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Vacancy Rates, Asking Rents Hold Steady

By Dana Hedgpeth
Washington Post Staff Writer
Monday, November 13, 2006

Vacancy rates and asking rental rates remained relatively stable in the region in the third quarter, as the federal government, law firms, nonprofit organizations and financial service companies continued to lease space in the District and Maryland suburbs, and government contractors dominated the market in Northern Virginia.

The vacancy rate for the region was 9.5 percent, virtually unchanged from the same time a year earlier. Rents were up slightly, to $31.60 per square foot from $30.21, according to CoStar Group Inc., a Bethesda real estate research firm.

"For the quarter it's all about good news," said Sigrid Zialcita, research director at the real estate services company Cushman & Wakefield Inc. "It is still a positive picture for the D.C. region. We still have single-digit vacancy across the board, and the biggest story is that we have increases in rent."

The stability of the commercial office-space market comes as the local housing market has weakened. The region's top Federal Reserve banker recently noted that nonresidential construction is on the rise, with investment up 7.2 percent over the four quarters ending in June.

"Indeed, over the last year overall construction employment has actually risen by nearly 210,000 jobs even as housing activity has softened," Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, told business leaders at a D.C. Chamber of Commerce luncheon last month.

The District ranks in the top five cities across the country with the lowest vacancy rates, with a vacancy rate of 7.6 percent, compared with 7.7 percent in the third quarter of last year.

Some of the larger leases signed include the Department of Justice taking 465,000 square feet of space at Liberty Square on Fifth Street NW so it can consolidate some of its offices, and FTI Consulting Inc. is signing a lease for 94,000 square feet of space at 1101 K St. NW.

Vacancies could rise as there are large blocks of space available or becoming vacant in the coming months at such sites as the 500,000-square-foot building at the Portals project in Southwest, the Victor Building on 9th Street NW, where the Smithsonian Institution is expected to move out of office space next year, and 1101 K St. NW, a new building with roughly 200,000 square feet available.

"The question we're asking [landlords] is, 'Where do you think all these tenants are coming from?' " said Tom Fulcher, executive vice president at Studley Inc., a real estate services firm that specializes in representing tenants. "It's a healthy market, but there are a lot of options for our tenants. They're not desperate. The landlords should be a little more desperate."

Still, higher construction costs in such products as concrete and copper wiring have allowed landlords to increase average asking rental rates in the District to $42.16 from $41.10, according to CoStar. Those rental rates are the second highest in the country, following New York's Midtown area, where asking rents average $53.08 a square foot.

One building in the District that's commanding among the highest rents is 1101 New York Ave. NW, a new building where a law firm and a financial services company will pay between $66 and $68 a foot, including real estate taxes, utilities and other services. The building is expected to open in the coming weeks and tenants are to move in this summer. The high cost for top-quality office space is leading some tenants who are in less fancy offices to stay put, brokers said. Half of the 5 million square feet under construction is already pre-leased to law firms and the federal government.

In Northern Virginia, the vacancy rate barely changed, to 10.5 percent from 10.6 percent a year earlier. Rents rose to $28.79 a square foot from $27.43.

Government contractors and federal agencies have filled most of the office space in this market. Among the large deals were the FBI's lease for 165,000 square feet in Vienna, and government contractors Apptis Inc. leased 106,000 square feet in Chantilly, while consulting firm Accenture took almost 80,000 square feet in Springfield.

There are expectations that the activity, however, could decrease.

"What's slowing down is the level of procurement dollars that have flowed through our region," said Herb Mansinne, a senior vice president at Jones Lang LaSalle Inc. who represents landlords in Northern Virginia. "For the last five years we've seen dollars flow to agencies that do intelligence, customs, homeland security and contractors. We're projecting that next year those levels will be reduced. We haven't seen it yet but it's coming. The question is, will the private sector step up and lease more space?"

Many developers are betting on that, as they are building almost 6 million square feet of space in the next five years, much of it in the Reston, Herndon and Route 28 south markets. Most of that -- 5 million square feet -- is being built with no tenants signed up.

"There's eight or nine projects [being built without having tenants pre-lease the space] in the Dulles corridor," said John Shooshan, a developer in Northern Virginia. "There's too much supply and not enough demand. There's nothing to distinguish yourself out there. There's no hotel next to it. You're not near the Verizon Center or the Metro. There's no critical mass of amenities. All of the access is by car. It's just commodity real estate."

Maryland's vacancy rate barely changed, to 10.2 percent from 10.3 percent, while rents increased to $25 a square foot from $24.05.

The expansion of small and medium-size, private-sector businesses in such markets as Bethesda, Frederick and Gaithersburg -- a trend reflected in the areas' low unemployment rates -- has led these businesses to lease nearly 70 percent of the 3.1 million square feet of space that has been leased this year.

One of the most important trends in Maryland is that tenants are upgrading from lower-quality space to higher-quality spaces, according to Tonya L. Ginter, director of research at GVA Advantis. "Tenants that didn't have the financials a few years ago after the tech wreck are now in stronger positions and are graduating to upgraded office space," she said.

Vacancy rates in Prince George's County remained high at 13.4 percent; the area is still trying to attract more major government tenants.

Last year at this time there was a frenzy of commercial properties being bought and sold as investments, but that has slowed. Year-to-date sales volume in the District dropped to $2.3 billion from a record volume of $2.9 billion over the same period in 2005, according to figures from Cushman & Wakefield.

As sale prices for offices in the District remain high at $433 a square foot, investors are moving toward better bargains in Northern Virginia and Maryland, say investment sales brokers. Space in Northern Virginia and Maryland averages $290 a foot and $244 a foot, respectively.

Some large portfolios have sold in Northern Virginia, totaling $2.3 billion this year, compared with $1.6 billion in the same period a year ago. Those included the sale of the 1.2-million-square-foot Fair Lakes business park owned by Fairfax-based Peterson Cos. In Maryland, the level of investment sales is expected to hit record highs above $1 billion for the year.

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