It sounds like a fantasy to rival Cinderella: 14th and U Streets NW, a city crossroad that has become a synonym for drug use and prostitution, turning into a revitalized intersection with new housing, shops and offices.

But this is the ambitious vision of the 14th and U Street area under an effort being planned by the District government, community groups and the largest private developer in that neighborhood.

So far, the evidence of change is seen mainly in a giant hole in the ground on the northwest corner of 14th and U, where the city's new municipal office building is to stand, and in a series of preliminary plats and drawings in the Dupont Circle office of architect Ted Mariani.

But if the drawings come to life, abandoned buildings and vacant lots will be replaced with perhaps 1,000 units of low- and moderate-income housing, a chain drugstore, a supermarket, a major retailer such as Sears or Hechinger, 100,000 square feet of office space or a hotel, and parks, plazas and pedestrian malls.

The 1,200-seat Lincoln Theater, a block away from the municipal center on U Street, now featuring "Kung Fu Zombie," would be renovated into a first-class stage-and-screen theater.

All of these elements are part of one project on three blocks, including the old Children's Hospital site, and is being put together by a unique joint venture of developer Jeffrey Cohen and two community organizations, the 14th and U Streets Coalition and the Shaw Project Area Committee.

Yesterday, the third Reclaim Our Neighborhood Festival was held at 14th and U to oppose crime and drug abuse in the area and to celebrate the anticipated impact of the new development. The block was filled with people, music and tables in a festive atmosphere in which merchandise was sold by local merchants and residents. Several blocks away, at 14th and W Streets NW, police were making drug arrests to discourage drug trafficking in the area.

"There definitely is a change in attitude among the residents that live in the area and from businesses," said Edna Frazier-Cromwell, head of the 14th and U Streets Coalition. "A lot of people had thought it the municipal building was a campaign promise that would not be realized."

A year ago, Mayor Marion Barry, in a surprise move, announced that he would be building the city's long-awaited municipal office building at that corner as a symbol of commitment to revitalizing the blighted and crime-ridden area. Construction started in January.

The Metro subway's Green Line is supposed to go into the area and would be another boost. But the subway is not expected to open there until 1990.

Today the area remains a shooting gallery, with winos and junkies congregating on street corners all day amid broken glass and debris. But the crowd has moved a few blocks from the construction site. Storefronts along 14th Street are boarded up, and the main businesses there are liquor stores, video arcades and auto shops. The closest drugstore is at Thomas Circle, more than 10 blocks away.

Changes are coming, but the community groups want to make sure the changes do not jeopardize what they like about their community.

"We want development but we also want to preserve the long-term residents and business people in the area. That will be the hardest thing," said Ibrahim Mumin, director of the Shaw Project Area Committee.

He pointed to neighborhood "institutions" such as Duke's Shoe Shine at 13th and U and the legendary Ben's Chili Bowl as the kinds of businesses that need protection from being priced out of the area.

"The great fear here is of displacement," particularly because some individuals already have been displaced, said Frazier-Cromwell. "Developers will have to be sensitive to that."

The community wants more rental housing along with commercial and retail space that can provide jobs, she said.

Jobs for local residents and reducing crime and drug use are priorities, and Mumin said his group so far is satisfied that the city has kept its commitment to hire from the area. Residents were hired to work on the municipal building, and a local security company started by former convicts is providing the security during the construction, Mumin said.

Construction on the 474,680-square-foot, eight-story municipal building is supposed to be completed late next year or early 1985. About 1,000 city employes will work there, but the city has not decided which agencies will move there. Some retail space also will be included on the ground floor.

"It's a key revitalization project--more than just an office building," said John E. Touchstone, D.C. director of public works. The city hopes for mixed-use development that will stress residential uses, he said.

The other significant activity in the area is land purchases by Howard University to support later expansion, city officials said. The old four-story Bennett Building near 14th and U is scheduled for renovation as a small office building.

But by far the most substantial plans are Cohen's joint venture with the community.

The joint venture, not yet in final form, essentially would give the community groups half ownership of the development. The profit-making partner would get the tax write-offs, and joining with the nonprofit organizations would give the project access to public funds, such as federal Urban Development Action Grants or industrial revenue bonds.

Cohen has owned the old Children's Hospital site on the block bounded by V and W and 12th and 13th Streets NW since 1978, and he had planned to renovate and turn it into the National Rehabilitation Hospital. Last year he decided instead to build the hospital at the Washington Hospital Center.

Now the plan is to combine the Children's Hospital site with the old Thompson's Dairy site--on the block bounded by U and V and 11th and 12th Streets--and the Lincoln Theater between U and V into a project of housing and retail space to be called Samuel C. Jackson Plaza, named for the noted black attorney.

Cohen, who acquired the old dairy site last year and plans to take ownership of the theater within the week, is working with community groups to finish plans.

Construction should begin in about 18 months and could be completed in three to five years, he said.

Cohen also owns several smaller sites in the area, including the Manhattan Laundry several blocks away on Florida Avenue, which he said he may turn into a headquarters for local groups.

Other developers have not flocked to the area since the announcement about the municipal building, because of the economy or because they suffered in other areas being promoted by the city, Cohen said.

"I don't know that there has been much of an impact from the announcement except in terms of people's expectations," he said.

"The municipal office building is not a panacea," said Frazier-Cromwell. "But it is a positive step toward seeing a renewal both physical and spiritual."