Rumble in the Markets
Muhammad Ali truly was the Greatest Heavyweight Champion of the World. A demonstration of his greatness unfolded when he battled and bested George Foreman at the Mai 20 Stadium in Kinshasa, Zaire in the immortal 1974 “Rumble in the Jungle”. The George Foreman of ‘74 was a chiseled specimen of heavyweight perfection, not the gently rounded pitchman we know today. He utterly destroyed “Smokin’ Joe” Frazier earlier that year in one round to win the heavyweight belt. Foreman was younger, larger and stronger than Ali and heavily favored by boxing experts to crush Ali as he had Frazier. Ali realized that he could not go “toe to toe” with Foreman, so he developed a strategy for victory through survival he dubbed the “rope-a-dope”. Through the rope-a-dope, Ali was able to conserve his strength and protect himself while Foreman punched himself out. After absorbing a beating for 7 rounds and allowing Foreman to wear himself out, Ali finally turned the tide, knocking out Foreman in the 8th with a devastating combination. Likewise for 2011, the survival guide for the DC Metro Area market has been the real estate rope-a-dope. Overall absorption has continued to be positive, but not enough to keep up with supply. In the 4th Quarter asking rents decreased by an average of $0.40/SF and the vacancy rate bumped back up to 13.3%. Although we’re not positive that we’ve completed the 7th round or our rumble, many signs show that the real estate market is ready to start swinging again in 2012. The reasons we’re cautiously predicting a continued strengthening of the market include:
- Demand is focused in the City. DC recorded 650,000 SF of positive absorption last quarter, while the suburban markets had 181,000 SF of negative absorption.
- Population growth rate and “coolness factor” for the DC leads the nation, with the District becoming a top choice for young professionals http://www.washingtonpost.com/local/districts-population-and-image-soar/2011/12/21/gIQAh1cLAP_story.html?wpisrc=nl_buzz
- Continued strength of investment sales (50% more investment sales closed and average sales prices 18% higher than 2010). Market Square, a 704,000 SF East End trophy property sold for $6.35 Billion, ($874/SF, 4.59% cap rate).
- Startups are proliferating. DC’s entrepreneur guide Foster.ly (http://foster.ly/) lists 13 Co-working locations and 44 incubators in the area, not to mention Microsoft’s planned Innovation Center at the St. Elizabeth’s site and a plethora of startups scattered throughout the nooks and crannies of the market.
- Construction starts are up for DC apartment buildings accompanied by strong demand for retail, especially in transitional submarkets (H Street, NE, 14th Street, NW, U Street, NW, Columbia Heights, etc.).
If our market was in the boxing ring, it’d be moving and jabbing, using its legs to prevent a pummeling, while looking for openings. The year ended with a lackluster 1,685,000 SF of space absorbed and less than 2.5 Million SF delivered. These are respectable totals compared to other markets, but only a shadow of the DC area’s former strength.
Landlords are battling a huge amount of empty office space in the DC Metro Area. Total vacancies have increased to almost 61 Million square feet. Knocking down this heavyweight supply of vacancies won’t happen quickly, it will take a full 15 rounds of strong growth to overcome. In the meantime, new inventory will be added to the market. Approximately 4.5 Million SF of new space is currently under construction across the region, half of which has been preleased. Almost 3 Million SF of that space will deliver in 2012. Therefore, any reasonable level of absorption (>1.5 Million SF) should reduce vacancy rates in 2012.
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The judge’s decision is that it’s that still a great time to be a tenant. Most submarkets will offer a multitude of options for the foreseeable future. Landlords have become even more anxious about retaining tenants and filling vacant space. The downside is that the best space usually gets leased first, especially in a soft market. Therefore, even though office leasing terms may be more concession laden, the biggest challenge may be finding “good” quality space.
Another still-open window of opportunity is the upside-down cost of owning vs. leasing. Traditionally, leasing has been the least expensive method of occupying office space. With the cost of borrowing hovering at historically low levels and sales prices remain flat, the cost of owning is frequently less expensive than 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 inside the Beltway has continued to subside and dropped to approach 10% at the end of the year. Many suburban submarkets will continue to be “soft” (Vacancy Rates > 13%) throughout 2012.
- 4.5 million SF of new office supply is still under construction, buffering future absorption.
- Capitalizing upon “Owner Anxiety” results in great leasing terms.
- “Aggressive” deals should be available at least through 2012.
- For the time being, the cost of owning is still lower than renting in many submarkets. This phenomenon will vanish when interest rates and sales prices increase.
- Average asking rental rates dropped slightly. Generous concessions in the “A” and “B” markets are still available, but have started to diminish.
- Construction costs are increasing, but still relatively low.
- “Turnkey” build outs are becoming more common.