Many office buildings in D.C. are now worth no more than the land they sit on.
The values of older commercial buildings in D.C. have been falling over the last few years as the pandemic-induced remote work shift led many companies to downsize their footprints and to consolidate into newer buildings.
As older buildings have become vacant, and as the prospects for redeveloping them have become more difficult, properties have traded for far below what local real estate executives had ever previously envisioned.
The bright side for the city, investors said Thursday at Bisnow’s D.C. State of the Market event, is that values can’t fall any further.
Bisnow/Jon Banister
Zelman & Associates’ Mark Franceski, Bernstein Management Corp.’s Terra Weirich and Tishman Speyer’s Dan Dooley at Bisnow’s D.C. State of the Market.
“I think we’re at the bottom,” Bernstein Management Corp. Senior Vice President of Investments Terra Weirich said at the event, held at 600 13th St. NW.
“When office values are closer to land value, even lower in some cases than what we thought land used to be worth, I think we’re at the bottom.”
But just because values have hit bottom, Weirich said, that doesn’t mean they are going to shoot back up.
“The question is, ‘How long are we going to stay here?'” she added. “It is hard to see major drivers for significant rent growth or significant cost reduction for development to make sense again.”
A series of sales starting in 2023 showed many older buildings were trading for about a third of their prior sales price, and pricing was reaching as low as $150 per SF, according to a Bisnow analysis in January 2024.
At the time, brokers said some buildings were on the market at an even lower level of $100 per SF. Investors at Thursday’s event said sales have now closed around that level.
That is a fraction of the 2019 average for Class-B and C office sales in D.C. of $406 per SF, according to Newmark.
Given that little demand exists to use these antiquated office buildings in their current state, their value comes from their location and the ability to convert them to another use or to renovate them to higher-end office space.
But it is difficult to make the financial math of those repositioning deals work. To explain this dynamic, PRP Real Estate Investment Management Chief Investment Officer Jon McAvoy laid out a hypothetical office repositioning deal.
Bisnow/Jon Banister
Pillsbury’s Jamie Bobotek, CBRE’s Joe Coleman, Zelman & Associates’ Mark Franceski, Bernstein Management Corp.’s Terra Weirich, Tishman Speyer’s Dan Dooley, Hines’ Andrew McGeorge and PRP’s Jon McAvoy.
If a buyer acquires an obsolete office building at $100 per SF and wants to renovate the property, he said the construction costs could reach as much as $300 per SF, a figure other panelists corroborated. And then, as that company looks to sell the renovated asset, it would want to make a return for investors of at least $100 per SF, meaning the property would need an exit price of at least $500 per SF.
The problem, McAvoy said, is the D.C. office market hasn’t been strong enough to support that kind of exit price.
“We’re not seeing the light at the end of the tunnel on that just yet,” McAvoy said. “The only way to make that possible is business growth, population growth and job growth.”
As the best-in-class segment of the office market has tightened, demand has emerged from big law firms seeking developers to tear down buildings and construct new offices for them. But McAvoy said the construction costs for a new office building may be prohibitively expensive.
“There’s not enough trophy, and folks can’t afford to build more because it costs $1K per SF or more to build something to put a law firm into,” he said. “So we find ourselves structurally stuck is the bigger issue.”
With how far prices have fallen, McAvoy suggested the city should buy some of the obsolete office properties and use them for public services.
“Everyone complains we don’t have enough schools, we don’t have better schools, and we don’t have places for our kids to play sports,” he said. “Well, now is the opportunity for the city to step up and retake some of this land and do something productive with it. So I would love to see that happen.”
Hines Senior Managing Director Andrew McGeorge also suggested the city could raze buildings to create more open, green space downtown.
“There are going to be the groups that do the conversions, or it could be a really nice park,” he said. “Those are the options. It’s going to be a very slow getting rid of that part of the market.”
Whether it is the city buying a property for public use or a developer for repositioning, now might be the best time to move forward with a deal, the panelists said.
“This is an opportunity,” Tishman Speyer Managing Director Dan Dooley said. “We’re going to bounce off this $100-per-SF land basis, which makes residential viable, and then that opportunity closes.”
A bounce back is poised to happen eventually because of how much the office development pipeline has dried up, said Joe Coleman, a CBRE senior vice president who specializes in downtown D.C. office leasing. While there hasn’t been much net demand growth in the market, supply has been falling due to slow construction and conversion of offices to other uses.
“We’ve stopped digging,” Coleman said. “We have a very limited supply of deliveries with development stopping, so that’s setting the stage for a rebound.”