On November 28, 2022, D.C. Policy Center Executive Director Dr. Yesim Sayin spoke to Bisnow:
Not everyone thinks that nightmare scenario of the 1990s — when the federal government took control of the D.C. budget — is coming. Yesim Sayin, executive director of the D.C. Policy Center, worked under the District’s chief financial officer in the months leading up to and after the Great Recession. At the time, she said, the financial outlook for the District was changing so fast that the council met roughly half a dozen times to revise the budget as revenues sharply declined.
“During that time, there was a lot of uncertainty as well, and we just didn’t know what would happen to the District’s real property,” Sayin said. “It’s a very high stakes thing.”
In that crisis, the CFO estimated revenues from real property down by nearly $1B over four quarters, taking into account sales of distressed assets as they became public. Sayin said the role of the CFO worked as intended then, averting a broken budget and the need for federal intervention by extension. But that wasn’t without pain — the cuts represented about one-sixth of the District’s total budget.
The concerns raised in Monday’s letter also start with tax revenue estimates from commercial properties. Those estimates are based on assessments, which are determined in part by a building’s cap rate.
The CFO estimates cap rates in part by looking at overall market conditions, and in times of economic uncertainty, cap rates go up, which drives down assessments and revenues as a result.
But when the CFO’s office released projected cap rates for the 2023 tax year in March, it lowered the cap rate for Class-B offices by 0.2 percentage points and Class-C offices by 0.5 percentage points. That has left property owners who expect the difficult economic environment to further depress property values scratching their heads.
“If those cap rates would have increased [for the next fiscal year], which I think they should have, the property values would have gone down,” Sayin said. “Rather, in downtown D.C., property values went up by like a billion dollars. And some of it is like The Wharf, you know, new delivery, but that’s not enough to explain all of it.”
Sayin said some nuances in the budgeting process may mitigate the impact, but she believes the CFO is being far too generous given the current economic environment.
“They cannot keep saying, ‘Oh, we’re not going to change the cap rates because nothing else is happening,'” Sayin said. “Clearly, it’s far riskier right now.”
The true impact to the budget is dependent on just how bad the distress in the office market becomes. Sayin predicts the market could lose $6B in value, which would mean the District loses over $100M in revenue, but she said some project the impact to be even greater.
If revenues fall far enough that they risk breaking the budget, the mayor must work with the council to pass a supplementary budget, which happened during the financial crisis.
Sayin believes the District’s true budget cliff is about two years away, as tax assessment appeals for older office buildings work their way through the courts and transactions — which the CFO uses to help set cap rates — begin to appear.
There are 733 large office buildings in the office-heavy parts of the District today, of which 228 are more than 25% vacant or are likely to become vacant in the next two years as tenants leave with no one to replace them, according to a data analysis by the D.C. Policy Center. Those buildings, in turn, could trade for bargain prices and potentially depress the values of similar properties.