Washington DC 4th Quarter 2009

The Opportunities of Uncertainty

For those that are ready to act in pursuit of an objective, uncertainly creates openings that aren’t normally available. This principle works effectively on many levels, from martial strategy to business negotiations. The current market continues to present plenty of uncertainty for tenants and landlords alike. The question is how will your organization take advantage of these opportunities while the market remains decidedly tenant friendly?

We believe that vacancy rates in our region have peaked and we will be feeding off of the oversupply for the next 3 years. However, the prime window of opportunity will remain open for the next 12 months or so as the best space in the current inventory is absorbed. There are still new office buildings under construction (almost 6 Million square feet) but new building starts have ceased. Six million square feet of new may sound like a lot of space, but it’s only 1.3% of the DC Metro inventory and much of this has already been pre-leased. Therefore, 2010 presents an ideal time for tenants to put uncertainty to their advantage for two key reasons: high vacancy rates and no new project starts.

The vacancy rate for the DC Metro Area has held steady at 13.3% for the past 2 quarters. Absorption was strong in the last quarter as almost one million square feet of additional space was leased while just over one million square feet was delivered. For the year, absorption across the DC Metro Area totaled a negative 360,000 square feet. The District was the biggest loser of 2009 in the DC Metro Area, shedding over 440,000 square feet of office space. Rental rates may not have dropped significantly, but we have seen concessions continue to increase. For example, a few leases to Blue Chip tenants in the District have included 8-11 months of free rent and improvement allowances of $80-100 per square foot. While these concession packages are fairly huge, keep in mind that full service rental rates in new buildings are still in the upper $60’s to mid $70’s per square foot.

As we predicted last quarter, indicators now show that the recovery started in the 2nd quarter 2009 (3.5% increase of GDP). However, this recovery is being driven by cost cutting and greater efficiencies. Job growth has yet to come into play and until new hiring starts in earnest we will not see steady absorption of vacant space.

As a purely tenant representation organization, we love seeing this type of uncertainty in the market. It gives us an ideal time to capitalize upon landlords’ uncertainty and strike the better deals for our clients. So, how long will the good times last? The best deals for the best space as the market is now (for tenants), we believe that the sweet spot for concessions will occur for at least first two quarters of 2010, then landlord confidence (and rates) will probably to pick up in the fall. However, once the wave of buildings currently under construction have delivered, nothing new will be developed for a while. There may be the occasional pre-leased building built, but speculative development will be taking a holiday for the foreseeable future. It’s too early to speculate about how tight the market may become a few years from now, but we believe that the DC area will be back to a 6-8% vacancy rate before the end of 2012.

One interesting phenomenon of the financial crisis remains the upside down cost of owning vs. leasing. Traditionally, leasing has been the least expensive method of occupying office space. Now that the cost of borrowing is somewhere around 6% and sale prices are flat, the cost of owning is frequently less expensive than the cost of leasing office space. Owning isn’t the right decision for every organization. However, if your organization is relatively stable in size and is able to pull together the equity required for a purchase, you may want to include purchase opportunities in your mix of options.

But What Does It Mean?

• The Vacancy Rate peaked 3Q09 and held steady 4Q09 at 13.3%.

• There is a small amount of new office supply still under construction, but no new office building starts planned for the foreseeable future.

• The first half of 2010 should offer the “best terms for the best space,” though “good” deals should be available for at least the remainder of the year.

• Very low interest rates and depressed sales prices have made the cost of owning lower than renting in many submarkets.

• Effective rental rates have decreased by more than 10% as concessions have increased along with lower coupon rental rates.

• Construction costs remain low (down 20-25% since over the past 6 months) resulting in the return of “turnkey” build outs.

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.