Washington, DC 1st Quarter 2009

Riding Out A Tempest

Even if you’re safely tied up in a hurricane hole, you’re still going to incur some damage before the skies clear and the seas calm. While Washington, DC is relatively well protected from the financial tempest raging through the rest of the country, this area is still getting banged around. Compounding our problems are the cross seas of general nervousness and uncertainly generated by heaping doses of dire news. Worrisome economic news reported during the first quarter included 23 bank failures and the Bureau of Labor Statistics release of national unemployment figures that jumped over 600,000, bumping the unemployment rate to 8.5%. Unemployment is expected to increase nationally over the next few months and could climb to as much as 10%. No matter how well local companies are doing, it’s making everyone very nervous and resulting in delayed decisions by businesses.

The silver lining to our storm cloud is the massive amount of federal funding that will flow through this region. The Washington Post estimates that our local economy will have to add 50,000 new jobs in order to support the administration of government stimulus programs. However, we estimate that it will take another 3-5 months before the impact of the stimulus funds is felt locally.

In the first quarter of the year, the Washington DC office market shrunk by the largest level in more than 15 years, recording almost 1,000,000 square feet of negative absorption1. In the span of 6 months, the District of Columbia reached over 1.5 Million square feet of negative absorption, while the vacancy rate has risen from 8.3% to 9.8%. Outside the Beltway, the suburban markets reversed their recent negative trend with approximately 200,000 square feet of positive absorption. In spite of the modest amount of space sopped up in the suburbs, the vacancy rates in the suburban markets increased to 13.4% (due to deliveries of new space.) Overall, the Metropolitan area vacancy rate rose to 12.3%.

Our take is that the market is going through an equalizing process. Rents for new DC buildings are more than double those in the suburbs. The vast majority of vacancies are in new Class A Buildings. The tremendous rental variance and space availability in the suburbs resulted in short-term suburban growth and downtown contraction. As a result, we are seeing a downturn in effective rental rates to the order of approximately 5%.

Looking ahead, over 11 Million square feet of new space is still under construction. Although some of it is has been pre-leased, vacancy rates will continue to rise and effective rental rates will continue to come down.

But What Does It Mean?

* Vacancies have increased within the District of Columbia.
* The “Class A” Market is softest.
* Effective rental rates have decreased by more than 5% as concessions have increased and coupon rental rates are lower.
* Construction costs dropped by 20-25% over the past 6 months resulting in effective rates dropping by more than 10% over the last quarter.
* Effective rental rates should continue to drop for the next 3-5 months, then rebound as employment ramps up to administer the federal stimulus funds.

* For those looking to take advantage of the downturn to buy a new home, the good news is that mortgage rates are extremely low. The bad news is that residential prices have not softened significantly for well located (inside the beltway) properties.

* This is a great time for tenants to be in the market. Virtually every submarket in the Washington, DC Metropolitan area is abounding with excellent short-term and long-term leasing opportunities. The slowing economy and softer market has created very good conditions for our clients. On the other hand, subleasing excess space has become more challenging. Over the next 12 months we expect to see continued softness in the Class A market throughout the Metropolitan area. Some business sectors may keep demand strong, especially for submarkets inside the Beltway. Washington will be one of the main beneficiaries of the Treasury’s “Rescue Plan,” and the management of the government’s stimulus packages. The result will be more legal and lobbying work as well as a greater presence by financial institutions in DC to interact with new partners in the federal government.

1 Absorption is the net change in occupied space over a given period of time. For example, if an organization vacates 10,000 square feet of leased space and moves into 12,000 square feet of space, the result is 2,000 square feet of positive net absorption. If an organization vacates 10,000 square feet and moves into 8,000 sq. the result is 2,000 square feet of negative net absorption.