tax incidence will be
developed and estimated with data on 160 office buildings from
the Boston Area in section VI.
Page 23
The Sample.
Greater
Boston
Area
the
distribution
the
in
The sample consists of 160 office buildings
of which follows the
A.)
distribution of office buildings in the region (see Table
Approximately 25% of the buildings are located in Boston, some
of
are
which
outside the Central Business District. Several
other buildings are located in two adjacent cities,
and
Brookline.
The
rest
Cambridge
the sample is from the suburbs
of
located around a circumferential
highway known
as
The
128.
office market around the 128 belt, which has grown up over the
past two decades, can be considered rather uniform in terms of
its
access
to
central Boston. Thus, comparing tax incidence
across these towns should yield good results.
All of the buildings in the sample were built
to
1980,
and since the data is from early 1985, all of these
buildings are older than 5 years. New buildings
additional
prior
attraction
high rents, unexplained
which
by
could
the
may
have
an
translate into unusually
sample
data.
These
mature
buildings should now have gone through releasing at least once
and lost any original luster.
Page 24
Table A: Town Statistics.
Town
No.
Bldgs.
RATE1
RATE2
Boston
Cambridge
Brookline
Bedford
Braintree
Burlington
Canton
Dedham
Framingham
Lexington
Needham
Newton
Peabody
Quincy
Stoneham
Wakefield
Waltham
Wellesley
Weston
Woburn
40
11
5
2
7
20
1
3
3
12
1
11
2
2
1
3
11
21
1
2
3.1%
3.5%
3.2%
2.2%
3.7%
2.2%
2.0%
3.0%
2.5%
3.0%
1.6%
3.4%
2.4%
3.1%
2.1%
3.0%
3.1%
1.6%
1.6%
2.6%
2.1%
2.6%
1.8%
1.3%
1.3%
1.1%
1.0%
1.3%
1.7%
1.6%
0.8%
2.3%
5.2%
1.5%
1.1%
2.2%
1.5%
0.8%
2.3%
1.0%
Page 25
allow
The control variables in the data base should
the effect differential taxes have on rents to come through in
the
These
regressions.
variables
quality and location. It is
vital
fall into two categories:
that
the
sample
contain
information which differentiates both between buildings in the
same
and
town
similar
buildings
in
different
towns. Two
buildings in one town will have different rents based on their
attributes of quality and functionality.
A
building
in
one
town would have a different rent if placed in another location
with
a
transportation,
different
worker
access and public
benefit package. The variables used in the sample
capture
of
much
this
attempt
to
variation, and do, but others, though
less attainable and definable, would greatly add to the
power
of this study.
Important location variables
ease
should
represent
the
of access a building has to its customers and workforce.
Access to major
ability
of
highways
and
transit
lines
represent
workers and clients to reach the office building.
Access to the white collar work force is demonstrated
percentage
the
of
by
the
college educated people in the immediate area.
Controlling for these quality variables allows for rents to be
compared across jurisdictions with differing tax levels.
Using asking rent may be a problem in a soft
if
concessions
are
being
market
made in leases. These concessions
Page 26
for
paid
improvements
include free rent and tenant
by
the
landlord which reduce the effective gross rent received by the
free
on
Data
landlord.
rent periods and tenant work should
ideally be converted into an income stream over the lease term
difficult
and subtracted from asking rent. It is far more
collect
this
information
on
each
to
building since it is not
published by brokers and is not readily disclosed by landlords
or tenants.
Other variables which would more completely describe
building quality and location would
from
attainable
sample.
the
The
improve
information
the
presence of a cafeteria,
degree of landscaping, expenditures on maintenance per
square
foot, views, architectural significance, and amount of parking
per
square foot (relative to neighboring buildings) should be
included as additional quality variables. Travel time
airport
as
well
to
the
a more detailed measure of the level of
as
road service (i.e. number of lanes) could
significant
be
as
far as transportation access is concerned. Labor supply is not
well
measured by the percentage of college educated people in
the area. Some measure
workers,
of
actual
numbers
of
white
collar
and top executives, residing around the town, scaled
by surrounding office space, would be desirable.
Fiscal variables should be
well
since
public
taken
into
account
as
spending which benefits office users will
offset tax costs and tend to raise rents.
Office
tenants
do
Page 27
not
directly
in
much
use
services, although
of
way
the
and
spending on roads, utility provisions, police, sanitation
fire
could benefit firms. Office workers can derive
fighting
parks
and traffic control systems.
Furthermore, moderate tax
induce
rates combined with excellent schools can
live
a
in
particular
area,
affect
to
workers
jobs
office
nearby
making
appealing. All of these factors can
as
items
such
on
substantial benefits from public spending
and
rents
gross
attempts to consider them are important.
Hedonic rent indexes are estimated for the sample in
order to separate the effect of taxes out from
affecting
on several variables was collected for
Data
rent.
building
number
(FLOOR),
of
square
constructed
rehabed
or
(AGE)
bills
were
looked
up
at
and
age
came from market study
reports from two major brokerage firms in the
tax
floor
per
feet
(SQFTFLR), number of buildings in the project (BLDG)
since
in
floors
each building. Gross asking rent (RENT), number of
the
factors
other
town
area.
Property
The
number of
halls.
mass-transit lines (TRAN) and highways (HY) which the building
has convenient access
to
was
included
in
the
data
base.
Finally, the percentage of population in the surrounding towns
with college education (COLLED) was measured (see Table B.)
FLOOR, SQFTFLR, BLDG and AGE fall into
category.
Rent
the
quality
should be related positively to the number of
floors, since upper floors generally demand a rental
premium.
Page 28
Number
of square feet per floor should have a positive impact
on rent since tenants with larger needs
more
easily.
Agglomeration
affects
can
be
accommodated
in the form of multiple
buildings in a single project should also yield greater rents.
The age of the building is a
good
proxy
for
its
level
of
service and condition, and should have a negative influence on
rent
levels.
However,
the
upwards in magnitude because
time
restrict
supply,
age
rising
leading
rents for newer buildings.
coefficient
to
may
development
be biased
costs
over
accelerated increases in
Page 29
Table B:
Variable Definitions.
Name
Definition
RENT
Gross asking rent for the building.
FLOOR
Number of floors in the building.
SQFTFLR
Total square feet in building divided
by FLOOR.
BLDG
Number of buildings in the surrounding
office park.
AGE
Age of the building
HY
Number of major highways through the
town building is located in.
TRAN
Number of mass transit (subway) lines
with stops within one mile of building.
COLLED
Percentage of the population in the
surrounding area with college degrees.
RATE1
Town's legal commercial tax rate.
RATE2
Calculated average effective town
tax rate.
(1985-year built.)
Page 30
VI. The Regressions.
As a base case, ordinary linear regressions were run
with rent as the dependant variable for the entire sample; the
suburban towns; and the three inner cities, Boston,
and
Cambridge
Brookline together. The reason for breaking the data this
'Suburban'
way is that the
office
suburban
towns
Thus,
market.
are
there
sub-sample and each town is in the same
three
cities
have
access
to
therefore more closely linked.
located
in
the
is uniformity in this
general
mass-transit
market.
The
and
are
lines
Though Boston is probably in a
class by itself, the variables HY and TRAN should account
its
especially
high
appear in Table 1. Most
128
for
rents. The results of these regressions
of
the
variables
are
significant,
although several are insignificant in the city regression. The
R-squareds
data.
for
each
regression are high for cross-sectional
Page 31
Table 1: Ordinary least squares regressions.
Regression
Variable
All Bldgs.
Suburbs
City
constant
11.70
(11.03)
10.19
(8.21)
19.29
(3.26)
-. 0812
-. 138
(2.77)
-. 109
(3.60)
Age
(3.30)
Floor
.212
(6.43)
Sqftflr
.0000146*
.217
(4.93)
.0000259
(2.08)
-. 0000495*
(.793)
.455
(5.63)
.514
1.46
(7.03)
(2.59)
Colled
22.92
(6.78)
19.07
(5.39)
2 .65*
(.102)
Tran
1.52
(6.26)
Hy
.0724
(.282)
1.22
(2.93)
.312*
(.838)
T (c)
.131*
(.716)
.204*
(.705)
-
64.1%
54.3%
58.8%
(1.05)
Bldg
R-squared
* Coefficient not significant.
t statistics are in parenthesis
.746*
(1.85)
.333*
(1.32)
Page 32
There is a significant constant in each
a higher constant than the
the
city
has
suburbs. Therefore, the
same
building
and
expected,
as
generate
gross
higher
rents.
regression,
Age
the
in
strong
a
has
should
city
negative
influence on rents, though slightly higher in the suburbs than
the city. Each year a suburban building ages, expected rent is
reduced $.14
psf.
psf.
while city buildings' rents fall $.11
each year, on average.
Size of a building should influence rent positively.
terms
Being on a higher floor is worth a premium in
floor, enables large firms to fit
more
space
efficiently.
is
floors
fewer
on
stories,
firms
may
available. Typical
and
space
Vertical
detrimental in the city for cultural reasons and
be
because most buildings have small
10,000
however
The number of square feet
per floor is only significant in the suburbs.
suburbs
use
from the city regression that additional floors
clear
bring additional rents of $.22 psf.
not
and
FLOOR could not be estimated in the
suburbs because the buildings were all four
may
view
prestige. Having a larger footprint, more square feet per
and
it
of
demand
buildings
while
in
space
which
is more
have
between
horizontal
in
the
footprints,
the
suburbs
50,000 square feet per floor, implying a possible
rent premium of up to $1.00 psf. for larger footprints.
The location variables function well in this market.
Page 33
Agglomeration
affects
are
the
by
evidenced
as
positive
significant positive coefficients on BLDG for each regression.
parks
Office
bring
building, while in the
Overall,
the
expected
$.51
psf.
the
city
higher,
is
effect
each
for
rent
additional
$1.46.
rent per building is over
additional
$.45 psf. COLLED, a measure of access to the white collar work
force, is very significant
to
and
sample
overall
the
the
suburbs. Firms pay more rent for locations convenient to their
workers.
access
TRAN,
insignificant
to
is
just
barely
in the city, but it has a positive coefficient,
as expected. In the overall
increases
lines
lines,
subway
gross
rent
access
sample,
by
psf.
estimated for the suburbs because the
$1.52.
transit
mass-transit
to
TRAN
is
not
lines
do
not
operate there. The number of highways running through suburban
towns
has a large positive affect on rents. Thus, the greater
the transportation access to a building, the greater the rent.
The variables TRAN, HY and COLLED did not work
in
the
together
city regression because of the limits of this sample.
The results from the total sample
COLLED.
well
are
better
for
TRAN
and
Boston creates problems for the highway variable, so
it is only significant in the suburban regression.
Finally, the variable which we are
most
interested
in, taxes per square foot (T) has an insignificant coefficient
in
all
regressions. It could be stated naively at this point
Page 34
that property owners bear the full burden of the property tax.
This is not necessarily true since the
correct
specification
of the model involves a non-linear estimation.
A major issue in specifying the non-linear model
is
what to use for the tax rate. Towns have established legal tax
2 1/2, property tax rates do
rates, but even with Proposition
not
follow
really
the
Capitalizing net income
legal rate.
after tax, and using this value and the tax bill to
the
determine
on a particular building yields tax rates that vary
rate
would
with a town often by 4 to 1 or more. An alternative
be
to take an average of the calculated rate for each building in
the
town
and
use
that
as
the
effective
tax rate on the
building.
The two possible tax rates; the legal rate, and
effective
estimations.
average
legal
used
in
six
non-linear
For each rate, the whole sample was estimated as
well as a city and suburb
with
were
rate;
the
rate
estimation.
The
city
regressions
and effective rate did not come out because
the sample is so limited,
and
thus
these
results
are
reportable. The regression results appear in Tables 2&3.
not
Page 35
Table 2: Non-linear regressions using 'RATE1'.
Regression
Variable
All Bldgs.
Suburbs
Constant
15.29
(7.51)
14.98
(7.43)
Age
-. 0981
-.165
(3.08)
(2.62)
Floor
.282
(5.28)
Sqftflr
. 0000179*
(1.03)
.0000362
(2.16)
Bldg.
.514
(5.04)
.624
(6.33)
Tran
2.20
(5.01)
Hy
-. 137*
Colled
Ratel
(c)
R-squared
(.407)
1.17
(2.25)
26.12
(5.92)
22.95
(4.92)
-1.20
(2.01)
-1.75
(2.87)
65.4%
60.3%
* Coefficient not s ignificant.
t statistics
are in parenthesis.
Page 36
Table 3: Non-linear regressions using 'RATE2'.
Regression
Variable
All Bldgs.
Suburbs
Constant
12.52
(9.77)
12.51
(8.81)
Age
-. 0850
(3.28)
-. 161
(2.94)
Floor
.226
(5.78)
Sqftflr
.0000141*
(.991)
.0000298
Bldg
.450
(5.44)
.529
(6.66)
Tran
1.69
(5.28)
Hy
.00178*
(.00641)
1.09
23.54
(6.56)
21.62
(5.41)
-. 260*
(.629)
-1.09*
(2.24)
64.1%
57.0%
Colled
Rate2
(c)
R-squared
* Coefficient not significant.
t statistics are in parenthesis.
(2.14)
(2.40)
Page 37
Most of the coefficients were qualitatively
no
matter
similar
what tax rate was used. Therefore, running through
these numbers in detail would not be interesting at all. As in
the linear case, colinearity problems again affected the
city
regression.
All
regressions
only
were good cross-sectional
fits with corrected R-squared's ranging from 55% to 65%.
coefficient
The tax psf. (T)
each
regression,
it
although
the
significant, except for
was consistently negative and
entire
using
sample
effective
rates. Effective rate is probably the best version of
average
the tax rate to use. It is
because
over
greatly
varied
over
improvement
an
rate
legal
properties just are not taxed at this rate. Using the
calculated building rate presents problems because
given
the
data available, the only way to do this calculation is to have
the
rate
dependent
on
gross
rent,
thus
introducing
an
additional simultaneity problem in the model.
Taxes
square
that property owners bear
taxes.
The
foot
are
not
suburban
the
market,
full
burden
however,
has
negative relationship between rents and taxes.
unexpected
and
very
surprising.
this result is that tax rates in the
rents.
If
a
a
significant
gross rents over the whole sample. This implies
on
influence
per
of
estate
real
a
significant
This
is
very
A possible explanation for
suburbs
are
driven
by
town has relatively valuable office space (high
Page 38
is
rate
rents) then a lower tax
needed
to
public
finance
expenditures. This influence would not be predicted for a city
like Boston where fiscal difficulties necessitate that as much
revenue as possible be soaked from all sources.
One other econometric method for estimating property
study.
tax incidence should be pursued before concluding this
Each
because
town,
as
desirable
relative
office
an
desirability
attributes,
its
of
location
towns
across
than
the
various
towns.
These
This
others.
the
can be described as the
same
building
rents
are then
difference in rent which would be paid for the
in
less
or
more
is
differential
regressed against the townwide variables. This
estimation
is
done in two stages.
R = a+bX+cD
(1)
where:
R = differential rent; a, b and c are constant;
X is a matrix of building characteristics;
and D is the matrix of dummy variables.
D = e+fY
(2)
where:
D is the vector of differential rents;
Y is the matrix of town variables;
e and f are constants.
First, one dummy variable is created for
except
one,
in
this
case
Boston.
(1)
includes
all
town
Boston is the base town
against which all differential rents are measured.
regression
each
building
The
variables:
first
FLOOR,
Page 39
SQFTFLR, BLDG and AGE (Table 4A.)
held
constant
so
that
the
Thus the
dummy
building
coefficients
type
is
become the
differential rents for each town.
The second
rents
derived
from
regression
(2)
the
regression
first
uses
the
differential
as the dependant
variable and the town variables; HY, TRAN, COLLED and RATE1 or
RATE2; as
independent variables. The coefficients of RATE1 and
RATE2 indicate the incidence of the tax. The results of
regressions are given in table 4B.
these
Page 40
Table 4A:
Two stage estimation of tax rate effect;
stage 1 results (Rents relative to Boston.)
Variable
Coefficient
T statistic
Constant
FLOOR
SQFTFLR
BLDG
23.04
.178
.0000308
.444
27.74
5.72
1.93
AGE
-
Cambridge
Newton
-2.58
-4.21
-7.64
-9.56
-6.58
-6.29
-8.09
-5.42
-6.31
-4.49 *
-4.02
Peabody
-8.86
Quincy
-10.17
-6.15
-12.11
-5.32
-1.20 *
- .45 *
-4.27
Brookline
Bedford
Braintree
Burlington
Canton
Dedham
Framingham
Lexington
Needham
Stoneham
Wakefield
Waltham
Wellesley
Weston
Woburn
.0829
* Coefficient not significant.
5.09
3.60
2.91
3.37
4.12
8.70
7.01
2.45
5.24
3.49
6.65
1.76
4.28
4.78
4.37
2.41
7.85
5.52
1.51
.17
2.28
Page 41
Table 4B: Two stage estimation of tax rate effect;
stage 2 results.
Variable
Ratel
Rate2
Constant
-10.16
(3.07)
-12.18
(6.31)
Hy
.454*
(.880)
.561*
(1.10)
Tran
1.51
(2.42)
1.36
(2.26)
Colled
21.59
(3.59)
22.76
(3.85)
Ratel
-72. 51*
(.853)
-22.88*
(.440)
Rate2
R-squared
55.6%
* Coefficient not significant.
t statistics are in parenthesis.
54.0%
Page 42
Two regressions were run, one using
using
other
(Table 4B.) All variables were entered in
RATE2
linear form only since there is no structural model
this
for
the
and
RATEl
developed
section. Both regressions have R-squared's of about
55%. Transportation lines have a positive influence on rent of
to
$1.45 psf. on average. The highway variable turned out
insignificant,
though this result would probably be different
if only the suburbs were looked at. As anticipated,
of
white
be
collar
workers
to
the
location,
proximity
as measured by
COLLED, brings a premium in gross rents. The results for taxes
turn out to be
which
negative.
Both
coefficients
were
negative,
could be explained if rental rates drive tax rates, and
towns are not budget strained. However, these coefficients are
not significant, thus it must be assumed that
taxes
are
not
being passed on to renters, based on these results.
tax
Although the two stage estimation of
reveals
incidence
that landlords pay the entire amount of the tax, this
result should not be looked at with too much confidence
it
was
attained
with
regressions
completely
devoid
since
of a
structural model much like with the original linear regression
presented earlier. Some economic theory
with
a
results
applied
here,
along
break up of the sample might lead to more interesting
which
would
simultaneous model.
coincide
better
with
the
non-linear
Page 43
VII. Conclusion.
The results of
on
presented
property
estimations show that
on
passed
office
to
while
that
model show
significant
tax
contradict
study
this
occurs
not
are
taxes
property
tenants. The results of the non-linear
in
the
there
sample
total
is
no
shifting of the burden to tenants, in the suburbs
gross
higher taxes are actually correlated with lower
This
theory
Linear and two-stage
incidence.
differential
the
rents.
despite the rapid growth occurring in the market
which should allow developers to equalize their rate of return
over the entire area.
observation
One explanation for this surprising
that
towns
with
more
valuable
office
is
space (higher gross
rents) than others can support their expenditures with a lower
tax rate, cateris parabis. If a town's budget is not strained,
property
values
it can afford to lower its
tax
rates
when
suburban
tax
rates
may be driven by rents
increase.
Thus
rather than the other way around. We
observe
this
in
study
only the resultant of two forces: landlords passing high taxes
on
to
tenants,
and
towns
lowering rates as values outpace
spending.
A problem with this study is its lack
which
measure
of
variables
the package of public benefits provided by the
Page 44
Town
lines.
subway
town, other than simply the number of roads or
on items benefiting office users and landlords
spending
would mitigate the net effect of the
tax
property
these
on
Furthermore, spending patterns which benefit office
parties.
to
workers living near the site may provide indirect benefits
the
in
tenants
form
of
an incentive for employees to live
nearby, thereby lowering wage demands at the site. (Carlton)
indicating
Using a variable like COLLED, while
white
collar
mix of the surrounding area, says nothing about
wage
the magnitude of the office labor force nor its
other
to
relative
of
taxes,
demands
areas. A location may be ideal for office
firms in terms of client access, but
terms
may
unbearable,
be
in
pollution, crime, etc., for workers to live
near. On the other hand, if high tax collections are spent
items
the
on
substantially beneficial to firms or workers, these are
likely to be passed on into greater
willingness
pay
for
measure
the
to
office space.
Nothing in this
extent
to
which
paper
allows
to
us
landowners and building owners divide their
share of the tax burden. Most building
owners
are
also
fee
owners so relative incidence would have to be imputed. Data on
land
sales
might
however the number
reveal
of
real estate tax incidence on land,
these
cross-sectional analysis.
sales
would
be
too
few
for
Page 45
In
determinants
conclusion,
of
town
study
more
tax rates
is
needed
should
be
included
information, the passing on of
observed in
in
the
(and the appropriate rate to
use in research.) Variables which measure the towns'
pattern
on
the
taxes
sample.
to
Without
tenants
isolation from other fiscal factors.
spending
cannot
this
be
Page 46
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