Co-author: Peter Johansson
In March of this year the Administration enacted the National Strategy for Real Property (National Strategy) and the Reduce the Footprint (RTF) policy. This directive expanded the scope of the prior Freeze the Footprint policy, which required all Federal agencies to freeze their real estate footprint. As stated in the press release, “With the establishment of the National Strategy and OMB’s new Reduce the Footprint (RTF) policy agencies will be required not only to continue to freeze but also reduce their real property footprint over the next several years. ” In addition to the Federal government, foreign governments have seemingly adopted a similar policy to reduce their footprint and capitalize on their real estate holdings as evidenced by the conversion of the former Italian embassy in DC to condominiums and other similar real estate dispositions by foreign governments.
In this post we conduct our own Q&A to analyze the potential impact of this policy on the commercial real estate market and to analyze the broader market of tax-exempt properties.
Q: To what extent has the District’s economy diversified away from the government sector and been able to absorb the space that resulted from the reduction in the government’s footprint?
A: In 2005 private sector employment accounted for 66 percent of all employment in DC. Today it accounts for 69 percent of total employment. Over this 10 year time frame, the private sector added 78,000 jobs while the Federal government added only 3,500 jobs. The sequestration had a large impact on Federal employment which experienced 3 consecutive years of declines beginning in 2011. More recently, Federal employment has stabilized. This is good news for the District’s economy but looking forward the private sector will still be the major engine of growth.
Q: What are some examples of former Federal properties that have been converted or occupied by private tenants?
A: Notable recent examples of this diversification include the conversion of the Old Post Office to a hotel and the planned redevelopment of the FBI headquarters building. Both of these properties are on prime real estate on Pennsylvania Avenue. In some cases, rather than dispositions and conversions, Federal agencies have relocated within the District, but the net effect has been a reduction in the Federal government share of the overall market’s footprint.
Q: What effect has this diversification had on the District’s real property tax base?
A: Concurrent with this shift in the employment base has been a decline in the share of market value of tax-exempt commercial properties as shown in the graph below. The market value of tax -exempt commercial properties, 49 percent in 2005, has declined to 47 percent in 2015.
Market Value ($ mil) and Share of DC Tax-Exempt and Non-Exempt Commercial Properties ,2005 vs. 2015
Q: What has the impact on tax revenues been?
A: While a two percentage point increase in the share of taxable properties is small, this change represented almost $3.5 billion dollars in market value and accounts for $59 million dollars in annual tax revenue. This isn’t to say that by virtue of the Federal government reducing its footprint, revenues will necessarily increase. Someone has to occupy this space and while some Federal properties may be highly desirable and a target for conversions (like the Old Post Office), other properties which lack amenities or floorplates suited for today’s office market, may languish on the market.
Q:The District still has a very high share of tax-exempt properties. What agencies, or who, accounts for this large share?
Share of DC Tax-Exempt Commercial Properties: by Sector, 2015
A: The Federal government still accounts for the lion’s share of tax-exempt properties with 59 percent of the overall market value. The other large tax-exempt sectors are not-for-profits, which include educational institutions, and make up 23 percent followed by the DC government, which accounts for 15 percent. Foreign governments hold 3 percent and public authorities like WMATA account for 1 percent.
Q: Is the presence of such a large share of tax-exempt properties unique to the District?
A: Surprisingly no. New York City for example has an even higher share. Almost 53 percent of market value in New York City is tax-exempt, higher than DC’s 47 percent. The sectors that account for this, however, are very different from those in DC.
Market Value ($ mil) and Share of NYC Tax-Exempt and Non-Exempt Commercial Properties, 2015
Q: How can New York City have a higher share than the District which is the seat of the Federal government?
A: Indeed the Federal government’s share of tax-exempt properties in New York City is far lower than in DC. However, public authorities, like the Port Authority of New York and New Jersey, which owns airports, land and properties including the World Trade Center site, have a much larger presence there than in DC. Even the land that was excavated from the World Trade Center site was used to create Battery Park City, owned by another public authority, the Battery Park City Authority.
Share of NYC Tax-Exempt Commercial Properties by Sector, 2015
Q: Do the District and the DC Area still have greater exposure to the Federal Government Reduce the Footprint policy, at least for office properties?
A: Yes the direct impact of this policy is likely to be greater in DC and the surrounding area than in other large office markets. The indirect impact of this program and Federal budget cutbacks is broad based and felt throughout the nation. Transit agencies face huge funding needs for their capital programs. To the extent that the Feds are cutting back on funding, local authorities and government increasingly have to capitalize and sell their real estate holdings to finance these needs.
We will have to see the details regarding the implementation and timing of this program. The pace of implementation, the quality of space being put on the market and the strength of private sector office using employment will all be critical factors in determining the impact this program will have. In some cases this could be a real opportunity for the private sector to step in to reposition or redevelop government property.
What exactly is the data?
DC property tax data is from the DC Office of Tax and Revenue. New York City data was obtained from the NYC Department of Finance annual Property Tax Report. NYC market values were calculated assuming a similar ratio of market value to tax for non-taxable and taxable values.
Bob Zuraski contributed to this post