D.C. Launches Conversion Abatement Fund As Planned Downtown Projects Stall

D.C. officials are launching a new push to assist office-to-residential conversions as they attempt to overcome developer skepticism that the projects are a realistic solution to the problems that ail the city's downtown. 

The Housing in Downtown tax abatement program, authorized and budgeted for last year, would offer a 20-year tax abatement to property owners that add at least 10 housing units and change a building’s use in a designated portion of downtown. The program starts with $2.5M of annual funding for the fiscal year beginning in October, with more funding allocated for future years.

But developers say the abatement, which requires 15% of units in a recipient project be held affordable for those making up to 60% of the area median income, won’t be enough to address the complicated math required to make housing work downtown. 

“It's mission: impossible,” said PRP principal Paul Dougherty, a developer who signed a letter to District officials last month raising alarms about the state of the downtown office market. “The math doesn't work.”

The Office of the Deputy Mayor for Planning and Economic Development is seeking feedback for the program through the end of February. In an interview, Deputy Mayor John Falcicchio said he understood the math for downtown conversions has only gotten more difficult as high interest rates raised the cost of construction financing.

But his office is betting that the program can be a valuable part of a pro forma for developers to piece together a solution for the roughly 17M SF of offices the District knows to be vacant downtown. What’s more, he’s hoping the request for information out for the Housing in Downtown program can help find out what developers need in order to make more office-to-residential conversions work.

“The message that we're trying to send out to the housing community is that we really need to see financial models to understand how we achieve this level of affordability, what the strains are,” Falcicchio said. “Access to capital is a big hurdle for folks, so we want to understand the current market conditions. What are they seeing? And how does it all pencil out?”

Gerren Price, head of the DowntownDC Business Improvement District, said in a statement that many proposed conversions are facing financial impediments to breaking ground. 

“It's important that the city offer incentives that will have the broadest appeal while also being fiscally responsible,” Price wrote. “Time is of the essence here: Already, several planned office-to-residential projects in the BID are currently on hold because of construction and financing costs.”

The Housing in Downtown program was born through a request for information circulated in December 2021 and incorporated into the mayor’s budget proposal the following year. The affordability requirement was raised by the D.C. Council when it was incorporated into the fiscal year 2023 budget. 

Now, the deputy mayor has hired a program manager, Olivia Jovine, to iron out the best ways to get money to projects when the program begins in earnest this fall. Officials hope the abatement program can make a difference in converting 6M SF of offices to residential, a goal D.C. Mayor Muriel Bowser set out for the central business district earlier this year.

Washington, D.C., led the nation in number of units converted from office to residential during 2020 and 2021, according to data from Yardi Matrix. That includes two conversions of old Coast Guard office buildings in Buzzard Point, and several additional conversions have moved forward over the last year. That includes Post Brothers' 500-plus-unit conversion proposed at Universal North and Universal South near Dupont Circle and Foulger-Pratt's 255-unit conversion proposed at 1425 New York Ave. NW, 2 blocks from the White House.

“The million SF [of conversions] that we do know of in the central business district, we think that may be all of the low-hanging fruit,” Falcicchio said. “To get into projects that are a little bit more complicated, or a little more costly, especially as we head into this season of high interest rates, we think that we do have to understand what the market can yield in terms of conversion.”

Dougherty is part of a group of developers that pushed for greater engagement with Bowser and others in her administration last fall, signing a letter warning officials that office values were falling and a wave of distress is likely.

But he has yet to see office values fall to a point where he thinks office-to-residential conversions are viable. Dougherty, along with a team of developers convened by Federal City Council, estimates that office properties need to reach about $100 per SF in order to make a conversion financially viable. He said he is seeing offices trade for double that price.

“Simply put, office buildings were designed to be office buildings and not residential buildings,” Dougherty said. “Most, if not all, of the developers that are undertaking conversions now, at the current market basis, are finding these conversions incredibly challenging and entirely not profitable. The squeeze simply isn’t worth the juice.”

Federal City Council analyzed the cost of conversions with inclusionary zoning restrictions, which require 8% to 10% of units be held affordable at 60% AMI under standard conditions downtown.

The group found that inclusionary zoning requirements would likely cause most conversion projects to be at best a break-even deal in today's market conditions, a difficult sell for risk-averse lenders. Requiring 15% of units to be affordable in order to receive the abatement would be even more onerous, Dougherty said.

“We were just looking at different ways to try to skin the cat to figure out a way that we can say, ‘Look, this is the way you should do it to make it work.’” Dougherty said. “Unfortunately, there's no clear-cut answer.”

Falcicchio countered that the Housing in Downtown program includes an abatement, whereas IZ is a mandate without a corresponding incentive. But he also acknowledged that a variety of tools would be needed in order to meet the goals. 

In January, the mayor’s comeback plan raised the possibility of seeking amendments to the federal Height Act, and Falcicchio confirmed that his office was in the early stages of identifying a proposal it could bring to Congress with the “unified” support of District leaders.

He said DMPED is considering the creation of several “residential nodes” in downtown D.C. where the District would request the height limit be raised to 160 feet, which is currently only allowed on select blocks along the northern side of Pennsylvania Avenue.

Developers widely support allowing greater density for blocks with vacant or underutilized office, as it would allow for more revenue-generating space to be added to currently maxed-out properties. Falcicchio is also betting residents will pay a premium for prime views and access to D.C.’s monumental core.

The District is also exploring raising the height limit for other neighborhoods outside of the central business district or the L’Enfant Plan, which includes most of central D.C.

“What we're saying is ... if we create these residential nodes, is that a place where we can tinker with the Height Act so we go from 130 feet to 160 feet to make it on par with the highest point on Pennsylvania Avenue in order for us to yield a change in use to residential?” Falcicchio said. “We're all just starting the analysis.”

There are other tools the deputy mayor’s office is also employing. Falcicchio said his office is in the final stages of disbursing more grants from the Vitality Fund, a $10M tool to incentivize businesses to locate downtown, and he expects they will exceed the office’s goal of securing 100K SF of office tenants through the program. 

That fund, though, was authorized with two funding tranches, both of which have been disbursed. Falcicchio said he didn't want to get ahead of the mayor’s budget proposal, which is slated to be released March 22, but he expects to have more discussions about re-creating the success of that program.

“With the amount of vacant office space that we have, we do think we’re going to have to invest more,” Falcicchio said.