Apr 17, 2024 - Real Estate
Town Talker

The office building market downturn is dragging D.C.

An illustration of cutouts of employees working at an office

Illustration: Rebecca Zisser/Axios

It's ugly out there for office building owners. Their investments were sky-high during Washington's renaissance — and now their net worths have tumbled as white-collar workers would rather WFH than clock-in downtown.

Why it matters: As D.C.'s office market gets pummeled, the plight of bruised real estate titans is also a drag on the rest of the city.

Catch up quick: The commercial real estate sector — largely composed of offices for the feds, law firms, and downtown companies of all sizes — brought in gobs of tax dollars during the 2010s boom.

  • The fat cats who owned the construction cranes and the real estate got richer.
  • City Hall got richer, too. From 2012 to 2020, tax revenue from commercial properties increased 58%, public data shows. The Wilson Building — where progressive lawmakers unseated business-friendly old timers — suddenly had more and more money to tackle homelessness and affordable housing.
  • All the while, D.C. grew faster than the U.S. economy at a clip of about 6%. Then came the pandemic.

D.C.'s chief financial officer, Glen Lee, now predicts 2% growth through 2028. And, Mayor Muriel Bowser has proposed half a billion in cuts and targeted tax hikes to handle a $4 billion budget gap over four years.

  • The office market's downturn and its ripples have a lot to do with it. Since peaking in 2021, taxes from commercial properties dropped 10.3% to $1.65 billion in 2023.
  • "This is something that absolutely affects everyone," says Gerren Price, who leads the Downtown Business Improvement District. "The city relies significantly on commercial tax property revenues to support the broader budget. We're already feeling it."

Zoom in: Consider 1899 L Street NW. It sold for $44 million in 2004. Its value on paper has since climbed to $66 million. But the reality of telework meant the 12-story office building recently sold for $22.6 million, the Washington Business Journal reports.

  • A building across from Franklin Park that cost $100 million in 2018 sold for a $64 million markdown last December, the Washington Post recently noted. Another building on 14th Street lost $44 million in value, selling for $18.2 million in January.

Behind the scenes: Many office building owners are challenging the taxman's assessment of their properties, arguing (as recent real sales show) that they are overvalued — therefore overtaxed.

  • Property sales are also down. That's another revenue source for the city drying up.
  • "We've been observing transactions have gone just to a handful a month. We used to have dozens," says Fitzroy Lee, a deputy to the CFO, an independent D.C. office that in these lean times is all the more influential. "We used to get investors all over, internationally."

The intrigue: So-called "zombie buildings" are everywhere in America — offices with high vacancies and bleak finances, especially due to high interest rates.

  • Stunning stat: Only 26% of office building loans in the U.S. were paid off in full when the debts came due last year, according to CRED iQ, an industry data collector. Observers call it a slow-moving train wreck. Smaller regional banks that hold many of the loans are often extending grace periods in hopes of weathering the storm until interest rates fall and activity picks up.

Converting those offices isn't so easy.

  • Bernstein Management Corp. paid $15 million in 2022 to buy 1735 K Street NW for an office-to-residential project.
  • But turning the 12-story building into luxury apartments would cost about $50 million, says CEO Joshua Bernstein. With borrowing and construction costs increasing, the math didn't add up.
  • "It's just completely uneconomical," he tells me. "We'll be sitting on our hands on that one … We could make other investments that are far more attractive."

What's next: Some buildings might just need to come down, an ironic reversal from the days when empty downtown land was gobbled up and turned into blocky office buildings.

  • Bernstein predicts some midblock office towers may be demolished for the sake of making neighboring structures more attractive, providing more air and light. "It's an astonishing devastation of value," he says.

💭 Everyone's talking about reviving downtown, and I'm wondering: Did anyone consider this idea? Town Talker is a weekly column on local money and power. Send your tips for rejuvenating downtown to [email protected]

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