By Adam Pagnucco.
Besieged by rising office vacancy rates, depressed leasing activity and weak sales, a group of office building owners has commissioned a report showing a pending drop in property tax collections. The owners are requesting county assistance and predicting budget headaches if they don’t get it.
Here are the problems as they see it. MoCo’s office vacancy rate has risen from 13.1% to 17.7% since 2019, partly because of changing work patterns since the pandemic. Net absorption – the difference between newly leased space and newly vacated space – has been negative in four of the last five years. Annual gross rent growth has been below 2.5% for at least 15 years. Office capital return rates in MoCo have been negative since 2011. In 2023, office transaction volume and price per square foot were at their lowest levels since at least 2005. So the picture here is of preexisting weakness that was exacerbated by the pandemic.
To illustrate the consequences of the above, the office building owners hired real estate consultant RCLCO to evaluate the impact of office market weakness on property tax receipts. RCLCO found that while property valuations and property tax collections had risen steadily since 2019, the office sector was one of the weakest performers. Furthermore – at least so far – occupied office space had fallen faster than office value assessments in the county’s ten most valuable multi-tenant office buildings, meaning that further valuation declines could be built in. The company calculated three scenarios under which office property tax collections could decline by $16-47 million annually within a decade.
Distress in the county office market is not a hypothetical thing – it’s real. Back in April, Brookfield Corporation – a mammoth office building conglomerate based in Toronto – defaulted on a loan for a dozen office buildings, with nine of them in the D.C. area and seven of them in Montgomery County. One of them was One Metro Square, 51 Monroe Street in Rockville, an office building recognizable to most county residents. Defaults such as these will surely impact assessments and tax receipts.
One Metro Square in Rockville, which is now in default. Photo credit: Loopnet.
Unmentioned in the RCLCO report is a whole range of costs the county has levied on the real estate sector recently, including a property tax hike; a recordation tax hike; an impact tax hike; new laws on radon testing, building energy performance and all-electric building standards; and rent control, which will deter some office to residential conversions. Add all of those things together with challenging market conditions and it’s a perfect storm.
The office building owners don’t have a specific ask right now, but clearly they are looking for financial assistance. Their press release and the RCLCO report can be found below.
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Contact: Charles Maier, ChazMaier@gmail.com
Decline in Montgomery County Office Market Jeopardizing Social Safety Net
New report cites revenue losses, urges government intervention to address office vacancies
Bethesda, MD (November 28, 2023) – Declining office property values in Montgomery County pose a serious threat to county government tax revenues, with experts estimating annual losses of potentially $47 million or more, and at least $16 million annually. Unless government programs and policies are instituted to aid the preservation of office properties, the decline will accelerate, according to a new report by real estate consultant RCLCO of Bethesda.
“As a businessman with a significant stake in Montgomery County real estate, my concern for the county’s economic health is both profound and personal,” said Douglas M. Firstenberg, a principal of Stonebridge, a real estate development firm based in Bethesda. “We engaged these experts to better understand the impact of a decline in office values on county tax receipts, and we urge the county to recognize this threat and take action immediately.”
Firstenberg was among 33 concerned business leaders to raise the issue – and the challenge – in a letter to Montgomery County Executive Marc Elrich and County Council President Evan Glass.
The county must adopt a sense of urgency to create and fund programs and policies to address office vacancy challenges and support private sector job, the letter stated. It also recommends evaluating comparable efforts elsewhere to inform the ongoing effort to drive constructive legislative initiatives to help the commercial market and County revenues to recover in the months and years ahead.
Nearby jurisdictions such as Washington, D.C. and Arlington County have proposed emergency measures to stem the decline. Last year, the District enacted legislation to incentivize the repurposing – either through conversion or demolition – of downtown office buildings to residential. Arlington is also expediting zoning amendments or policy changes to support non-traditional uses in obsolete office spaces. Other urban areas are experiencing similar drops in office vacancies, some labeling distressed properties as “zombies” that negatively affect retail, the perception of safety, and harming small businesses, which damages the vitality of cities.
Since 2019, the Montgomery County office vacancy rate has increased from 13.1 percent to 17.7 percent, a drop that is partly attributable to post-pandemic work patterns of remote work and the evolving nature of office space needs. The persistence of that “new normal” makes it imperative for the county to come to terms with what the market dynamics could mean for its tax base, the RCLCO report states.
“Coupled with declining income, it is inevitable that the county’s office building assessments and the resulting revenue will be under downward pressure,” the report noted. “If the value of existing office buildings declines by as much as 30 percent, a repricing that many industry experts believe has already occurred, Montgomery County could lose up to $47 million in annual tax revenue.”
However, while the report also found that property tax revenue has grown steadily during the past four years, effectively buffering the tax base and causing overall revenue to increase, office starts are essentially non-existent and apartment starts are continuing to slow, causing apartment building assessments to taper off from their recent peak. Only three office buildings, totaling 581,000 square feet, are currently under construction in Montgomery County, down from eleven buildings totaling 2.6 million square feet in 2019.
Today, new office buildings account for more than 14 percent of total office assessed value—highlighting the significant role new construction has played in buffering the county tax base, and just how much the county stands to lose due to poor market conditions. Apartments will no longer offset the decline in other commercial types – most noticeably office, but also retail and hotel – which have not seen assessed value growth in recent years, according to the report.
Office space across a top ten of the highest-valued pre-2019 office buildings decreased by 19 percent from 2019 to 2023, while older buildings constructed before 2020 have lost more than $156 million of their assessed value in that same period. Several building owners have already turned their properties back to the banks as depressed leasing activity has caused a decline in interest from institutional investors, a reticent lending market and a growing number of distressed sales.
Converting older office properties to alternative uses – such as rental residential – are only financially and physically feasible in specific cases. Those depend on the layout of office buildings, how far office values fall relative to their replacement cost, and zoning and permitting hurdles. Countering the negative effects of declining office values will require exhaustive planning for economic recovery, the first step of which is fully comprehending the risks and vulnerability that exist today, the report said.
“These market dynamics will not be addressed without intervention,” said Chris Bruch, President and CEO of The Donohoe Companies, Inc. “The county must act urgently to create and fund programs and policies to address office vacancy challenges and support private sector job growth to counteract the negative effects of declining office values.”
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The RCLCO report can be downloaded below.