This much is clear: commercial real estate faces uncertainty

July 8, 2012

Uncertainty is in the air in the nation’s capital, and the impact on commercial real estate is clear, especially in the office sector.

While regional vacancy rates for retail and industrial property have been more or less in line with the broader national market, the region’s office vacancy rate has not followed suit. Office vacancy in the Washington region has increased even as the national office vacancy rate has been ticking down incrementally over the past eight quarters.

Federal spending austerity means that the General Services Administration is reducing its leasing footprint. Contractors heavily reliant on federal procurement are cutting their payrolls and returning office space in anticipation of a shrinking top line.

Northern Virginia has been the most heavily impacted in the region. In the Rosslyn-Ballston and Interstate 395 corridors, both teeming with government and contractor workers, vacancy rates have increased as tenants gave back nearly 3 million square feet, on the aggregate, during the past year.

A bright spot in the office market: the District is proving to be a tenant favorite. Vacancy rates in D.C. proper have slightly improved during the past year, despite nearly one million square feet coming on line. Over the past four quarters, tenants have soaked up 8.8 million square feet, and with downtown vacancies tightening up, landlords have gained a little pricing power, and rents are up 1 percent over the past year.

The same uncertainty affecting the GSA leasing sector also appears to be spooking investors, as year-over-year office sales volume has decreased each quarter since last year. Indeed, during the first half of 2012, office investors acquired $2.3 billion in property in the nation’s capital, off 40 percent from the $3.8 billion in investment activity during the first half of 2011.

Pricing is also cooling. So far this year, office properties are trading for an average of $305 per square foot, down 11 percent from the $344 average during the first half of 2011.

The prospect of reduced business travel and softer employment in the region may also be affecting investor interest in hotels and apartments. Multifamily investment activity is off by nearly $500 million this year in comparison to the same time last year, a 23 percent year-over-year drop. Buyers have been less active snapping up hotel properties this year as well, with investment activity off by 34 percent in 2012.

However, whether investors view the Washington’s commercial real estate market as being half empty or half full may well depend on one’s perspective. As risks weigh on the Eurozone and the threat of recession looms over China, some investors see the metropolitan area as a relatively safe haven.

Just last week, Brookfield Office Properties plunked down $106 million for 799 9th Street NW ($506 a square foot), a 96 percent occupied high-end office building. Earlier this year, The Trump Organization was selected to redevelop the Old Post Office Pavilion after committing to investing more $200 million in its conversion to a luxury 250-room hotel with restaurants, spa amenities and conference facilities.

Investors are clearly not as bullish on the nation’s capital as they were in 2010 and 2011, but it appears that the hazard of investing in commercial real estate here is perceived to be low compared to other international gateway cities.

Erica Champion is a senior real estate economist with CoStar Group in Washington.

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