Calendar year 2023 has already witnessed significant office sales in Washington, D.C. that highlight the tenuous demand of the asset class in the current market. On March 31, 2023, a 155,901 sq. ft trophy office building at 1050 17th Street NW in downtown Washington, D.C. traded for $59,812,500 or $384 per square foot. Recently delivered in July 2020, the property boasts convenient access to the greater Central Business District (CBD) as well as modern amenities and workspaces. Unfortunately the property has struggled to attract both office and retail tenants in the three years since delivery (at the time of sale, the building was approximately 95% vacant).
Meanwhile, the Office of Tax and Revenue (OTR)—the entity responsible for assessing the annual fair market value for all real property in the District—has valued the building at $98,631,180 ($633 per square foot) for tax year 2024, notably 65% higher than the recent sale price. More recently, 2100 M Street NW—a 301,347 sq. ft, nearly vacant Class B office building in the West End—sold on May 9, 2023, for $66,700,000 ($222 per square foot) with plans to convert the space for multifamily use. It traded at almost $25.7 million less than what it sold for in the pre-pandemic year of 2019. Similarly, the OTR has assessed the office building for $86,015,800 ($285 per square foot) for tax year 2024, 29% higher than the purchase price.
These case studies give insight into the shortcomings of the OTR’s model when evaluating vacant office buildings. Each year, the OTR publishes a set of guidelines that are used to determine the assessed value of a property for the upcoming tax year; these data points include inputs for submarket rents, vacancy, expenses, and capitalization rate, with a limited amount of adjustments possible to reflect a property’s operating performance. However, these guidelines are especially rigid in their practical use. Specific issues that typically arise in the case of a vacant office building—such as increased lease-up cost, increased concessions, reduced asking rents, and rent loss as a result of vacancy in excess of stabilized figures—fall outside the range of allowable adjustments within the OTR’s model and are consequently left largely unaccounted for in a property’s assessment.
Unfortunately for real property owners in the District, these failures of the model will result in overly inflated real estate assessments this year and in future tax years. This is particularly concerning given the current state of the Washington, D.C. office market, which has been characterized by rising vacancies, limited leasing activity, and the downsizing of office footprints since the pandemic began. Continued uncertainty over the asset class recovery poses additional concerns for assessment values moving forward. Office properties in the District that are facing occupancy problems, regardless of class, may find themselves paying more than their fair share of property taxes.
The subject matter experts at Ryan are exploring creative strategies to assist our clients and minimize tax liability where possible. We urge you to reach out to one of our local team members to discuss how we can help.
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- Cutchin Powell