Commercial Rents Keep Rising
2nd-Quarter Vacancy Rates Tighten as Job Growth Continues

By Dana Hedgpeth
Washington Post Staff Writer
Monday, August 14, 2006

Vacancy rates dropped slightly and rents rose in the Washington area's commercial office market for the second quarter of this year, as one of the nation's strongest office markets continued to benefit from job growth in government contracting, law and service-related industries.

The area's vacancy rate for the quarter was 9.3 percent, down from 9.9 percent during the comparable period a year earlier, according to Bethesda-based research firm CoStar Group Inc. Asking rents were $31.11 a square foot, up from $29.98.

Most major markets around the country have had declining vacancy rates, but New York and the Washington region are among the tightest markets, researchers said. The vacancy rate in New York for the quarter was 6.7 percent, and rents were $45.42 a square foot. In Atlanta, which is more typical, the vacancy rate was 14.4 percent and rents were $18.95.

As always, there were fluctuations within the Washington area.

In the District, the vacancy rate was 7.6 percent in the quarter, down slightly from 7.9 percent a year earlier. Rents rose to $42.16 from $40.76.

In the first half of the year, 1.9 million square feet of space was leased in the District. That exceeds the average 1.4 million square feet of space that is leased annually, according to real estate services firm Jones Lang LaSalle Inc.

The federal government, which had not been leasing large chunks of space for the past few quarters, signed three big deals, totaling 280,000 square feet at Patriots Plaza on E Street SW, a building that had been nearly vacant since it was built last year. The Justice Department is consolidating to offices at 450 Fifth St. NW, the former home of the Securities and Exchange Commission.

"There was a worry before this flurry of government activity that spaces wouldn't fill up," said John Sikaitis, research director at Jones Lang LaSalle. "Now that's being dissipated."

There was also strong demand from service-related businesses and law firms.

Of the 5.1 million square feet of space under construction in the District, 45 percent is pre-leased, according to Cushman & Wakefield, a commercial real estate firm. That's a sign, brokers and developers say, of continued demand in the market.

"Big tenants now have options for new buildings, where a year-and-a-half ago there weren't a lot of options like that," said Tom Fulcher, executive vice president at brokerage Julien J. Studley who represents tenants looking for space. "You feel more comfortable that there's a lot out there. The pressure has been released of having to continue to pay more and more rent."

So landlords of new buildings may find it difficult to demand rents high enough to compensate for skyrocketing construction costs.

Jim Donohoe, president and chief executive of Donohoe Cos., a major developer in the region, said costs of such items as windows, steel and roofing materials have gone up 20 percent in the past year as energy costs have escalated. "The cost of a new building is getting so high that the rents are not commensurate with the costs," Donohoe said. "Rents will go up, but it will take a little time to have pent-up demand that will pay the higher office rates."

Real estate professionals say prices paid for top-quality office buildings in the District are likely to retreat slightly after substantial increases in recent years. The average price to buy office space in the District is $700 a square foot, up 30 percent from last year, according to Cushman & Wakefield.

Tishman Speyer Properties of New York is reportedly prepared to pay $2.8 billion for the 26 office buildings in the District owned by CarrAmerica Realty Corp. New York-based Blackstone Group LP recently bought CarrAmerica and its entire portfolio for $5.6 billion, which valued its District buildings at about $2.1 billion.

"We're going to see market price increases really taper off metro-wide," said Sigrid Zialcita, research director at Cushman & Wakefield. "Is that bad? Absolutely not. We've reached record prices in the region, and now it's getting back to norm. We've just been very spoiled getting all those substantial increases. This is a market every investor wants to be in."

In Northern Virginia, the vacancy rate dropped to 10.4 percent from 11.4 percent in 2005. Asking rents were $28.40 a square foot, up from $26.87.

About 1.4 million square feet of new space was under construction in the second quarter, with much of it being built without tenants, according to Cassidy & Pinkard Colliers, a District-based commercial real estate services firm. Government contractor Northrop Grumman Corp. signed some of the largest deals, taking about 275,000 square feet of space in the Route 28 south corridor and Tysons Corner markets. Brokers in Crystal City did three of the largest leases, as they filled space left behind from the U.S. Patent & Trademark Office's move to Alexandria.

Rents have jumped more than 8.5 percent since the beginning of 2005, according to research from Jones Lang LaSalle. At Washington Technology Park II, a 250,000-square-foot building in Chantilly, an information technology company leased space for $25.50 a foot in March. Three months later, Northrop Grumman leased space in the same building for $28 a square foot, Zialcita said.

"There's a dwindling supply of large blocks of space in that area, and that's pushing up rates," Zialcita said.

In Northern Virginia, 7.6 million square feet of space is under construction. A large share of it is in the Reston-Herndon and Arlington-Alexandria markets.

"We're moving to a tipping point where we may have an oversupply and lack of demand in certain pockets beyond the Beltway," said John Shooshan, a developer in Northern Virginia. "We've had job growth of 75,000 to 80,000 a year in the region, but with interest rates rising and oil prices, too, you worry about the convergence of a drop in demand and oversupply."

But in Tysons Corner -- a 23-million-square-foot market that is one of the area's biggest -- there are few large blocks of space for a company that might need one. "It's crying out for someone to deliver a high-quality building," said Tony Womack, a senior vice president with Jones Lang LaSalle who specializes in Northern Virginia.

Maryland's vacancy rate dropped to 10 percent from 10.5 percent in the second quarter of 2005. Asking rents rose to $24.69 a square foot from $23.52.

The demand for office space came mainly from small, professional service firms in Bethesda and Silver Spring. Biotech firms and the National Cancer Institute leased space in Rockville. Four District-based companies in the venture capital and money management business are looking to pay $40 a square foot to sublease about 90,000 square feet of space in Mills Corp.'s new headquarters in Chevy Chase, according to brokers close to the deals.

In Maryland, 3 million square feet of space is under construction and much of it is being built without having tenants lined up. In Germantown, large blocks of space remain available because so many technology companies went out of business several years ago.