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WA lawmakers weigh tax breaks for developers turning offices to homes

By Heidi Groover, The Seattle Times
Published: February 1, 2024, 8:14am

SEATTLE — Washington lawmakers are mulling new financial breaks for developers who convert commercial buildings into apartments or condos, an attempt to respond to the state’s glut of empty office buildings and dire need for new homes.

Supporters say offering developers incentives will help spur conversions of underused buildings, creating much-needed housing and reinvigorating downtowns. But some skeptics question whether tax breaks for private developers are the right tactic to fight rising housing costs.

Remote work continues to take its toll on the office market across the state, particularly near Seattle. About 14% of office space is empty or available for sublease across the Puget Sound region, including Seattle, Tacoma and the Eastside, the highest share since 2010.

“We have a whole bunch of office and commercial space that we want to try and do something with,” said Sen. Yasmin Trudeau, D-Tacoma, who is sponsoring a bill to allow cities to offer developers property tax breaks on conversion projects.

Seattle is eyeing other financial incentives.

Mayor Bruce Harrell’s office supports Trudeau’s proposal and is considering exempting conversion projects from mandatory housing affordability requirements. Those rules require developers to either include affordable homes on-site or pay a fee toward affordable housing.

While the incentives would benefit conversions of any commercial spaces, supporters see opportunity mostly in transforming empty offices. Demand for office space in Seattle is among the weakest of the country’s major cities, according to the leasing platform company VTS, which tracks property tours.

Stagnating demand can erode the value of office buildings, creating a financial risk for building owners who may have loans coming due.

Spokane developer Chris Batten told state lawmakers the tax break proposal “represents the single best opportunity for any immediate meaningful incentive to stave off what could become a dire situation.”

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As leases signed before the pandemic begin to expire, “there is a commercial cliff that threatens the viability of downtowns across the state,” Batten said.

Still, offering tax breaks to private developers sparks debate within the state’s Democratic establishment.

Longtime Rep. Frank Chopp, D-Seattle, voted against the conversion proposal in a House committee this week and said he has concerns about the way the tax break is designed.

Chopp questioned the constitutionality of the proposed property tax break, as well as another exemption the state already offers, the Multifamily Tax Exemption, or MFTE.

“I don’t think that’s the proper way of doing these kinds of projects,” Chopp said in an interview Tuesday, advocating instead for other state efforts to fund affordable housing built by nonprofit developers.

The debate comes as Washington lawmakers continue to grapple with the state’s housing affordability challenges, which they have addressed largely with supply-side solutions rather than limiting rent increases. Legislators this year are also considering proposals to boost density and loosen restrictions on small apartments.

What the proposals would do

The conversion proposal under consideration in Olympia, SB 6175 and its companion bill HB 2308, would allow cities to create tax incentive programs targeted at commercial-to-residential conversions. The incentives would give developers a property tax exemption on the value of the building for 30 years if at least one-fifth of the new homes were affordable.

Those homes would need to be affordable to people earning 80% of the area median income — about $71,000 a year for a single person in King County, $60,000 in Pierce County and $50,000 in Spokane County.

Developers could also get relief on state sales and use taxes paid during the conversion if 10% of the units were affordable for 10 years. Projects could include rental or for-sale housing, and developers would need to apply for the tax benefits by the end of 2029.

Trudeau said generating affordable housing is critical when the government is subsidizing builders.

“When we give incentives, what we’re saying is we expect the most public good out of this project. That’s why we’re using taxpayer money to do it,” she said.

“If we don’t build inclusively, we are going to continue to exacerbate our housing crisis and our homelessness crisis,” Trudeau said.

Developers from Spokane asked lawmakers to allow more expensive units, affordable up to 115% of area median income, or roughly $72,000 for a single person in Spokane, rather than $50,000.

In Seattle, Harrell’s office supports the bill and “would explore its implementation” if it passes, spokesperson Jamie Housen said in an email Monday.

The tax break could help make a conversion in Uptown pencil out, said developer Marc Angelillo.

“Passing this bill would certainly assist in getting us closer to making it work financially,” Angelillo said. While many factors will affect plans to convert offices into apartments, a property tax break would be “a big help,” he said.

The proposal would save the Uptown project an estimated $127,000 in property taxes per year, according to a state analysis.

While lawmakers debate the idea in Olympia, Seattle’s Office of Planning and Community Development is also proposing changes meant to encourage conversions, according to public records.

That proposal would exempt conversion projects from Mandatory Housing Affordability, or MHA, the city’s requirement that developers pay into a fund for affordable housing or set aside affordable units on-site.

The changes would also exempt conversion projects from design review, parking requirements and other city regulations, though historic preservation rules would still apply. The incentives would apply to conversions of buildings that are at least 3 years old and in areas of town that allow commercial and multifamily buildings, such as downtown.

Developers could not dramatically expand an existing building but could add up to 15 feet to the height of the building and rooftop features. The mayor plans to send the proposal to the City Council in the coming months.

While the planning department acknowledges the policy would mean forgoing some MHA revenue — one of the city’s primary sources of affordable housing funds — the department argues the effect is minor because the city expects a small number of conversions and the benefit of adding new homes offsets the downside.

Not everyone agrees. Michele Thomas, director of policy and advocacy at the Washington Low Income Housing Alliance, called exempting conversions from MHA “absolutely ridiculous.”

The planning office argues that developers pay MHA in exchange for being able to build larger buildings, but that boost in development capacity isn’t available when converting an existing building. Thomas disagrees, saying the ability to transform commercial buildings into apartments or condos represents a huge financial benefit for builders. The housing alliance supports the state tax break bill because of its affordability requirements.

“We need affordable housing in Seattle, and everybody has to play a role, including for-profit landlords and those who own commercial buildings,” Thomas said Wednesday.

Effects could be limited

Researchers estimate dozens of office buildings across the Puget Sound region could be good physical candidates for conversion, from dated suburban office complexes to Seattle’s historic Smith Tower.

And a handful of office conversions are already planned. Along with the Uptown project, Martin Selig Real Estate plans to turn 12 floors of office space in a building at Third Avenue and Lenora into apartments. In Tacoma, developers have proposed conversions at several buildings, including the former DaVita building downtown.

But even with incentives, the number of conversions is likely to remain limited. Some newer office buildings with luxury amenities are still attracting tenants, many commercial buildings aren’t practical for conversions into residential spaces and construction costs remain high.

A fiscal analysis of the state proposal makes no attempt to estimate how many cities may enact the tax breaks or how many developers may take advantage of them.

Seattle estimates that if the city changes are approved, it could see up to a dozen projects, totaling 1,000 to 2,000 apartments or condos, over seven years. The state projects Seattle will need about 112,000 new homes over the next 20 years, many of them more deeply affordable than units that are likely to be in conversion projects.

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