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The Increasing Levels of Vacant Office Space: The Achilles’ Heel of DC's Office Market

Daniel Muhammad
Monday, July 15, 2024 - 4:00pm
Image 1: Thumbnail stacked bar chart titled 'Vacant Office Space in DC by Class, 2005–2023 (in millions of square feet).' Class A (dark purple) and Class B (light purple) vacant space are stacked by year. Total vacant space started at 7.2M sq ft in 2005, dipped after 2006, climbed steadily, and reached 18.1M sq ft in 2021 before spiking to 26.5M sq ft in 2023. Class B vacancy increased sharply after 2021.

When a city's commercial office buildings are experiencing a trend of increasing net vacant space over the long term, it signifies a growing lack of demand for office space in the market. This surplus of available office space can prompt a decline in property assessment values as the buildings produce less net income and are considered less sought-after assets. In this context, fewer investors/potential buyers may be less inclined to purchase these buildings, reducing sale prices for the few transactions that do occur. These buildings' overall market value diminishes with lower sale prices and decreased demand.

The following analysis illustrates how the recent trend of rapidly increasing levels of vacant office space in DC is impacting the value of several hundred large office buildings. The analysis identifies more than 500 high-value, large commercial office buildings in DC, and finds that at least 86 percent of them are expected to lose value at some point between 2020 and 2025. Among these buildings expected to lose value, we estimate a total loss of more than $12 billion in building value. The declining value of these buildings as well as decreased sales transactions are affecting commercial property and deed tax collections.

Shrinking Office Demand Drives Vacancy Rates Higher

One of the major problems plaguing the District of Columbia office market is the growing amount of vacant office space. Between 2020 and 2023, vacant office space increased by 8.4 million square feet (msf) or 46.2 percent. (Figure 1)

Figure 1

Figure 1: Stacked bar chart titled 'Vacant Office Space in DC by Class, 2005–2023 (in millions of square feet).' Class A (dark purple) and Class B (light purple) vacant space are shown for each year. Total vacant space was 7.2M sq ft in 2005, remained relatively stable through 2019, then rose to 18.1M sq ft in 2021 and accelerated to 26.5M sq ft in 2023, with Class B vacancy accounting for the majority of the post-pandemic increase.    

Source: CoStar

    

Initially, Class B office space experienced a faster increase in vacancy rates than Class A office space. However, due to the surge of remote work starting in 2020, new office leases across both sectors required, on average, 13 percent less space. Consequently, the total space demanded by all office tenants decreased by 5.2 million square feet (3.8 percent) between 2020 and 2023, the most significant decline in total space in the past two and a half decades (Figure 2).

Figure 2

Figure 2: Grouped bar chart titled 'Change in the Demand for Leased Office Space by Class, 2016–2023.' Green bars show 2016–2019 changes; blue bars show 2020–2023 changes. Class A: +7.8% (pre-pandemic) vs. -1.7% (post-pandemic). Class B: -2.9% vs. -7.5%. Both Classes combined: +3.6% vs. -3.8%. The chart illustrates a clear reversal from pre-pandemic demand growth to post-pandemic demand contraction, with Class B experiencing the steepest decline.    

Source: CoStar

    

While the decreasing demand for space is a primary cause of the growing amount of excess office space in recent years, this issue has been further exacerbated by the continuous, albeit modest, expansion in the net supply of office space (Figure 3). This increase in supply from 2020 to 2023 has been exclusively in Class A properties, with Class B space decreasing over the same period. Consequently, the city's direct vacancy rate rose from 11.7 percent in 2020 to 15.6 percent in 2023.

Figure 3

 
Figure 3: Dual line chart titled 'Annual Change in the Demand and Supply of All Leased Space, 2016–2023.' Demand (orange) and Supply (green) are shown as annual percent changes. Supply grew steadily (0.7%–2.6% per year). Demand tracked supply closely through 2019, peaking at +1.7% in 2019, then turned negative: -1.7% in 2021, -1.0% in 2022 and 2023. The divergence between growing supply and declining demand reflects the structural shift away from office space after 2020.    

Source: CoStar

    

The supply of office space is the total square footage of city office space in privately owned, existing, and fully constructed class A and B commercial office buildings that are leased, for lease, or for sale.  The demand for office space is the total square footage of space for the same set of buildings that is under a lease obligation and physically occupied by a tenant.

The Primary Source for Declining Values

As vacancy rates in the District of Columbia office market have increased, another consequential trend has emerged: declining property values. This decrease is the result of various factors, including the notable increase in vacant office space.

Table 1 shows the economic situation of all fully taxable office buildings with an assessment value of more than $10 million in 2020. Of the 572 office buildings, the top 20 percent highest valued buildings (114 buildings) accounted for half of the $66.1 billion in assessed value and $1.219 billion in total real property taxes paid by all that year.

Table 1: Table titled 'Table 1: The Highest Valued Large Commercial Office Buildings in DC, 2020 ($in thousands)' dividing 572 properties into five quintiles by assessment value. Quintile 1 (114 properties): $1.9B total assessment, $16.6M average, $35.2M total RPT, $308.6K average RPT. Quintile 2 (115 properties): $4.6B total, $40.2M average, $86.5M total RPT, $752.3K average RPT. Quintile 3 (114): $9.5B total, $83.4M average, $178.2M total RPT, $1.6M average RPT. Quintile 4 (115): $16.7B total, $144.9M average, $311.2M total RPT, $2.7M average RPT. Quintile 5 (114): $33.4B total (50.6% of all), $293.2M average, $607.7M total RPT, $5.3M average RPT. Grand total: $66.1B assessed value, $1.2B real property tax. Data Source: ORA analysis of OTR's annual real property tax data for TY 2020.

However, by 2023, 85.3 percent of these buildings experienced a decrease in value, causing them to lose a total of $6.9 billion (11.9 percent) in value and pay $143.2 million less in real property taxes in 2023 (Table 2).

Table 2: Table titled 'Table 2: Large Commercial Office Buildings with Reduced Assessment Values from 2020 to 2023 ($in thousands)' showing 488 properties that declined in value, grouped by quintile. Total assessment value declined by -$6.9B (-11.9%), and real property taxes declined by -$143.2M (-13.3%). Quintile 1 (87 properties): -$217.1M (-14.9%), -$4.5M RPT. Quintile 2 (99): -$599.2M (-15.4%), -$12.5M RPT. Quintile 3 (99): -$1.0B (-12.6%), -$21.4M RPT. Quintile 4 (99): -$1.4B (-10.1%), -$27.8M RPT. Quintile 5 (104): -$3.6B (-12.0%), -$76.9M RPT. Data Source: ORA analysis of OTR's annual real property tax data for TY 2020 and TY 2023.

In Figure 4, you can see the real property taxes paid by large commercial office buildings with an assessment value of more than $10 million in 2020 (LCOBs) as a proportion of real property taxes paid by all properties in the District from 2005 to 2023. The percentage of taxes paid by LCOBs reached its peak in 2015 at 47.9 percent and has been steadily declining since then. In 2023, LCOBs only accounted for 37.8 percent of all property taxes paid to the District, as the assessed value of LCOBs grew by just 4.1 percent from 2015 to 2023, while residential property grew by 58 percent.

Figure 4

Figure 4: Line chart titled 'Property Taxes for Large Commercial Office Buildings as a Share of Property Taxes Paid by all City Properties' from 2005 to 2023. The share started at 43.7% in 2005, grew to a peak of 47.9% in 2015, then declined steadily to 37.8% in 2023 — a significant drop reflecting falling office property values relative to the rest of DC's tax base.    

Source: ORA analysis of OTR's annual real property tax data for TYs 2005-2023

    

Additionally, the steady decline illustrated in Figure 4 is expected to persist, with 492 (86.0 percent) of the city’s most valuable LCOBs projected to experience an additional 10.8 percent decrease in value between 2023 and 2025(Table 3). The FY 2025 assessment values are currently proposed assessments and have not yet been through the appeals process, meaning the final decrease between FY23 and FY25 could be higher than shown in Table 3. These assessment values come from our Real Property Tax Administration.

Table 3: Table titled 'Table 3: Large Commercial Office Buildings with Reduced Assessment Values from 2023 to 2025 ($in thousands)' showing 492 properties grouped by quintile. Total assessment value declined by -$5.4B (-10.8%), with an average reduction of -$11.0M per property. Quintile 1 (96 properties): -$229.8M (-16.0%). Quintile 2 (102): -$697.9M (-19.4%). Quintile 3 (102): -$1.0B (-13.2%). Quintile 4 (99): -$1.6B (-11.8%). Quintile 5 (93): -$1.9B (-7.9%).

Source: ORA analysis of OTR's annual real property tax data for TYs 2023 and 2025

If we combine this projected loss in value with already realized losses, 86 percent or more of the city's highest-value LCOBs (large commercial office buildings) could lose a total value of $12.3 billion at some point between 2020 and 2025 due to a decrease in demand for leased space (as shown in Figure 5).

Figure 5: Stacked bar chart titled 'Figure 5. Reduction in Assessment Values of LCOBs (Large Commercial Office Buildings) from 2020–2023 and 2023–2025 ($in millions).' The bar shows two stacked periods of decline: 2020–2023 saw a reduction of -$6,908.9M (blue, upper portion), and 2023–2025 saw a further reduction of -$5,420.8M (purple, lower portion), for a combined cumulative decline approaching -$12.3B in assessed value.    

Source: ORA analysis of OTR's annual real property tax data for TYs 2023 and 2025

    

Note that this loss does not account for buildings with increasing values during this time, which will offset some of this loss. When we look at the entire cohort of 572 high-value office buildings we identified, assessment records indicate their total value is expected to decline from $66.1 billion in 2020 to $55.9 billion in 2025. This represents a loss of $10.2 billion, or 15.4% of their total value. The 2025 assessment values are subject to appeal and could drop further.

Decreased Interest in Buying DC Office Buildings and the Impact on the Deed Tax

The difficult market conditions appear to be contributing to a decline in investor confidence, prompting property investors and potential buyers to hesitate or even abandon their pursuit of owning city office buildings. Consequently, the diminishing interest in purchasing office properties more ostensibly reflects the challenges confronting the city's commercial real estate sector.

Table 4 shows that from 2020 to 2023, there have been fewer market sales and more foreclosures than in the previous four years. (Six of the market sales in 2020 to 2023, entailed converting office buildings to primarily residential use.)

Table 4: Table titled 'Table 4: Large Commercial Office Building Market Sales and Property Transfers, Years 2016–2023.' The table shows annual transaction counts by type (Market Sales, Foreclosures, Other Sale/Transfer Types, and All Property Sales and Transfers). During 2016–2019: 65 market sales, 1 foreclosure, 50 other transfers, 116 total. During 2020–2023: only 38 market sales, 5 foreclosures, 26 other transfers, 69 total — reflecting a dramatic slowdown in office building transactions after 2020.    

Source: ORA analysis of OTR's annual real property tax data for TYs 2016 to 2023

    

Between 2021 and 2023, the average sales price per square foot for commercial buildings declined by 17.3 percent for Class A office buildings and 19.6 percent for Class B buildings (Figure 6). The decline in the number of sales and prices of commercial buildings explains the halving in commercial deed tax collections (as a share) between 2005 and 2023 (Figure 7).

Figure 6 and 7: Two charts. Figure 6 (left) titled 'Market Sale Price for Office Buildings Per Square Foot by Class' shows Class A (green) and Class B (blue) price per square foot from 2016 to 2023. Class A peaked at $607/sq ft in 2021 and fell to $502 by 2023. Class B rose from $454 in 2016 to a peak of $474 in 2021, then declined sharply to $381 by 2023. Data Source: CoStar. Figure 7 (right) titled 'The Value of Commercial Property Transactions as a Share of Value of All Deed Tax Transactions' shows the share declining from a high of 65.9% in FY 2005 to 35.3% in FY 2023, with the lowest share on record. Data Source: ORA analysis of OTR's Deed Tax data.

Impact on Building Values in the Medium-Term

Between 2012 and 2023, unoccupied office space in the District of Columbia more than doubled from 11.7 to 26.5 million square feet. As a result, the direct vacancy rate increased from 9.3 to 15.6 percent. Since 2020, the demand for office space has decreased due to the rise of remote work, and this trend is expected to continue over the next three years. According to CoStar, the amount of empty office space in the city is projected to increase by an additional 11.8 million square feet (equivalent to 44.5 percent) by 2027. But while falling average office rents per square foot and rising market cap rates are also adversely affecting office property assessments, the predominant factor is the increase in vacancy rates. These trends are expected to result in continued lower annual assessment values for hundreds of office buildings until at least 2027.

Figure 8: Dual line chart titled 'Figure 8. Annual Demand and Supply for All Leased Office Space in DC, 2005–2023 (in millions of square feet).' Supply (dark green) grew from 126.4M sq ft in 2005 to 158.2M sq ft in 2023. Demand (orange) grew more slowly from 119.2M sq ft in 2005 to a peak of approximately 136.9M in 2020, then declined to 131.7M sq ft in 2023 — creating an increasingly large gap between supply and demand. Data Source: CoStar.    
     
 

What is this data?

This study used administrative real property tax data from the Office of Tax and Revenue as well as commercial real estate market data from CoStar between the years of 2005 and 2023. CoStar Group, Inc. is a company that provides information, analytics, and marketing services to the commercial property industry both in the United States and abroad.