What do empty office buildings and over-leveraged commercial developers have to do with Arlington’s parks, libraries and schools? A lot, actually.
There’s a storm brewing in the business landscape that has yet to unleash its full fury. In the worst case, fierce economic winds and rain could lash taxpayers and the county services they hold dear, from recreational programs and transit routes to emergency responders.
The problem comes down to funding. Arlington has historically derived more of its tax base from the commercial sector than the average suburban municipality does, notes Terry Clower, director of regional analysis at the Schar School of Policy and Government at George Mason University. Doing so has allowed the county to offer high-level services and an enviable quality of life—with perks such as magnet schools, arts programs, abundant parks and athletic facilities.
But as more and more office buildings sit empty with the shift to remote work, commercial landlords are struggling to pay their bills. By the end of 2023, Arlington’s commercial vacancy rate was above 22%. The revenue stream for many of the things that make Arlington a desirable place to live is eroding.
“There will be hard choices [ahead],” Clower says. “Do you want your property taxes higher or fewer services?”
“There will be hard choices [ahead]. Do you want your property taxes higher or fewer services?”
Real estate taxes provide more than half of Arlington County’s annual revenue, and for decades, that burden was split 50/50 between commercial and residential property owners, explains County Board Member Matt de Ferranti. This year the scales tipped, with homeowners and residential landlords shouldering about 55% versus commercial contributing 45%. Chronic office vacancies now threaten to push contributions from the commercial sector even lower.
“This really does make it a crisis for the entire community,” says Kate Bates, president and CEO of the Arlington Chamber of Commerce. “The county tax base relies heavily on the commercial sector. Whatever you care about—parks, schools, libraries—we need the business community to be thriving to fund those priorities.”
Last fall, Arlington officials projected a budget shortfall of $25 million to $40 million for the fiscal year beginning July 1, 2024. The $1.65 billion budget the county board approved in April is balanced, but it includes a 6.4% real estate tax hike. Add to that Arlington’s new stormwater utility fee and the impact is palpable. Homeowners will be looking at an average increase of $541 in taxes and fees in fiscal year 2025, according to county manager Mark Schwartz. For apartment buildings, real estate taxes will go up by an average of $233 per unit annually—a cost that landlords may be inclined to pass along to renters.
Another looming challenge lies in the raft of older buildings nearing the end of their useful life as offices. Competition from newer, shinier commercial buildings—combined with tenant businesses leasing less space—means older buildings are emptying out. And without rents coming in, building owners can’t pay their taxes. It’s a phenomenon playing out in major metropolitan areas across the U.S. with the shift to remote work.
“Arlington is not immune to the effects of the broader economy and the changing dynamics of the workplace,” says Ryan Touhill, director of Arlington Economic Development (AED), a county agency.
At the end of 2023, Arlington’s commercial vacancy rate was 22.1%, compared with 15.1% at the end of 2019. For older “Class B” buildings, the 2023 vacancy rate was an even higher 24.4%. Touhill expects that figure to remain elevated “for the foreseeable future.”
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During the pandemic, companies were forced to find creative ways to keep employees working remotely. Now businesses are rethinking their protocols around how often workers are required to go to the office.
Arlington officials have been buoyed by Amazon’s policy requiring employees in the office three days a week. Real estate analytics giant CoStar Group, which will soon bring some 650 employees to its new headquarters building at 1201 Wilson Blvd. in Rosslyn, requires workers in the office four days a week.
But hybrid work policies have already prompted many companies to downsize their space needs. Across the U.S., Clower says, the average square footage leased per employee has dropped from 300 in the 1990s to about 170 today.
Arlington’s current surplus of office space doesn’t even reflect the full impact of this trend. Many companies have kicked the proverbial can down the road, extending their leases for a few years while they figure out how much space they actually need in a post-Covid world. Nationwide, about 45% of the commercial office leases signed before the pandemic have yet to expire, notes Phil Mobley, national director of office analytics at CoStar Group.
“If conditions stand still, we’ve got two to three more years of tenants vacating more space than they take in,” Mobley says. “It’s more pressure on landlords. It’s more pressure on the value of the buildings.”
While certain industries like health care, banking and government contracting (requiring security clearances) have always needed workers on site, other employers are scrambling to entice staff to return full time.
A telling statistic: The number of U.S. workers using key cards to swipe into their offices has dropped drastically since 2019. Only 65% or fewer are showing up on any given day. On Fridays that number drops to a third, according to a February analysis by the key card company Kastle, based in Falls Church.
“There’s a push among executives for higher attendance,” Mobley says, “but it doesn’t translate into a rising tide of attendance.”
Executives at the Shooshan Co., the developer behind Ballston properties such as Marymount University’s satellite building at 1000 N. Glebe Road and the 23-story mixed-use building at 4040 Wilson, are hoping employees return. On-site work breeds mentorship, collaboration and other benefits to company culture, says Kevin Shooshan, principal of the Arlington-based real estate firm. “I don’t think we were designed to live in 700-square-foot apartments and work in those homes,” he says. “My hope is the pendulum has swung too far.”
Shifts in the labor market may eventually give employers more leverage to pull workers back in, adds his father, president and CEO John Shooshan: “As you see unemployment move up over time, I think the employers get more of an upper hand to say, ‘I need you back in the office.’ ”
But a wholesale return to the way things were seems unlikely. Some companies are already moving to smaller digs as leases expire. Others are leveraging the oversupply of commercial space to demand concessions from landlords, such as renovations and months of free rent.
“The last two or three years have seen the highest concessions, the most difficult economics for landlords I’ve seen in a long time,” says Dave Millard, a commercial real estate broker and principal with the global firm Avison Young.
Rental rates are up a modest 1.4%, says GMU’s Clower, but that doesn’t count all the givebacks. Commercial landlords are in a precarious spot: As their borrowing costs go up, they can’t raise the rents high enough to cover those costs without driving tenants away. And they can’t afford to lose any more tenants.
Meanwhile, building improvements that might help with retention have become cost prohibitive. Interest rates for line-of-credit loans (the kinds of loans property owners use for tenant improvements) are based on the prime rate—which was 8.5% as of February, up from 3.25% two years ago, notes Jenny Shtipelman, a senior vice president at National Capital Bank. Borrowing money has become quite expensive.
The pandemic may be in the rearview mirror, but its physical impact on the business landscape has yet to be fully realized. Many leases are in the seven- to 10-year range, meaning companies that signed leases right before Covid have not had the chance to consider moving or downsizing.
When corporate tenants do relocate or renegotiate their leases, CoStar’s Mobley says, they are reducing their space needs by an average of 21%. Lease transactions (turnover stemming from companies leaving old leases) are 6-7% higher than they were in 2019.
Across the U.S., CoStar estimates some 58 million square feet of commercial space sat empty in 2023, and it’s predicting 95 million square feet of lost occupancy this year. That would make 2024 the worst year ever for “net absorption” (a metric that reflects the total amount of leased space, minus the amount that’s been vacated)—even more dramatic than 2020. “It would be as if the entire San Antonio office market became vacant,” Mobley says.
Tim Hughes, a shareholder at the Arlington law firm Bean Kinney & Korman, says his company (which counts real estate among its practice areas) downsized well before Covid. In 2018, Bean Kinney relocated from Arlington’s Navy League Building to a new space about 3,000 square feet smaller on Wilson Boulevard. Moving paper documents to the cloud eliminated the need for rooms full of filing cabinets. The firm downsized private offices while beefing up collaborative spaces like conference rooms. These days, Bean Kinney generally requires staff to come in three days a week, though attorneys have more leeway to work remotely.
The switch to hybrid work is also having a trickle-down effect on neighboring service businesses. Fewer workers in the office means fewer customers for office-adjacent dry cleaners, restaurants and retail shops. (Bates of the Arlington Chamber laments the shuttering of her favorite bulgogi spot near her office in Courthouse.)
Touhill is optimistic those service businesses can be part of the solution as the county refocuses development priorities on “place-making”—turning what used to be sterile strips of office buildings into welcoming neighborhoods where people not only work but also live and play.
“Our long-term goal is to make Arlington more resilient,” he says, pointing to Ballston as an example of a neighborhood transformed. That district’s urban-style mix of residential and lifestyle uses keeps things lively in the evenings and on weekends, allowing service businesses to keep the lights on. The goal, Touhill says, “is not to be dependent on getting everyone back to the office.” It’s to create other reasons for people to stick around.
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As if the mass exodus of business tenants weren’t problem enough, commercial developers and landlords are also facing higher interest rates. In recent decades, when interest rates were at rock bottom, developers got greedy and built too much office space on speculation, says John Shooshan.
Now, with borrowing rates creeping ever higher, “the spigot for new office [development] has been almost completely turned off,” says Kevin Shooshan. No new office space broke ground in Northern Virginia in the fourth quarter of 2023.
And here’s where the ground beneath the commercial sector gets really unstable: While residential homeowners can take out 30-year mortgages on their properties, the average timeline for a commercial loan is 10 years or less. As these loans end, commercial building owners are finding banks hesitant to back them and financing more expensive. “No one wants to underwrite what’s been a falling knife,” says John Shooshan.
As a result, Clower says, a growing number of building owners are “sending the lenders back the key.” Those defaults are driving commercial property values—and therefore tax assessments—down.
“You see just about every week a story about a building that is sold at a big discount,” observes CoStar’s Mobley. As of January, 7.4% of loans on large commercial buildings nationwide were delinquent, compared with 1.4% at the end of 2022. Average prices are down 13% nationwide, compared with where they were at the end of 2021.
CoStar estimates the drop will reach 30% by the middle of 2025.
As of January, 7.4% of loans on large commercial buildings nationwide were delinquent, compared with 1.4% at the end of 2022.
Not even shiny “Class A” buildings are immune. Consider the Rosslyn tower at 1812 N. Moore St., which has healthy occupancy and a marquis tenant in Nestlé. Even so, owner Monday Properties narrowly avoided foreclosure on the building in late 2023 before a last-minute debt restructuring.
Normally banks impose borrowing limits that keep a loan within a certain percentage of the building’s value. As vacancy rates rise and building valuations decline, banks are requiring landlords to put more cash into their properties. A building that used to be worth $100 million and qualified for an $80 million loan might now be worth only $40 million and qualify for a $36 million loan.
The value of Arlington’s commercial office space dropped 8.5% between 2022 and 2023. The decline might have been even worse, says Derek Dubbé, director of real estate assessments for Arlington County, if not for new construction that offset an 11% decrease in the valuations of older existing properties.
John Shooshan says no one—building owners, bankers, assessors—has been in a hurry to acknowledge the full impact of lower building values. “There’s a big disconnect between reality and what the assessments are,” he says. “I don’t think we, as real estate owners, lenders or municipalities, want to accept the realities of this diminution of value.”
If assessments were pegged more to current market realities, Shooshan says, “You will see [residential real estate tax] rates go up. You will see a disproportionate burden on the residential taxpayer.”
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All of this leaves elected officials grappling with tough decisions around Arlington’s revenue framework—and some potentially unpopular policy changes.
“In as great a place to live as Arlington, all residents and businesses, including homeowners, should understand it is possible that [tax] rates may need to increase for the county to continue to deliver the high-quality services residents have come to expect and enjoy,” says County Board Member de Ferranti. “We are mindful of the impacts those increases would have and would do our best to balance the need for services and low tax rates if a rate increase is needed. We hope all of us can consider that we will need to evolve and grow through these changes to our economy.”
Arlington has staked a lot of its response on a mouthful of letters—CMRI. Launched in 2022, the Commercial Market Resiliency Initiative is an effort to remove red tape, making it easier and faster for developers and companies to obtain the approvals they need to do business here—especially when it comes to alternative building uses for enterprises that didn’t even exist when the county’s zoning and land use rules were originally written.
Arlington Chamber president Bates cites micro fulfillment centers (which handle the last few miles of the delivery chain for online retail orders) as an example. When the micro fulfillment company Gopuff wanted to set up shop in Arlington, the approval process was stymied because there was no precedent. “Nobody knew what a micro fulfillment center was,” she says.
Other emerging business models addressed in CMRI’s first round of policy reform included brewpubs, dog boarding facilities, commercial kitchens and makerspaces.
Going forward, Bates hopes county leaders will take a broad-based approach to land-use approvals, rather than reviewing each category on a use-by-use basis. “As things get more competitive, we have to make a great case for why a business should choose Arlington,” she says.
Dismantling regulatory barriers may also pave the way for older buildings currently sitting empty to be converted for other uses, adds AED’s Touhill. Housing is one option, although the conversion mechanics don’t always work. (Who wants to live without windows in the interior of a large building?)
“There’s not one answer,” he says. “We need to be open as a community to apply a mix of tools. We are having to rethink what our urban districts look like. We all recognize the world is different now. We can’t afford to not do anything.”
Clower of GMU compares the current drama in the commercial real estate market with the 1980s, when tax law changes and the savings and loan crisis forced companies and governments to be creative. Maybe, he says, governments and landlords can work in public-private partnerships to redevelop the oldest office buildings.
Arlington is certainly not the only municipality struggling with revenue shortfalls caused by office vacancies. But its historic reliance on commercial tax revenue makes it particularly impacted, Clower observes.
“Folks in Northern Virginia do like high-quality government services,” he says. “They just don’t like paying for it.”
Building Blocks
What will become of Arlington’s older office buildings that sit empty? The county’s Commercial Market Resiliency Initiative (CMRI), which is currently wending its way through public meetings and strategy sessions, aims to open them up for alternative creative uses by prioritizing the following:
Speed. For redevelopment and conversion of offices to other uses, the county is re-examining how it classifies changes (as either “major” or “minor”) to allow simpler proposals to move through the approval process faster.
Tools. To make it easier for landlords to attract tenants, the county is reconsidering its policies around signage (all the way down to sandwich board advertising), parking and public spaces.
Place-making. County officials are also seeking new ways to make neighborhoods more vibrant so businesses and residents will be drawn in. For example, the county board voted last year to extend pandemic rules allowing outdoor dining.
Tamara Lytle is a freelance writer in Northern Virginia covering politics, business and other topics.