Washington, DC 4th Quarter 2008

Shelter From The Storm

When your boat is in the way of a hurricane, you’ve generally got 2 choices: ride it out in deep water or seek a sheltered harbor, a.k.a. the hurricane hole. Right now we’re experiencing the equivalent of a financial hurricane and the eye of this storm has yet to pass. Fortunately for those of us based in the nation’s capitol, Washington, DC is the closest thing to an economic hurricane hole. From a real estate perspective, area vacancy rates are more than 11%, rents are lower, construction prices have dropped 20-25%, and investment sales have stopped cold. There will certainly be more fallout due to resolving the vast amounts of bad debt, etc, but at the same time a significant number of leases are being signed. Furthermore, the DC Metro Area has just started seeing the benefits of the Troubled Asset Relief Program (TARP) and the economic stimulus plan.

So far, it appears that the fundamentals of our local economy are essentially good. Washington, DC has arguably become the best metropolitan area in the country to ride out the storm, and a prime beneficiary of the massive Government intervention. However, the rest of the US and most other developed countries are trying to recover from a bad case of the flu. It’s as if our economy has been fueled by pure sugar for the past 8 years, and is now doubled over with its intestines twisted in knots. We’ll pull through but it will take a while for the medicine to work its way through our system.

Although our local economy has not come to a screeching halt, most businesses are holding their breath before making any major decisions.

The local submarket continues to be best grouped from the perspective of being inside or outside the Beltway. The vacancy rates for submarkets inside the beltway have remained in the single digits, while the outlying suburban submarkets are over 13%.

In the fourth quarter of 2008, the US Government accounted for the majority of demand for space. Uncle Sam signed the three largest leases in the area (all within the Beltway) for an aggregate of approximately 1.4 million square feet. At the same time, absorption (i.e. demand) within the District of Columbia was negative 1,037,482 square feet. To put this into perspective, we haven’t seen this kind of drop in demand for since the early 1990’s. Just like the early ‘90’s, investment sales have all but ceased to occur.

For example, absorption for the Washington, DC Metropolitan Area was slightly positive (48,000 square feet) and deliveries of new buildings drove the overall vacancy rate up to 11.5%. However, the District of Columbia recorded over 567,000 square feet of absorption and the vacancy rate actually dropped to 8.4%. Note that this activity was recorded before the sub-prime implosion and the demise of Lehman Brothers. At this time, we are seeing a significant slowing in leasing activity within the District, but there are still a number of significant deals alive and well.

Looking ahead, over 12.7 Million square feet of new space is still under construction. Although much of that is has been pre-leased, vacancy rates will continue to rise and rental rates are coming down. Lenders may become landlords as developers are unable or unwilling to carry vacant buildings.

But What Does It Mean?

This is a GREAT time for tenants to be in the market. Almost every submarket 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. Concessions are up, construction costs have dropped 20-25% and free rent is coming back. On the other hand, subleasing excess space has become more challenging. Over the next 12 months we expect to see increasing 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 their new partners in the federal government.