The collapse of the commercial real estate market in the District during COVID-19 has some property owners looking to convert empty downtown office buildings into housing.
Developers buoyed by signals of support from city hall have already converted or plan to convert several former government office buildings into apartments.
Emily Hamilton, a senior fellow at George Mason’s Mercatus Center free-market think tank, said the conversions could solve commercial vacancy problems and housing affordability issues “at the same time” by permitting housing construction in current commercial zones.
“Even prior to the pandemic, commercial vacancy rates were higher than residential vacancy rates due to more binding limits on housing construction,” Ms. Hamilton said. “Today, with more people working remotely and shopping online, the difference is even larger in many places.”
Vacant office and retail spaces with “for lease” signs have become common sights on Capitol Hill during the pandemic.
According to Newmark Research’s latest office market report on the District, commercial vacancy rose during the fourth quarter by 18.6% over the previous 12 months.
Newmark said ongoing office construction is also keeping vacancies high: It projects the D.C. area will “deliver 4.8 million square feet of new and renovated office product by the end of 2022.”
On Jan. 28, the D.C. government collected feedback from commercial property owners on how the city could help them convert vacant office space into affordable homes and workforce housing.
City officials say a conversion program that boosts 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 that was approaching 17% in the third quarter of 2021.
However, the revenue gain only works if vacancies remain high. The nonprofit D.C. Policy Center reported Oct. 7 that property values and tax rate differentials show that “each square foot of commercial office space in the downtown areas creates 2.5 times the property tax compared to each square foot of multifamily residential space.”
The city’s two largest users of commercial real estate, the federal government and law firms, have both decreased their footprint in recent years.
In Southwest, the former U.S. Coast Guard headquarters at Buzzard Point was recently converted into 480 luxury apartments, and developer Jair Lynch is planning to replace the former Department of Agriculture office on Maine Avenue with a 13-story-plus penthouse building that offers 530 high-end units.
Last month, Lincoln Property Company and Cadillac Fairview Corp. bought the former Department of Homeland Security headquarters in Northwest for $82 million after the previous owners abandoned plans to renovate it when the commercial market declined. The 51-year-old, 12-story office building, vacated in 2018, will become a 264-unit residential property with an underground parking garage.
Morgan Knull, a realtor who has sold refurbished residential properties in the District for 20 years, said an Obama-era General Services Administration mandate has contributed to the conversions. That rule required federal agencies to downsize square footage even before the pandemic, leading to smaller commercial footprints for government tenants when they renewed their leases.
“This has had a trickle-down effect on other commercial users, as downtown retailers faced declining foot traffic during the day due to workers not commuting to downtown offices,” Mr. Knull said.
Even before the pandemic, many D.C. law firms were relocating offices into suburban Maryland and Virginia. Now some of those new offices are being shuttered 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 from 41,000 buildings in 47 states that D.C.’s weekly office occupancy rate was just 27.4% on Jan. 26, well below a 10-city average of 31.2%.
Hans Dau, CEO of the Mitchell Madison Group consulting firm, said the District has always resembled similar cities with high crime rates in their low commercial occupancy. But he added that Washington is not the only city with underused commercial space.
“Office occupancy rates will never go back to pre-pandemic levels,” Mr. Dau said. “Interestingly, some of the more crime-ridden 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 decrease their commercial footprint this year as fewer businesses seek to lease space.
“That is because a significant number of companies have decided for various reasons an actual shared, physical office space is an unnecessary expense and perhaps a liability,” Mr. Earle said.
Brian Marks, an economist who teaches at the University of New Haven, agreed.
“I think 2022 will be the year for a new price equilibrium in commercial real estate as we move toward a post-COVID-19 world that reflects changes in space utilization,” Mr. Marks said. “We can expect some improvement in rental prices as economic growth continues and employment improves, but weaknesses shall remain.”
But Charles Mizrahi, a former Wall Street trader who founded Alpha Investor, said it’s premature to discount the commercial real estate market.
“Vacant malls are being reborn into schools, churches, and medical centers. Department stores and other large spaces are being converted into warehouses,” Mr. Mizrahi said. “Commercial real estate continues to innovate and find ways to keep the rent coming in.”