Commercial real estate slump forces DC developers to turn downtown offices into housing

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The collapse of the commercial real estate market in the district during COVID-19 has prompted some landlords to convert empty downtown office buildings into housing.

The developers, backed by signals of support from the town hall, have already converted or plan to convert several former government office buildings into apartments.

Emily Hamilton, a senior researcher at George Mason’s Mercatus Center free market think tank, said conversions could solve commercial vacancy problems and housing affordability problems “at the same time” by allowing the construction of housing in current commercial areas.

“Even before the pandemic, commercial vacancy rates were higher than residential vacancy rates due to tighter limits on housing construction,” Ms Hamilton said. “Today, with more people working remotely and shopping online, the difference is even greater in many places.”

Vacant office and retail space with “for rent” signs have become common sights on Capitol Hill during the pandemic.

According to Newmark Research’s latest report on the office market in the district, commercial vacancy increased in the fourth quarter by 18.6% over the previous 12 months.

Newmark said ongoing office construction is also keeping vacancy high: He expects the DC area “to deliver 4.8 million square feet of new and renovated office products by the end of of 2022”.

On January 28, the DC government gathered feedback from commercial property owners on how the city could help them convert vacant office space into affordable housing and workforce housing.

City officials say a conversion program that would increase tax revenue by $5 and $10 per square foot could be implemented within the year.
The city reports that its central business district is 92% commercial and 8% residential, with a vacancy rate approaching 17% in the third quarter of 2021.

However, the revenue gain only works if vacancy rates remain high. The nonprofit DC Policy Center reported Oct. 7 that property values ​​and tax rate differentials show that “every square foot of commercial office space in inner cities creates 2.5 times the tax land to each square foot of multi-family residential space”.

The city’s two largest users of commercial real estate, the federal government and law firms, have both reduced their footprints in recent years.

In the Southwest, the former U.S. Coast Guard headquarters at Buzzard Point was recently converted into 480 luxury apartments, and developer Jair Lynch plans to replace the former Department of Agriculture office on Maine Avenue with a 13+ story penthouse building that offers 530 high-end apartments.

Last month, Lincoln Property Company and Cadillac Fairview Corp. bought the former Department of Homeland Security headquarters in the Northwest for $82 million after previous owners scrapped renovation plans when the commercial market declined. The 51-year-old, 12-story office building, vacated in 2018, will become a 264-unit residential property with underground parking.

Morgan Knull, a real estate agent who has sold renovated residential properties in the district for 20 years, said an Obama-era General Service Administration warrant contributed to the conversions. This rule required federal agencies to reduce square footage even before the pandemic, resulting in a reduced commercial footprint for government tenants when they renewed their leases.

“This had a ripple effect on other commercial users as downtown retailers faced reduced daytime foot traffic due to workers not coming to downtown offices. -city,” Mr. Knull said.

Even before the pandemic, many DC law firms were relocating offices to suburban Maryland and Virginia. Now some of these new offices are closed as more employees continue to work from home thanks to COVID-19.

Last year, Lowe and USAA Real Estate renovated two office towers in Alexandria’s Park Center into 435 residential apartments.

Office buildings that remain open are often underutilized. Office swipe card provider Kastle Systems reported in an analysis of its security data of 41,000 buildings in 47 states that DC’s weekly office occupancy rate was just 27.4% on January 26, well below a 31.2% average across 10 cities.

Hans Dau, CEO of consulting firm Mitchell Madison Group, said the district has always resembled similar towns with high crime rates in their low commercial occupancy. But he added that Washington isn’t the only city with underutilized commercial space.

“Office occupancy rates will never return to pre-pandemic levels,” Dau said. “Interestingly, some of the deadliest cities such as San Francisco, Chicago and New York are at half the occupancy levels of cities such as Houston, Austin and Dallas.”

Peter Earle, an economist at the libertarian American Institute for Economic Research in Massachusetts, said cities like the district would be wise to reduce their commercial footprint this year as fewer companies seek to rent space.

“That’s because a significant number of companies have decided, for various reasons, that real shared physical office space is an unnecessary expense and possibly a liability,” Earle said.

Brian Marks, an economist who teaches at the University of New Haven, agreed.

“I believe 2022 will be the year of a new price equilibrium in commercial real estate as we move towards a post-COVID-19 world that reflects changes in the use of space,” said Mr Marks. “We can expect some improvement in rental prices as economic growth continues and employment improves, but weaknesses will remain.”

But Charles Mizrahi, a former Wall Street trader who founded Alpha Investor, said it was premature to neglect the commercial real estate market.

“Vacant malls are springing up in schools, churches and medical centers. Department stores and other large spaces are being converted into warehouses,” Mizrahi said. “Commercial real estate continues to innovate and find ways to bring in rents.”

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