D.C. area commercial real estate market was flat in the third quarter

October 13, 2013

Listless. Subdued. Tepid. Those were just a few of the adjectives used to describe the state of the Washington region’s commercial real estate market in the third quarter.

The federal government has played a large role in the lackluster market. Sequestration, the shutdown and the impasse over the federal budget are all exerting a drag. The Office of Management and Budget’s “Freeze the Footprint” policy, which prevents federal agencies from increasing the total square footage of their office space, isn’t helping either.

“All of those factors collectively have really handcuffed tenants and their ability to make decisions,” said Scott Homa, vice president of research at Jones Lang LaSalle. “There is a sense of paralysis in terms of activity in the marketplace, in terms of growth in the marketplace, but there are areas where we can see some optimism.”

But until the federal government makes some decisions, the wait-and-see approach is likely to continue.

“We need to get straight at a government level,” said Mike Ellis, mid-Atlantic market director of Jones Lang LaSalle, “and then hopefully the corporate level will start expanding their wings.”

Vacancies are going up across the region. According to Delta Associates, 1,122 buildings had at least 10,000 square feet of available space in contiguous blocks last month. That’s an increase of 51 buildings from September 2012. Half of that vacant space is located in Northern Virginia.

CBRE reported that office leasing velocity throughout the entire region was one-third less than the third-quarter average for the past three years.

Delta Associates predicts that rents will edge down slightly in the fourth quarter and stay soft in the coming year as vacancies remain elevated. Tenants who can afford it are capitalizing on the weak demand by upgrading to newer spaces and negotiating lower rents. Budget-minded companies are looking to renew their leases and consolidate their spaces rather than moving to a new space and incurring moving costs.

Jones Lang LaSalle believes the lack of new construction on the horizon as well as the number of leases expiring will likely rebalance the office market in the next two years.

“We’re seeing a demand issue in the commercial office space area,” Ellis said, “but most of the other [commercial real estate] areas are doing pretty well.”

Here’s a look at three areas in this region and how they fared:

Suburban Maryland

Total vacancy rates surged to their highest level in 14 quarters, according to a report by Jones Lang LaSalle. The 18.5 percent vacancy rate was driven by continued government renewals and weak private sector demand.

“It’s been very, very, very slow in terms of overall activity,” Homa said.

Increasing vacancies and declining rental rates are forcing landlords to re-brand their buildings to make them more attractive. An example of this trend is MRP Realty and Rockpoint Group, which bought the Air Rights Center in Bethesda earlier this year. Last month, the company said it would rename the building Bethesda Crossing, add a fitness center, redo the lobbies and improve energy efficiency.

No new development entered the market during the third quarter, and market conditions are limiting new projects. An inability to pre-lease sufficient space is preventing developers from obtaining financing.

CBRE predicts the vacancy rate in Montgomery County is likely to rise through 2014-15 because of federal lease consolidations.

Northern Virginia

Vacancy soared to its highest level in more than a decade, according to a report by Jones Lang LaSalle. The 18.7 percent vacancy rate was a result of a confluence of factors. After two consecutive quarters with no deliveries, eight buildings opened, totaling more than 1.5 million square feet. However, less than 18 percent of the space was pre-leased. 1812 N. Moore, a building in Rosslyn that’s the tallest in the region, was built without any pre-leasing. Meanwhile, sequestration’s impact continued to be felt as government contractors braced for the possibility of more spending cuts.

High vacancy rates were especially prevalent in Arlington County where the federal base relocation and closure process and the arrival of several new buildings have led the vacancy rate to balloon to 20.3 percent, its highest level in more than 20 years.

“Virginia was hit a lot harder than other markets throughout the region in terms of ill-timed deliveries,” Homa said.

The District

Vacancies were flat in the third quarter at 12 percent. Several federal leases were signed; however, all but one were short-term extensions. Private leasing was concentrated mostly among mid-size tenants. The higher education sector continues to be active as universities search for places to meet their growing need for space.

Although there are plentiful choices at 30,000 square feet or less, large spaces are in short supply. This has prompted large tenants, especially law firms, to enter the market well before their current lease expires, and they are downsizing in the process.

For instance, Keller Heckman, whose lease at 1001 G St. NW was set to expire in 2016, signed a renewal in the third quarter that reduced its footprint at that location by 18,000 square feet.

Kathy Orton is a reporter and Web editor for the Real Estate section. She covers the Washington metropolitan area housing market.
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