‘Shocking’ Plunge In Office Values Reveals Depth Of D.C.’s Looming Economic Crisis

It’s not easy to watch $64M evaporate. 

But that’s what Doug Donatelli did last month when he and his partners decided that selling a downtown D.C. office building for $36M that they had bought for $100M was the smarter decision than putting more money into the asset. 

“We would love to have seen a signal from the market telling us it made more sense to make the investment than to bail, but that signal was never there,” said Donatelli, co-founder of DSC Partners.

The sudden disappearance of nearly two-thirds of the building’s value was difficult for Donatelli, the former CEO of First Potomac Realty Trust and a 35-year veteran of D.C.’s office market. He had seen a clear path to adding value when he bought it in 2018, but his firm is far from alone in mistiming the market.

A string of investors has been wiped out in recent months by the most dramatic disruption to the city’s office market most commercial real estate professionals have ever seen. 

“It’s shocking, but it’s reality,” Donatelli said. 

Several building sales in recent weeks have peeled back the curtain on just how hard office values have been hit by remote work and the trend of companies downsizing and fleeing to newer buildings. 

After a lengthy freeze in sales transactions due to rising interest rates and cautious capital sources, this wave of deals shows that owners have capitulated — accepting that many of their buildings are worth no more than the value of the dirt they sit on — and they are deciding to cut their losses. 

The properties sold in recent weeks have all traded for less than 40% of their previous sale prices, and there is concern that values have further to fall.  

“From a longtime market participant, it is astounding what you see some of these deals trading for,” said Solitude Cove Capital founder John Kevill, the former president of U.S. capital markets for Avison Young. “What is to me more interesting is even at that level, I think some of these deals are overpriced.”

Bisnow spoke to 15 D.C. office experts and city leaders for this story, and they described a market facing an existential problem without precedent. They say the crisis is just beginning to unfold, as more office owners this year will decide to sell at dramatic losses.

This will not only lead to the loss of hundreds of millions of dollars that investors and lenders put into buildings — it is also expected to blow a massive hole in the city’s budget. 

The rapid deterioration of property values comes at an alarming time for the nation’s capital, as local leaders grapple with coinciding crises of rising crime, depressed foot traffic, low transit ridership and the loss of economic anchors like the Capitals and Wizards sports franchises. 

“There are enormous implications for everybody,” said Tracy Hadden Loh, a Brookings Institution fellow who serves on the board of the Washington Metropolitan Area Transit Authority. “We’re talking about millions, trillions of dollars.”

The District of Columbia has 126M SF of office space across 650 buildings, according to CBRE. Roughly 300 of those buildings are classified as Class-B and C. Those buildings, which total 33M SF, have largely been deemed worthless by the market, their only value lying in the land beneath them where something else could be built. 

Nina Albert, D.C.’s deputy mayor for planning and economic development, told Bisnow that city leaders realize this disruption in the office market is “more extreme” than past cycles, and the District is working to encourage the repositioning of assets. 

But to convert or tear down a building for redevelopment, investors say prices must fall even more to make the math work. And that fall isn’t possible without huge financial pain to the city's real estate industry and its property tax revenues.

The depth of the plunge is expected to become a battle of its own, as landlords and local assessors argue over how much a property that hasn’t sold is worth.

That fight will begin to unfold in the coming weeks: D.C. is expected to release its annual tax assessments by March 1, then landlords have one month to file an appeal. Those appeals will undoubtedly be widespread, and many will have to be adjudicated by the courts. 

“We’re buckling in,” said Grant Steinhauser, principal at property tax consulting firm Ryan. “We expect a lot of these appeals to be long, hard fights.”

The Fall

The ride for office owners over the last year has felt less like a roller coaster and more like the Tower of Terror.

Landlords have known their property values were in free fall as vacancy soared, interest rates spiked and investors soured on the sector, but they didn’t know when the drop would stop. 

A lack of sales for months left D.C. with few examples to show how the market was valuing office buildings, but a series of year-end trades has now revealed where the market’s floor is: roughly a third of a property’s pre-pandemic price.

“We’ve certainly never seen [values] evaporate this quickly,” said Kyle Luby, head of the D.C. office for brokerage firm Stream Realty. “It just seems like a perfect storm of struggles in the leasing market, increases in rates, rising construction cost. It’s just this whole whirlwind.”

The recent string of D.C. deals, largely older buildings in the downtown area, illustrates how far values have fallen. 

• 1850 M St. NW sold out of foreclosure in August for $37.5M, down 66% from its 2017 price of $109M.

• 1201 Connecticut Ave. NW sold out of foreclosure in November for $21.2M, down 71% from its 2019 price of $73.6M. 

• 1250 Eye St. NW sold for $36M last month, down 64% from its 2018 price of $100M.

• 1101 14th St. NW sold for $18.2M early this month, down 70% from its 2017 price of $62M.

• 919 18th St. NW sold early this month for $16.3M, down 69% from its 2013 price of $53M. 

When office investors buy a building, they typically take out a loan for at least 50% of its value. When they are forced to sell for around a third of that previous price, that means the entirety of their equity in the deal is erased, and the lender also takes a sizable loss. 

“We’re in the early stages of how much value has been destroyed, how much value has been lost,” Donatelli said. 

The average price of Class-A office buildings in D.C. fell 43% from its 2018 peak to $339 per SF last year, and the combined Class-B and C segments fell 44% from their 2020 peak to $254 per SF last year, according to Newmark data.

Several older buildings over the last year have sold for around $150 per SF. Brokers see some older midblock buildings that were once worth over $300 per SF now on the market for around $100 per SF, a price that values the buildings themselves as basically worthless. 

“Essentially, they’re valuing it at the dirt level for that stuff,” Newmark Executive Managing Director James Cassidy said.

Part of the reason values have fallen so far — in addition to the high vacancy, lack of leasing demand and elevated interest rates — is that sellers needing to unload a building have had a hard time finding a buyer. 

“Our market’s been fundamentally broken over the last 12 months because there’s not a lot of equity to buy the asset class,” Cassidy said. 

The first nine months of 2023 saw just $444M of office sales volume in D.C., well below the historical average, according to Newmark. But the final three months saw a spike in deals, with $837.5M in assets trading hands, the busiest quarter for office sales in two years. 

This string of transactions has continued into January. Cassidy said it has been helpful for the market in creating comparables for owners to value their properties, and the publicity around the deeply discounted deals has brought in some opportunistic investors.

More deals have begun to close because of the shifting attitude of sellers, who one year ago had a wait-and-see approach with some optimism that the capital markets could improve, Kevill said. But now, with interest rates remaining high and the cost of holding and leasing their buildings making it a risky bet, many have realized the smartest decision is to cut their losses.

“We’re on a slow, steady march to that realization for many sellers,” Kevill said. 

Stonebridge principal Doug Firstenberg, a longtime D.C. office owner who has developed more than 10M SF of properties throughout the region, came to this realization when his firm, along with joint venture partner Rockwood Capital, sold 7500 Old Georgetown Road in Bethesda last month for $29.9M. The price for the building, which long served as Clark Construcion's headquarters, was roughly 22% of what they paid for it in 2019. 

Firstenberg declined to comment on that deal, but he said owners across the market are beginning to accept lower prices for their assets.

“We have a product type that fundamentally is never going to be the same,” he said. “Overall demand is down, and the type of demand has fundamentally changed. That is a huge implication for where values are going. It’s not just where rents are down. You can’t fill these buildings. They don’t meet the needs of the tenants.”

Several of the deals have come from lenders selling properties after foreclosing on buildings where owners defaulted on their loans. MRP Realty Associate Vice President Nick Gordon said most lenders aren’t set up to hold large amounts of office assets on their books and have immediately initiated sale proceedings, a trend he expects to continue this year. 

“If you’re forced to take these back and you can’t handle them, you have to sell for whatever the market gives, and that’s just creating this situation where they’re taking what they can get,” he said. 

The string of sales has started to draw the attention of city officials and appraisers, who will soon be battling over the value of hundreds of office assets that haven’t traded hands.

“This is the most drastic, most dire situation we’ve seen from the D.C. office market,” Ryan’s Steinhauser said.

‘Enormous Implications For Everybody’

As it becomes clear just how far office values are falling, a better picture is also forming of just how deep the ramifications could be for all Washingtonians.

A significant share of the District's budget is on the line. About 15% of the city’s revenue comes from commercial properties, according to the Urban-Brookings Tax Policy Center. Sinking revenue means less money for everything from police officers to schools to the Metro and pothole repair. 

“Everyone stands to lose,” D.C. Policy Center Executive Director Yesim Sayin said. “Tax revenue pays for government support and services that all D.C. residents need or use. So that is a very, very disconcerting, very nerve-wracking picture for me.”

In February, D.C.’s Office of the Chief Financial Officer released a letter warning the city would lose $464M in tax revenues from real estate between 2024 and 2026. 

“The expansion of remote work, coupled with higher interest rates, pose a serious long-term risk to the District’s economy and its tax base,” Chief Financial Officer Glen Lee wrote in the letter.

The office market’s impact on city revenues is posing a challenge across the U.S., but D.C. is especially vulnerable, Brookings’ Loh said, because it has a higher share of commercial properties compared to residential, and those commercial properties are taxed at a higher rate than housing.  

“The ramifications for D.C. are particularly severe,” Loh said.

In its most recent revenue estimate, the OCFO last month projected commercial revenues would drop every year for the next four years. While the District received nearly $1.7B in tax revenues from occupied commercial buildings in 2022, the OFCO predicted that figure would be $136M lower in 2027. The report says continued office market decline would pose an added risk to the outlook.

“If you look at the CFO’s forecast, you can see that we’re feeling the pain,” Loh said. “This isn’t a subject that’s up for debate.” 

But the costs to the city don’t stop at commercial tax revenues. Loh said it will be important to watch the “second-order effects” from the office disruption, like a decline in fares for the transit system and falling downtown sales tax revenue, factors that could additionally hinder D.C.’s finances.

WMATA is facing a $750M budget shortfall for fiscal year 2025. The transit system laid out a stark picture in December, saying that without more investment, the region could expect drastic cuts to rail and bus service, fare hikes and layoffs. Loh said the system’s health is especially dependent on office traffic.

“The D.C. Metro’s share of trips that are journey-to-work-related is higher than any other transit system in the United States,” she said.

‘We Are Buckling In’ 

In a few weeks, owners will find out how much the city thinks their properties are worth. 

On March 1, D.C. will send out assessment notices to owners, thereby conveying how much they are expected to pay in property taxes. That kick-starts a typically routine appeals process — owners fighting for lower values by presenting updated data on what has occurred at their properties and in the market. 

But in recent years, the spread between how owners believe their properties should be valued and what the government thinks has been getting wider as the office market falls into more distress. This year, owners are bracing for an especially high-stakes battle.

“[When] the new assessments come out, everyone's going to be looking for them, everyone’s going to have their eyes open,” Steinhauser said. “Certainly, I expect there to be some uproar if there isn’t a pretty proactive step taken by the assessor’s office to lower office values.”

The vast majority of owners of large office buildings appeal their assessments every year, Steinhauser said. But this year, landlords are expected to seek massive discounts, freshly armed with a cache of sales data to justify just how far values have plunged. 

Last year, office valuations were lowered by between 5% and 10%, Steinhauser said.

“Owners thought value should have gone down pretty aggressively last year, and they didn't,” he said. 

This year, with office landlords facing record-high vacancy and more distress than any other city in the country, Steinhauser said owners will be more concerned with their tax bills and will seek reductions of 30%, 40%, 50% or more. 

“They're going to be looking for something drastic,” Steinhauser said.

The big variable that will affect how far assessments will drop is what assessors determine to be each office class's capitalization rate, the measure of return investors can expect on the money put into the properties.

“What is at stake right now, as some of these buildings start to transact at these very low dollar valuations, is this opens up a question for every kind of office building, whether it’s commodity or trophy: Is the cap rate changing for office as a product?” Loh said. “This is an open question that people are going to be disputing.” 

Even in a year like this, Steinhauser said, it is unlikely that the District would do anything radically different with property assessments. 

“I don't think that the assessor is going to proactively reduce values by 50%. That would be drastic, and we really never see a change that drastic from one year to the next,” he said. “But certainly, some sort of proactive reduction on the assessors' part could be expected.” 

Regardless of how much assessed office property values drop this year, it is clear they are moving in a downward trajectory that will be difficult to recover from. For longtime D.C. office owners like Donatelli, it is unlike any prior cycle they have seen in their careers.  

“It’s going to be painful, really painful, especially for people who are fully invested in office in D.C.,” Donatelli said. “It’s going to be really painful for the city government. The tax revenues they've depended on from commercial real estate are really threatened.”

Climbing Out Of The Hole

D.C. leaders say they recognize the problem and are taking action.

Mayor Muriel Bowser’s administration is betting that filling downtown with apartment buildings is its path to recovery, creating mixed-use neighborhoods rather than the traditional office-centric district that exists now.

The city has a goal of housing 15,000 new residents downtown by 2028, in part by incentivizing developers to turn obsolete office buildings into housing. 

In July 2022, Bowser signed into law a 20-year tax abatement program for owners that add housing, 15% of which must be affordable, to their properties in a designated portion of downtown. The program allocated $2.5M of annual funding from 2024 through 2026 and $6.8M in 2027. The Mayor’s FY 2024 budget increased funding to $41M for tax year 2028.

Last summer, Bowser announced a forthcoming Downtown Action Plan that would provide a framework to transform the heart of the District by spurring new development. Albert, the deputy mayor, said the plan will be rolled out in the coming months.

“There's a doom-and-gloom perspective, which assumes that nobody's doing anything,” she told Bisnow. “What we are doing is making sure that we position ourselves so that as the market rebounds, that we are well-positioned as a city to rebound with it.”

But to achieve the city’s vision of turning offices into housing en masse, developers say values will have to drop even further, creating more short-term pain for office owners and city revenues. 

Gordon said MRP looked at buying older D.C. office buildings last year to potentially convert into apartments, but the prices sellers wanted were still too high.

“Some of the deals that got done were at numbers that didn’t pencil to us,” he said. “Whereas we think the opportunities that will are coming.”

In the meantime, Bowser is asking owners not to give up on downtown. Speaking at an event hosted by the D.C. chapter of Commercial Real Estate Women this month, the mayor said she recognizes there is “a lot of angst” among property owners about values, but the long-term trend shows that investing in downtown is a moneymaker.

“It's true, we're having a few soft years, but they will go up,” she said. “We are asking the property community downtown: Hold on. Stay invested.”