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Regional Office Leasing Activity Lowest Since 1995

By Alejandro Lazo
Washington Post Staff Writer
Monday, May 19, 2008

Demand for office space in the Washington region continued its decline in the first quarter, with leasing activity dropping to its lowest level in more than a decade.

Despite high-profile deals in the District's NoMa neighborhood in Northeast, with National Public Radio announcing it will build a new headquarters there and the Department of Justice leasing a building under construction, the Washington area had its slowest leasing period since the second quarter of 1995, according to data from CoStar, a real estate research firm in Bethesda.

Analysts said companies were increasingly wary of committing to space in the midst of a slow economy.

"Market activity is dramatically slow," said Robert Hartley, director of research for the Washington office of the commercial real estate firm CB Richard Ellis. "People are just not stepping up, and not a lot is going on. . . . You have had some really exciting news from a handful of groups, but it still continues to be pretty uncertain."

In the first three months of 2008, 6.3 million square feet of office space was leased, compared with 7 million in the first quarter of 2007. That decline of 10 percent comes as developers are finishing projects financed in the years of the boom. Some 131 buildings with about 14.4 million square feet of office space were under construction in the region at the end of the first quarter, according to CoStar. The downturn in leasing combined with the developments in the pipeline could create a glut, analysts said.

"What I am wondering is, with supply coming online so much faster than demand, who is really going to step up and take that space?" Hartley said. "There are still a lot of people talking about continued development, and that is a little worrisome. We really need to see a lot more activity from all sectors. We need to see more government leasing, we need to see private-sector leasing."

The Washington area's vacancy rate at the end of the first quarter was 11 percent, up from 9.8 percent at end of the first quarter in 2007.

While average asking rents in the region increased by 2.1 percent in the first quarter, to $33.95 per square foot from $33.24 per square foot at the end of 2007, analysts said concessions such as months of free rent and extra money to build out interiors are increasingly common components of deals, lowering the true amount tenants are paying for space.

"Even in D.C., where free rent was not offered in the last five years, a new deal has anywhere between three to 12 months of free rent," said Scott Homa, research manager for Jones Lang LaSalle.

More companies in the area are also choosing to stay put rather than risk leasing new space, according to a report released last week by Jones Lang LaSalle.

The report analyzed leases bigger than 20,000 square feet that were completed in the District and Northern Virginia in the first quarter. It showed that 42 percent of those deals were renewals, compared with a historical average of 27 percent.

The report cited the increased cost of building out interiors due to rising commodity prices as a big reason tenants are staying put. The uncertain economy was another factor. The net result has been a slower market, said John Sikaitis, director of research for Jones Lang LaSalle and a co-author of the report.

"Renewals don't move the market; renewals keep the market stable," Sikaitis said. "So the renewal activity has created some depressed confidence in the overall market."

The District has had some positive news. The law firm Arent Fox said last week that it would move its office one building over, from 1050 Connecticut Ave. NW to 1000 Connecticut Ave. NW, when its lease expires in 2012. The former building at 1000 Connecticut Ave. is nearly demolished. A 370,500-square-foot, 12-story office building will rise in its place, with Arent Fox taking floors two through nine.

Also last week, developer Boston Properties said it would break ground Friday on Square 54, a mixed-use, 2.5 acre, town center at 2200 Pennsylvania Ave. NW, adjacent to the Foggy Bottom-GWU Metro station. The development will include retailers, a grocery store, apartments and office space.

The District's vacancy rate was 9.1 percent at the end of the first quarter, up from 8.5 percent at the end of the first quarter of 2007, while average asking rents increased to $47.45 a square foot, from $44.13.

The vacancy rate ticked up in parts of Northern Virginia, particularly in Reston and Herndon, where 15 new buildings totaling nearly 2.8 million square feet of office space have risen since 2005, the majority of which were built without tenants lined up. With leasing slowing, the vacancy rate in Reston and Herndon edged up to 15.4 percent at the end of the quarter, compared with 11.2 percent a year earlier.

"Everybody is trying to figure out when the market is going to turn," said Michael Vardell, the developer of Overlook Towers Phase I, a nine-story, 217,000-square-foot office building completed in Herndon last year that now sits empty. "I think developers, in their nature, are optimistic people, but certainly current conditions are testing that."

In the office market along Route 28 South, where developers began building on speculation in 2005 while expecting a wave of defense contractors to expand into the area, the vacancy rate was 17.9 percent, an increase from the 11.9 percent rate of a year ago.

In the Maryland suburbs, demand for office space also tapered off. The vacancy rate in Prince George's County was 17.1 percent, up from 14.8 percent. Montgomery County's vacancy rate increased to 9.8 percent from 8.9 percent.

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