Washington has long been considered one of the stronger office markets in the country. Pension funds, insurance companies and other institutional investors continue to put capital into the region’s premier office buildings, willing to pay top dollar for solid tenancy and the higher rents these buildings command.
However, the office investment picture is more complex than the high-profile transactions that dominate the headlines would suggest.
Bidding wars for trophy-class office properties in the District highlight the fact that demand for the best buildings has outpaced the number available for sale. With competition so fierce, the pricing premium paid for the cream of the crop has jumped significantly.
Since 2012, four- and five-star properties have traded at a 115 percent premium compared with the average price paid per square foot for all office buildings sold in the region. This premium is far higher than the 60 percent premium paid for such properties at the peak of the previous cycle from 2005 to 2006.
The flood of foreign buyers into the D.C. office market is partly responsible for the price increase. Just last month, Fosterlane Management Co., a U.S. investment subsidiary of the Kuwaiti Investment Authority, purchased Metro Center One for $822 per square foot. That acquisition follows its June 2013 acquisition of 1200 19th St NW for $886 per square foot.
The National Pension Service of Korea, Mitsui Fudosan, Qatar Investment Authority and the Norwegian Government Pension Fund have all added D.C. properties to their portfolios in recent quarters. In addition, established players such as Tishman Speyer and Washington Real Estate Investment Trust continue to seek out high-end office property in the area. Such buyers tend to favor stability and predictable returns over a longer investment period.
In the D.C. market, rents for four- and five-star office buildings in the east end and the central business district neighborhoods average more than 20 percent higher than asking rents for three-star offices. And, the vacancy rate is nearly three percentage points lower than the overall market average, at about 11 percent.
Because market fundamentals for the core four- and five-star properties are much healthier than those for broader D.C. market, it’s not surprising that institutional investors are willing to pay a premium for them. Investors with the necessary capital and flexibility to compete in bidding wars for the trophy-quality assets seem to be comfortable with more conservative returns.
Meanwhile, lower quality office properties are facing elevated vacancy levels and limited prospects for rent increases any time soon.
Charlie Schwieger is a real estate analyst and Ethan Vaisman is a real estate economist with CoStar Group in the District.