Office Building Deals Drop Off
Monday, August 11, 2008
In April, when a wealthy Irish investor bought the I.M. Pei-designed building at 2099 Pennsylvania Ave. NW for $173 million, or $867 a square foot -- a record for the District -- it appeared that the region's cachet and a weak dollar might keep the commercial real estate deals rolling.
But like much of the rest of the nation, the commercial real estate sector has been hit by the double whammy of a credit crunch and an economic slowdown.
In the District, $1.4 billion worth of office space traded hands in the first six months of the year, a 61 percent drop from the $3.6 billion sold by mid-2007, according to Real Capital Analytics of New York. The drop-off was even more pronounced in Northern Virginia, where building sales plummeted 87 percent, to $914 million from $6.8 billion a year ago. In Maryland's suburbs, building sales fell 13 percent, to $459 million from $527 million.
"The commercial real estate game doesn't work without debt, and it is very hard to come by these days on attractive terms," said Dan Fasulo, research director for Real Capital.
Other cities have faired similarly. Manhattan, the nation's biggest office market, saw a 59 percent drop, to $6.4 billion from $15.5 billion. Deal volume fell 60 percent in Los Angeles, to $1.84 billion from $4.65 billion. Chicago had a 23 percent drop, to $1.7 billion from $2.2 billion.
Although Washington's economy is still growing, with a 3.9 percent unemployment rate and 25,300 jobs added in June, the pace has slowed. That has made the companies that lease office space more cautious and less willing to take new space.
A total of 6.5 million square feet of office space was leased throughout the Washington area in the second quarter, a 10 percent decline from the same period last year, according to the Bethesda research firm CoStar. The majority of those deals were tenants renewing their leases, said John Sikaitis, research director for the Washington area office of Jones Lang LaSalle.
Although the area's vacancy rate ticked up to 11.3 percent from 9.9 percent over the past year, the average asking rent in the Washington area continued to increase, though at a slower pace than in past years. The average price for a square foot of office space was $34.02 at the end of the second quarter, a 3 percent increase.
"There is a notable decline in tenant demand, but you still have rents at their peak rates," said Sigrid Zialcita, director of research at Cushman & Wakefield. But "if things don't change in the economy, or things get worse, rents will have to go down."
Several office developments were launched in recent years throughout the region. About 14.9 million square feet of office space remained in the development pipeline at the end of the second quarter.
In the District, about 8.1 million square feet of office space remains in development, with new buildings rising in traditional downtown spots as well as in emerging neighborhoods such as NoMa (north of Massachusetts Avenue) and around the new Nationals ballpark.
Some of these projects have been in high demand, such as Vornado/Charles E. Smith's 1999 K St. NW, slated to be rented to law firm Mayer Brown when the building is completed next year. Others are completed and have yet to land tenants, such as a 326,000-square-foot project by Brookfield Properties at 77 K St. NE.
The biggest of these projects is the 1.4 million-square-foot renovation of the Department of Transportation's former headquarters at 400 Seventh St. SW by its owner, District-based David Nassif Associates. That building has no tenant lined up but will not be completed until the end of 2009.
The economic downturn is playing out in different ways in the region. Dense areas with access to Metro maintained low vacancy rates and had rent increases in the second quarter. More suburban markets have had bigger upticks in vacancies, and in some, rents have fallen.
The vacancy rate in the District edged up slightly at the end of the second quarter, increasing to 8.8 percent from 8.5 percent one year ago. With space tight, developers and building owners increased rents 5 percent, from $45.19 to $47.45 a square foot.
Similarly, the Rosslyn-Ballston corridor had a vacancy rate of 8.5 percent at the end of the second quarter, up from 7.8 percent the year before. Rents there increased 3.6 percent, from $34.66 to $35.91. JBG Cos. plans to break ground this year on Central Place, a 521,000-square-foot office building above the Rosslyn Metro station.
The Reston and Herndon area, which in the past few years has seen a wave of speculative development (development with no tenants lined up), saw its vacancy rate jump to 16.7 percent from 11.1 percent, with asking rents declining 1.2 percent from $31.45 to $31.07 a square foot. New projects there are unlikely, Zialcita said.
A similar picture emerged in the office market along Route 28, south of Dulles International Airport. Before federal contracting began moderating, developers built speculative office space in the area anticipating that defense contractors would take it. Leasing has been slow in the area. The vacancy rate improved slightly to 19.2 percent from 19.6 percent, as rents declined 2.4 percent, from $28.82 to $28.12 a square foot.
Time Warner Cable gave the Dulles area a shot in the arm last month, after the second quarter's end, leasing about 195,000 square feet. The cable company took a building at the South Lake at Dulles Corner, a 10-story building in Herndon.
In Maryland, demand for office space tapered off with a dip in financial services jobs and a sluggish biotech industry, said Rob Hartley, director of research for the firm C.B. Richard Ellis.
Montgomery County's vacancy rate increased to 10.4 percent from 8.9 percent, and rents increased 4.3 percent to $29.74 from $28.46 a square foot. The vacancy rate in Prince George's County has increased to 17.2 percent from 13.3 percent over the year, and asking rents fell by 2.1 percent to $22.46 from $22.94 a square foot.
Morgan Sullivan, a senior vice president with Jones Lang LaSalle, said that Prince George's County has fewer national business than many other markets, making it particularly vulnerable to the housing and economic downturn.
"With the overall sluggishness of the national economy and the housing downturn, financial firms and residential real estate firms are really struggling so that a number of them have gone out of business and returned their space to the market," Sullivan said.