Office Vacancies Creep Upward
Supply Outpaced Demand in Some Areas

By Allan Lengel
Washington Post Staff Writer
Monday, March 5, 2007

Vacancy rates inched upward in the Washington area commercial office market for the fourth straight quarter, ending in December, as new buildings opened and demand eased slightly.

Experts said the market overall remained strong, propelled by a steady infusion of new jobs and the federal government's continued hunger for space. But some raised cautionary notes about such areas as Capitol Hill and Northern Virginia's Dulles corridor, where vacancy rates top the region's average, and large chunks of additional office space are under construction and about to come on the market.

"The supply is ahead of the demand in those markets. I think over time it will be absorbed. I think it just may take more time than people hope," said Tom Fulcher, executive vice president at Studley Inc., a commercial real estate brokerage that represents tenants.

Overall, the Washington office market, which includes the District, suburban Maryland and Northern Virginia, recorded a vacancy rate of 9.6 percent in the final quarter of 2006, compared with 9.3 percent in the third quarter, 9.2 percent in the second and 8.9 percent in the first quarter, according to Bethesda-based research firm CoStar Group.

Sigrid Zialcita, research director at Cushman & Wakefield, a commercial real estate firm, said the creeping vacancy rate in 2006 represented a normal fluctuation in the market, and was probably caused by the influx of new buildings and "a moderation of demand for office space."

"It's no cause for concern, it's a very healthy market," Zialcita said. "The market is one of the healthiest in the U.S."

During the fourth quarter, 22 buildings totaling 3.5 million square feet were completed in the region, compared with 33 buildings totaling 2.6 million square feet in the previous quarter, according to the CoStar report. The bulk of new buildings were in the District and Northern Virginia.

The change in occupied space -- known as the net absorption rate, a measure of the market's health -- grew in the fourth quarter from the third. Tenants occupied 1.7 million more square feet of space in existing buildings, up from 1.4 million, according to the CoStar report.

The District had a positive net absorption rate of more than 1 million square feet in the fourth quarter, compared with a positive rate of 926,267 square feet in Northern Virginia and a negative figure of 219,560 square feet in suburban Maryland, which is normally considered the softest of the three markets.

The fourth quarter had its share of buying, selling and general movement.

Giant Food vacated 192,000 square feet of office space in the Landover area; United Airlines moved out of 120,000 square feet in the Route 28 corridor in Fairfax County; and FEMA moved out of 121,404 square feet in Hyattsville in Prince George's County.

On the up side, Northrop Grumman, the global defense and technology company, moved into 242,000 square feet in the Dulles corridor; National Cable and Telecommunications Association moved into 52,911 square feet in the District; and the law firm of Venable, Baetjer, Howard & Civiletti took over 38,200 square feet in Tysons Corner.

The healthy job market in the Washington area helped fuel the upbeat commercial market, which contrasts with the lackluster residential real estate market. This year alone, the region is expected to add 33,500 jobs, according to an analysis from Studley.

What happens on the federal level could affect those estimates. Fulcher said the recent change in political leadership in Washington is giving pause to some government contractors who are watching to see whether the Democratic leadership tries to reel in spending to cut the federal deficit, which could result in a decrease in demand for office space and services.

"It's an important part of the economy," Fulcher said of the government leases. "I think it's just a concern. When you bring someone new in as the head of the defense appropriations committee, there's a level of uncertainty that makes people uncomfortable."

In a random survey of 10 major U.S. markets over the past five years, Washington ranked second with a cumulative employment growth of 14.9 percent, behind the Tampa/St. Petersburg market with 24.7 percent, according to CoStar.

Office-building sales were up in 2006, compared with the previous year, according to the CoStar report. In the first nine months of 2006, there were 339 sales of office buildings totaling $6.7 billion, amounting to an average $218 per square foot. That compared with 328 sales totaling $6.2 billion, or an average of $195.66 a square foot during the comparable period in 2005.

One of the biggest commercial office transactions in 2006 involved a sale-lease buyback of Human Genome Sciences' 950,912-square-foot building in Rockville. HGS sold the building for $425 million, or $446.94 per square foot, then leased it from the new owner, Biomed Realty Trust of San Diego.

The biggest lease signings in the fourth quarter included: DFI International, a management consulting service, which signed for 102,568 square feet in the Ballston area; the American Diabetes Association, which signed a renewal and expansion for 78,000 square feet in the Interstate 395 corridor; and the Department of Homeland Security, which signed a lease for 76,987 square feet in the Ballston area.

As for vacancies, the District had a 8.1 percent vacancy rate in the fourth quarter, 7.5 percent in the third quarter and 7.1 percent a year ago. The hike was the result of an infusion of new office space, according to CoStar.

In Northern Virginia, the vacancy rate inched up to 10.3 percent in the fourth quarter from 10.2 percent in the third. In suburban Maryland, the vacancy rate was at 10.5 percent in the fourth quarter, up from 10.1 percent.

In all, 130 buildings -- or 16.3 million in square feet -- were under construction in the Washington market at the end of the fourth quarter and 37 percent of that was already pre-leased. The breakdown included 41 buildings in the Dulles corridor, 16 in the Leesburg/Route 7 corridor, 11 in downtown Washington, 10 in Frederick and five in the Capitol Hill area.

Fulcher, the executive vice president at Studley, said the 37 percent pre-lease figure was a "very strong number."

Overall, asking rents rose to $32.36 a square foot in the fourth quarter, up from $32.10 the previous quarter. Fulcher said rental prices are likely to increase. And even if there's an economic bump in the road, he said, prices probably won't decline. Landlords are more likely to offer concessions such as free rent for a limited number of months.

In the District, an appetite for office space persists, pushing up rents, a Studley report said, and the same is true in suburban Maryland, particularly in highly desired areas like Chevy Chase, Bethesda and Silver Spring.

In Northern Virginia, the report said, the market "will continue to garner interest from tenants in the District looking for more affordable space options."

"However, there is still some unease over the amount of speculative construction in Northern Virginia, particularly outside the Beltway," the report said.