The Federal Government’s Piecemeal Return Threatens DC’s Office Market

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Some offices still have calendar pages and white boards covered with messages and to-do lists from before the pandemic. In one deserted building, an employee has found himself the only one coming to the office so often, that he’s taken to a mid-day jog in the empty hallways, circling the floor by himself. These aren’t scenes from “The Last of Us.” These are what it looks like inside the massive volume of federal government offices in the nation’s capital that have been functionally empty since March of 2020.

The federal government is the largest individual office tenant in the country, and nowhere more so than in Washington, D.C. The concentration of federal activities and offices in the District, which employs roughly 365,300 federal workers, has impacted the region’s office market like no other.

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No horror story of bureaucratic inertia and red tape has moved as slowly and tensely as the return of the federal workforce after the peak of the pandemic, at least for office owners in the District. Many workers come in just two days a pay period, or once a week, creating a hollowness at the core of the city’s commercial districts. Different agencies and their unions have negotiated a variety of remote work and telework plans: The National Archives and Records Administration allows up to five telework days per week, and the National Science Foundation lets employees telework up to eight days per pay period.

With the General Services Administration, or GSA, leasing just over 43 million square feet, or a third of the total market, this emptiness has cast a profound shadow on related businesses and the larger real estate market. (The GSA failed to respond to repeated requests for comment.)

“Buying or selling a federally leased building used to be the best bet in real estate,” said JLL’s Howard Traul, senior managing director and co-lead of the Government Investor Services team. “They always renewed and they didn’t like to move. But now there’s so many buildings that the federal government is leasing all or a large part of that they haven’t been in for three years.”

It would actually be easier if the government did rip off the Band-Aid and right-size its real estate footprint now, said Traul’s colleague, Austin Sanders, because at least there would be a new equilibrium for the market to move towards. But now, nothing’s really happening, just a series of short-term lease extensions, which has contributed to a souring office market. Office occupancy in D.C. dropped 1.2 million square feet in 2022, with 20.5 percent vacancy overall, CBRE found. The GSA signed just a single lease in the fourth quarter, a pittance compared to a number of blockbuster new deals and renewals in 2021.

“The private sector is slowly inching back,” said Lucy Kitchin, who leads Transwestern’s Government Services advisory group. “But the federal government is not back, and that’s having serious implications on transit and transportation, retail, and eventually it’ll have tax implications for D.C.”

Government agencies have been loath to act, with unions protecting remote work and work-from-home privileges as a boon to effectiveness and recruitment, and leadership reluctant to downsize and lose budget allocation. Many commercial owners were holding out hopes that President Joe Biden, who could issue a directive on return to work to his cabinet, would again mention a back-to-office push during his State of the Union Address (he did not) like he did in 2022. D.C. Mayor Muriel Bowser has pushed for “decisive action” to get federal workers to return, and Republicans in Congress have passed laws restricting telework and talked about the need to get off the couch and into a cubicle, but so far it’s all mostly talk. There could be a momentum shift when the pandemic health emergency is repealed in May. But without concerted, focused, bipartisan pressure, says Traul, the stalemate continues.

“The federal government needs to see the federal workforce and what they spend as a form of stimulus,” he added.

Exposure to empty government workplaces covers a broad swath of the city, with the lack of vibrancy dragging down small businesses, reducing the amenities and retail options that bolster office leasing. But the problem is especially pronounced in a few areas, such as the Southwest (minus the Wharf) and NoMa. While federal tenants are still paying rents for unused space, the emptiness is starting to weigh heavily on the financial strength of local office stock and helping contribute to a spate of vacant storefronts.

“Net effective rents for offices have fallen to a degree, but I think that the base lease rates are holding rather steady because quite a bit of D.C. is institutionally owned and well capitalized at the moment,” said Matt Pacinelli, Managing Director of Stream Realty’s D.C. office. “Conversely, land values are dramatically down, and there will be a few transactions this year that will demonstrate that land values are down to a level probably not seen within the last 20 or 30 years.”

He points to 700 11th Street, a 12-story office tower that was occupied by a major law firm, Williams & Connolly, that moved to the Wharf. Lender Allianz has been marketing the building with Eastville, and Pacinelli understands the price they’re seeking is now hovering around $200 a square foot, a steal for one of the “premier downtown sites in D.C.” This may be the first of many dominoes to fall.

“A meaningful share of the market will be underwater, and we’ll have to address that issue as their debt expiration approaches,” he said. “And at the moment, there’s very little debt financing available for office.”

There’s a case to be made that federal office occupancy may never recover. The pandemic, and the aging government workforce — 28 percent of federal employees planning to retire by 2027, per JLL research — may have set up a test case for federal agencies to significantly shrink their footprints and save taxpayer dollars. The federal government’s real estate footprint already shrunk roughly 20 million square feet in the last decade, per the Government Accountability Office.

Agencies are now conducting portfolio-wide office space analyses to identify the most cost-effective opportunities — those that best support mission attainment and customer service — to consolidate, dispose, and modernize their portfolios, according to the Office of Management and Budget. Throughout this process, they’re expected to reimagine their workplace approach informed by lessons from the COVID-19 pandemic, as well as nationwide workforce and workplace trends, and integrate these considerations into the next iteration of their capital plan, according to an OMB official.

The official said they were confident in the strength of this existing government-wide capital planning process and the existing real property policy framework, and believe it will identify appropriate office space portfolio reduction opportunities over time. In early February, two agencies, the National Transportation Safety Board and Commodity Futures Trading Commision, both considered new leases that would consolidate space and slash their overall footprint, cutting their collective annual lease payments from roughly $30 million to $16 million.

“I think it may come down to a cultural conversation versus an economic conversation,” Transwestern’s Kitchin said. “Do we really trust somebody auditing us from their bedroom? Do we really want to create two cultures, one in which if you work for the government, you work from home, and will the private sector put up with that?”

Currently, with hope that politicians take up their cause and start canvassing federal leaders to demand a return to the office, owners are stuck waiting. D.C. landlords don’t have a lot of good options with a lack of other industries able to take up so much slack during a downturn, and the large floor plates of D.C. offices (due to the District height restrictions) making office-to-residential conversions even more difficult than they generally are.

Nor does the city. Real estate taxes are derived from the value of office buildings, and if those buildings are vacant, the assessed value is dramatically reduced, and therefore the tax revenue generated from them is equally reduced.

“It’s just a gradual degradation,” said Traul. “Retail will just continue to go out of business. Downtown becomes more and more uninhabited, crime goes up. I don’t know if there’s a cliff in this scenario.”