Washington, DC 1st Quarter 2008

Mixed Markets, Mixed Messages

Reality is a function of perspective. Landscapes appear drastically different from varying vantage points. For example, life is serene when sitting on the beach, but can be treacherous a few yards away in the surf. Likewise, the Metropolitan Washington, DC office market has a healthy glow when observed as a whole, but is going backwards in various submarkets.

“The Big Picture” is that the submarkets inside the Beltway remain strong while the outlying submarkets have weakened significantly. Overall, absorption (net increase of space leased) was barely positive last quarter totaling just 18,184 square feet. Inside the Beltway, absorption for the District of Columbia and the R-B Corridor (Rosslyn through Ballston) totaled approximately 1 Million square feet (DC absorbed 158,716 square feet and the R-B Corridor absorbed a whopping 826,478 square feet. At the same time, the combined absorption for Fairfax County and Suburban Maryland was negative approximately 1 Million square feet (Fairfax posted negative 685,536 square feet and MD had negative 363,235 square feet).

Meanwhile, average rental rates continued to rise. At year end 2007, the average asking office rental rate for the entire Washington, DC Metropolitan Area was $34.11. At the end of the first quarter, the average asking rent rose 34 cents to $34.45 per square foot. Why do rental rates continue to rise? The easy answer is because more Class A space continues to be delivered, raising the average. The more complex answer is that “asking” rents don’t fully reflect the final deal, operating expenses have risen rapidly and free rent and improvement allowance concessions are not included in this statistic.

As illustrated above, deliveries are outpacing demand. We continue to predict that the overall Metro Area vacancy rate could rise to 12% later this year. Provided that overall absorption remains positive, rents will hold firm. Should we experience an ebbing of demand, do not expect rents to go down, rather concessions will continue to increase.

McBride’s Rule for Softening Markets

Lagging Demand + Higher Construction Costs =

Greater Concession Packages.

But What Does It Mean?

As a company that only represents tenants, these changes in the market represent good news for our clients. More space equals greater competition among landlords for tenants, which equates to greater leverage when negotiating leases.

Due to lenders’ underwriting demands, it is difficult for landlords to offer discounted rents to compete for tenants. Therefore, the concession market must rise in order to attract new tenants to Class A buildings. In new Class A buildings in Downtown DC we have already seen tenant improvement allowances rise to $65 – $100 per square foot. In the suburban markets, we are starting to see a return to “turnkey” buildouts as landlords attempt to control buildout costs and attract tenants. The bottom line is landlords have significant incentive to put more money into their investments rather than to undermine the value of their assets by lowering rents or risking long term vacancies.