D.C. Office Is In A 'Category 5 Hurricane.' How Does It Rebuild?

Office owners are in a whirlwind of trouble in the nation's capital. 

Properties are hitting the foreclosure auction block weekly, while others are selling for a fraction of what they were worth just a few years ago, with both banks and owners taking massive losses.

“Office is in a Category 5 hurricane,” Carr Properties CEO Oliver Carr said at Bisnow’s D.C. State of the Market event this month, echoing comments made by Starwood CEO Barry Sternlicht last summer. “It's the worst it's ever been.”

As the waves of distress wash over the central business district, now is the time to think big and make plans for a downtown that will be drastically different from the one we know today, several real estate leaders said. 

“We have no choice,” Transwestern Development Co. regional partner Toby Millman said at the event, held at BGO's 777 6th St. NW. “We have to save our core. A healthy region needs a healthy core. I think almost everyone in this room recognizes that.”

But to do that, industry executives say D.C. has to readjust on a grand scale and launch aggressive efforts on multiple fronts: funding conversions of vacant offices, demolishing and redeveloping obsolete properties, and attracting more private-sector businesses to make up for the shrinking federal office footprint. 

Developers have already begun converting some office buildings to residential, but Millman said those properties have been the “low-hanging fruit,” and strategy can't solve the whole problem.

“This next phase is going to be much heavier,” Millman said. “And I see that as being a more wholesale, massive redevelopment of downtown. And I mean literally tearing down whole blocks of old office buildings.” 

In recent months, auction houses have seen a slew of large, prominent buildings downtown going up for sale. 

Last week, State Farm Life Insurance Co. took back a 123K SF property near the White House for a third of its assessed value, and a science nonprofit purchased a 91K SF building between Dupont Circle and Scott Circle for $10M. Last month, Starwood Property Trust took back a vacant, 383K SF property on K Street, formerly home to a federal agency, for $44M.

Meanwhile, the buildings that landlords are able to offload without going through foreclosure are selling at steep discounts as office vacancy continues to hit record highs quarter after quarter.

“We've seen the values of office buildings in D.C. fall by almost 50% on average,” Carr said. “Half the buildings in this market, at least, are over-leveraged. So it’s a pretty dire situation.”

This all points to a drastically shifting landscape. But at the moment, it’s unclear what the other side looks like and how to get there. 

“We need to have a lot more discussion on how to turn things around,” Carr said. “Otherwise, obsolete, old, over-leveraged buildings are just gonna sit that way, and we're gonna have a void downtown that none of us want.”

D.C. has created a number of programs aimed at turning things around. 

The city has unveiled a pop-up permit program that clears regulatory hurdles for temporary retailers to fill vacant storefronts downtown. It also unveiled a soft landing program this spring to support and attract international companies and entrepreneurs to the city through discounted and flexible office space and streamlined visa opportunities. 

In March, the mayor's office opened applications for a new 20-year tax abatement program for office-to-residential conversions for a specific part of downtown. The program caps the funds at $2.5M for fiscal years 2024 through 2026, $6.8M in 2027 and $41M in 2028.

Millman called the tax abatement a “huge win.” Transwestern has a yet-to-be-announced office-to-residential conversion downtown that plans to use the incentive, he said. 

“It’s going to allow projects like ours to move forward that might not otherwise,” he said.

But panelists said programs like that need a supercharge.

“A $2.5M tax abatement. That’s like three new apartment buildings. That’s nothing,” Carr said. “We need, I don't know, $100M a year — which the city would probably choke on that, given the financial challenges the city's facing. But we need solutions at scale. Much, much more than what we have today.”

Developers and owners are looking to the city for other solutions, arguing it can’t put all of its eggs in the office-to-residential basket. 

Hoffman & Associates Chief Investment Officer Jon McAvoy said he is all for the office-to-residential strategy and is very much in favor of the incentives. But he said it “needs to be one of many strategies.” 

“It has gotten a ton of attention, but there are a lot of other things that continue to need attention in order to ensure we can push ahead,” he said.

The budget for FY 2025, adopted by the D.C. Council on Tuesday, approved tax abatements for conversions of office to purposes other than residential — a program that is capped out at $5M for 2027, $6M for 2028, $8M for 2029 and 4% growth each year after, the Washington Business Journal reported. 

But what will become of buildings that don't make structural sense for conversions?

“There's going to be a period of head-scratching about what to do with the remaining buildings,” Millman said. “And I think it’s going to be a more wholesale redevelopment situation where you're looking at entire blocks being demolished. I know that sounds crazy.” 

He pointed to projects over the last decade like City Center and The Wharf that completely overhauled large swaths of District land for drastically different purposes.

City Center, now 2.5M SF of high-end retail, office, hotel and residential, had been the site of the city's convention center until 2004. The Wharf, which until the mid-2010s was used largely as a fish market, is now a 3.2M SF mixed-use waterfront destination.

One of the issues standing in the way of repurposing properties, though, is the transfer tax, Brookfield Properties Executive Vice President Cy Kouhestani said. Those taxes use the assessed value and not the transaction value, figures which have an especially wide spread in today's market.

“That’s just discouraging what we all want, which is underutilized product to be revitalized,” he said. 

Investment flowing back into the city also heavily relies on what happens with interest rates. The Federal Reserve has held rates between 5.25% and 5.5% since last summer, and the latest predictions are that a rate cut won’t come until the fall at the earliest.

“I don’t see equity coming back to the table in a strong and meaningful way until you actually see rate cuts,” TMG Senior Vice President Katie Yanushonis said. “I don’t think they’ll do it on a hope and a prayer.”

In addition to accelerating the redevelopment of vacant offices, panelists said the city must also push to bolster the demand for its offices to keep some of the downtown as a thriving commercial hub. 

The federal government used to provide a stable source of demand for D.C., but federal workers still haven't come back to offices in force, depleting foot traffic and retail activity and leading the government to reduce its leased footprint. 

Public Buildings Reform Board founder Dan Mathews, who previously served as the General Services Administration's public buildings commissioner, said federal government employees’ return to work has been at about half the rate of the private sector. 

“Federal employees have barely come back to office,” he said.

Federal agencies were only using 12% of their federal headquarters buildings on average, the PBRB found in a study conducted from January to September 2023.

With the federal government’s lackluster return, the city needs to be looking to lure more private sector office tenants, Carr said. 

He pointed to a business attraction effort in Austin, Texas, launched in the early 2000s, in which the public and private sectors worked together to recruit businesses, with a group of Austin-based CEOs going out to sell why other companies should move to the city. 

“We’ve got to play offense,” Carr said.