When the clock strikes midnight tomorrow, it will signal the start of the third year of a slumping market for commercial real estate in the Washington area.
From the Ground Up posed five key questions about the year ahead to three people whose job is to analyze and understand real estate trends in the region: David G. Houck, the senior vice president in charge of the Washington office of the Staubach Co., a tenant brokerage; Jay Olshonsky, managing director for the Washington area for brokerage CB Richard Ellis; and Mary Petersen, a senior vice president of Cassidy & Pinkard and veteran researcher of local commercial real estate.
The three disagree on some nuances of what the year ahead will look like, but largely agree on the big question; all three describe 2003 as unlikely to be either good or bad for real estate in Washington. The overall outlook, they each say, is largely flat, with risks ahead.
QWill the severely depressed market for real estate outside the Capital Beltway in Virginia show any signs of life in 2003?
Houck: "It's entirely dependent on the economy. It depends on whether venture capital money comes back, whether telecommunications companies come back. And my opinion is that the tech sector is going to remain in its current condition, however you would describe it, flat. And I think real estate will follow that."
Olshonsky: "I'm hoping it doesn't deteriorate any more, but I think it's going to be flat to a slight increase at best. What's out there will be mainly government contracting and government use. There's not much happening in the private sector now."
Petersen: "There are going to be some space requirements, but a lot of that is driven by leases expiring, not new demand. There could be some federal government impetus, as Virginia is where the big blocks of space are. I think Northern Virginia always tends to recover faster than people think it's going to, but it could still be a tough year."
For more than a year, the commercial real estate industry has hoped to see strong demand for office space driven by the federal government and its contractors. Will it finally happen in 2003?
Olshonsky: "I think it's coming, but I don't think it's going to make any significant difference in vacancies. It's not going to be the 10 million square feet of space a year we would need to match the private-sector growth in Northern Virginia we were getting a few years ago."
Petersen: "You can have expansion in government contractors with a lag before it affects the real estate market. They're just revving up again, and hiring employees, getting security clearances, winning contracts, that all takes time. That lag could continue for part of '03, certainly."
Houck: "Certainly transactions will occur, but I'm not convinced that government contractors are going to be the savior of markets outside the Beltway, and markets inside the Beltway are in pretty good shape already."
The leasing market in the District and inner suburbs has been weaker than it was a couple of years ago, but strong compared with most other cities and with the outer suburbs. Will that change in the coming year?
Petersen: "Downtown is still a very stable market, but it has definitely softened. Tenants in the 5,000- to 50,000-square-foot range are still being very cautious about spending. Their businesses aren't growing for the most part, and they have to be really careful about expenses. We're seeing activity going out three and four and five years, but not much growth in demand in the near term."
Olshonsky: "I don't think it will get significantly better or worse. It's very flat."
Houck: "In D.C., the associations, the lobbying firms, the public affairs firms, even law firms have a pretty good business. And leases always expire. So I think the D.C. market will just remain steady."
Sales of buildings have boomed this year in the District and inner suburbs, despite soft leasing activity. Will investment sales turn out to be the next bubble to burst?
Petersen: "Investors are willing to accept low returns right now. If you're making 7 percent on a stabilized real estate asset tossing off cash, that looks great compared to a double-digit return from stocks that has parentheses around it. You look great. And interest rates are very low. So current prices might make sense if you're a long-term holder, but if you're looking to flip your building, the problem is that if interest rates go up, you won't be able to sell your building for as much."
Houck: "Will that bubble burst? If interest rates start rising, the pricing will change. Investors look at our market now, and know it's expensive to get in, but don't have many choices on where to place investment dollars right now."
Olshonsky: "I think prices will maintain themselves. If you're a pension fund right now, buying an office building that's fully leased five blocks from the White House looks awfully good compared with your alternatives."
We've seen very few foreclosures on buildings in this slowdown. Now that we're entering year three of the down market, will we start to see more landlords forced to give up the keys to under-performing buildings?
Olshonsky: "We've seen very few foreclosures -- yet. I think if we get any upward movements in interest rates, and continued flat demand that we're in now, there are some buildings where you'll see that situation. Certainly by the middle of 2003, starting in the outer suburbs, then moving in."
Petersen: "That could certainly happen. Landlords had more realistic expectations going in, cash guarantees, and so on. But as we go into another year of slow demand, some of that cash is going to burn off."
Houck: "Inside the Beltway, there aren't many highly leveraged entrepreneurial owners. It's large institutions that may choose to sell at a loss, but they won't be foreclosed on. There are developers further up the 270 corridor and out near Dulles Airport who may be forced to sell, but even out there, in the suburbs, the ownership is much more stable than it was in the late '80s."
Neil Irwin writes about commercial real estate and economic development every week in Washington Business. His e-mail address is email@example.com.