CoStar: District expected to see uptick in office vacancies

February 26, 2012

Expanding businesses continue to bring down vacancy rates in most downtown office markets, including Washington, where the vacancy rate has decreased from a peak of 11.8 percent in mid-2010 to 10.6 percent at the end of 2011.

However, while leasing momentum in other downtown office markets continues to build as the economic recovery progresses, in D.C., leasing momentum is stalling, largely because of uncertainty surrounding federal spending and the 2012 election.

Some may see a bit of irony in this after the Washington office market escaped the Great Recession relatively unscathed. Many major cities saw numerous business tenants downsize, causing vacancies to increase. Meanwhile, in Washington, expanding federal agencies moved into local office buildings, keeping vacancies down. In a ranking of the largest downtown office markets around the country, D.C. ended 2011 with the second lowest vacancy rate behind New York.

CoStar Group’s forecast calls for office vacancy rates to decline in the downtown office markets of Seattle, San Francisco, Boston and New York in 2012, but D.C. and Chicago are projected to see a slight uptick in vacancies. Rapidly expanding tech firms are filling existing vacancies in Seattle and San Francisco. Businesses in Boston’s and New York’s downtown office markets tend to come from a broader spectrum of industries, and a slow but continued recovery in the financial sector should allow vacancies to decline in those markets.

Downtown Chicago is grappling with an outsized amount of “shadow” office space, space that is leased by a company (and therefore not counted as vacant) but sparsely occupied, with numerous empty desks due to layoffs in recent years. Together with a relatively sluggish job growth forecast in Chicago, office vacancies are not expected to decline quickly. Some large tenants have been renewing leases for less square footage, resulting in a net loss for the market.

In Washington, a few major office buildings are expected to be completed this year, including 1000 Connecticut Ave. NW and the NPR headquarters on North Capitol Street NE. However, net new demand for space is expected to be very weak. The General Services Administration is no longer taking down large blocks of office space as it did in 2010, and government-related enterprises are hesitant to expand in such an uncertain environment. As a result, we expect new supply of office space in D.C. to outpace new demand, causing the vacancy rate to increase to 11.2 percent at the end of the year, higher than the expected year-end vacancy rates in Seattle, San Francisco and Boston.

With vacancies expected to rise, rental rates in D.C. and Chicago will remain under pressure this year. New York and San Francisco, which historically experienced some of the most volatile office rents in the nation, have the strongest projected rent growth for 2012 — each with about 7 percent growth anticipated. Nevertheless, asking rents in Washington will remain the second most expensive of the group, even during a sluggish year.

Stephanie Hession is a senior real estate economist with CoStar Group in Washington.

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