Washington, DC Year End 2005

No Sign of Cooling

2005 was a banner year for the Washington, DC Metropolitan Area on many fronts. Demand continued to outstrip supply, causing the inexorable decline of vacancy rates and rising rents. The last quarter of the year was the 10th straight quarter for lower vacancy rates and the first quarter in this cycle that the vacancy rate for Maryland has dropped below 10%. This continued strength of the office leasing market has only put more fuel on the fire of the investment market. To wit, average cap rates for building sold 4Q05 were 6.9% compared to an average cap rate of 8.08% a year prior. Given the potential for higher returns in the stock market, it will be interesting to see how investor demand is affected and where cap rates end up a year from now.
For the year, we saw 11,668,899 square feet of total absorption (2,336,273 square feet in the 4th Quarter) and a year end market wide vacancy rate of 9.2% (down from 9.5% in the 3rd Quarter). By market, the vacancy rates were 7.6% (6.7% direct and 0.9% sublet) in DC, 10.1% (8.8% direct and 1.3% sublet) in VA and 9.6% (8.6% direct and 1.0% sublet) in MD.
All signs point to a robust, but balanced market for at least the next several quarters. For example, almost 16 Million Square Feet of new office space will deliver over the next 4 quarters with approximately 47% of that space already preleased. Barring any dramatic decrease in demand, rental rates should remain steady, and may rise slightly. Employment indicators show that demand should remain strong and there’s no huge oversupply of space poised for release, in spite of the significant amount space being delivered this year. However, should demand flatten, the overall vacancy rates may increase slightly (< 1%) in 2006.

But What Does It Mean?

We are fortunate to live and work in a market experiencing ideal conditions for sustained growth: For the time being, our commercial real estate market is enjoying balanced supply, continued expansion with steady, but modest rental escalation.
However, as a tenant, low vacancies rates and escalating rents pose a real estate management challenge. In this type of market, competition among multiple tenants for space will become more prevalent. The particular challenge for tenants is executing a successful strategy for creating and maintaining leverage throughout lease negotiations. Under these conditions, we find that the most successful tactics are: start early; look hard for weaknesses in the market (i.e. CBD for smaller tenants, Midtown & Crystal City for larger tenants); and emphasize the desirability of the tenant organization to the prospective landlords.
At the end of the day, competition amongst various options is the key to getting the best lease terms. Whether your organization is planning to renew or relocate, it’s imperative to find ways to include competitive opportunities. If you’re located in a particularly “tight” submarket, the best way to create more competition with your existing location is to start the process earlier or consider space in different submarkets. For example, if your organization requires less than 20,000 square feet in the District, there are still numerous opportunities in the Central Business District. If your needs are significantly larger, especially if you’re currently located in Northern Virginia, considering Crystal City as an alternative will greatly increase your options and bolster your leverage to negotiate with many landlords.