Third Quarter 2013 Market Report

The McBride Market Report
Washington DC – Third Quarter 2013

Space Wave

It’s often said that life is cyclical. I believe it’s more wavelike. By nature, waves (http://en.wikipedia.org/wiki/Waves) are defined by their repeating rhythm as they swing from trough to top in terms of size and frequency. In the water, wave shapes echo the sea bottom. In the office market, waves of vacancy reflect expansion and contraction of supply as it meets the shoreline of demand. It has been over 20 years since we’ve seen a “Space Wave” of vacancies like the one we’re seeing now.  Not since the wake of the S&L crises in the late ‘80’s/early ‘90’s have we seen such an abundance of large (>50K square foot) blocks of immediately available space.  Although there’s been no dramatic change in the vacancy rate (holding steady at approx. 14% for the better part of a year) the makeup of the vacancies have undergone a dynamic shift. For the first time in a generation large office tenants have their pick of an abundance of immediately available opportunities.

Just as wind is the primary engine for wave generation, the current space wave has been driven by businesses’ relentless pursuit of efficiency. Private offices have shrunk or disappeared, technology has changed the way we all work and eliminated the need for many support areas (libraries, document production, numerous stations for support staff, etc.). DC’s large law & accounting firms have realized that by designing new space supported by current technologies and work flow practices can create 15-20% savings in the size of space needed.  With Class A/Trophy building rents of $65-75/SF, design efficiencies created in new space have frequently justified moving to newer, more expensive buildings.  The moral is that architectural efficiencies can easily trump rental rate in a lateral move (relocating to a new property of a similar quality).  As a result over 35 buildings in downtown DC currently have at least 50K square feet available and 12 buildings have at least 100K square feet of vacancy.

The other similarity to the space wave 20 years ago has been the highly discounted sales prices for vacant suburban office buildings.  We haven’t exactly returned to the era of buildings being sold for $50/SF, but in some cases, prices are substantially less than replacement costs. For the vast majority of the sales market, prices for investment quality properties remain strong, especially in the multi-family sector.

The most challenging market slice has been finding space for DC’s burgeoning home-grown technology companies. The ongoing recovery is fueling a boomlet of new, companies desiring locations on the edge of the business district or in newly rejuvenated urban neighborhoods. While many of these companies are finding good economic conditions for funding and a growing urban tech culture, their greatest challenge has often been identifying affordable space to support their mission.  In particular, finding short term (less than 5 years) options and buildings with a “tech” (i.e. open space with a post industrial/steam punk) vibe are few and far between.  Common solutions to this challenge have been to take advantage of previously built out, sublease space and retrofitting older properties offering good economics to create floors that work well for open space layouts.  While tech companies still represent a small fraction of the market, it is possible that they could help revitalize some of the larger blocks of existing vacant space.

Building_Heights_Screenshot

Vital Stats:

  • 13.9% Vacancy Overall Rate (DC – 9.7%; Suburban Markets – 15.7%)
  • 1.2 Million SF of Absorption 3Q2013 (but only 1 Million SF of total absorption over prior 12 months due to negative absorption in 4Q2012 and 1Q2013)
  • Almost 1 Million SF of new space delivered 3Q2013 (hence vacancy rates remain unchanged)
  • Average asking rents 0.7% lower (while concessions have also increased)
  • Sales volume (number of transactions) is down 30% from 2012, but prices for investment quality assets remains strong (6.5% average Cap rate)

What Does It Mean?

  • The drive towards efficiency will continue to result in a churning of old space as new properties deliver. Functionally obsolete buildings such as the former NPR Building, 1201 Penn, 1301 Penn, 1150 17th Street, etc. will give rise to a new wave of properties designed to support the modern workplace.
  • Huge new development projects (395 Air Rights; NoMa; the Southwest Waterfront, etc.) will compete with redevelopment sites as they stand poised to deliver significant amounts (>7 Million SF) of new space.
  • Large tenants (requiring >50K SF) should have the run of the market for at least the next 18-24 months.
  • Smaller tenants will also enjoy the benefits of a “tenant friendly” market conditions. Their challenge will be finding good quality space carved out of large, existing vacancies.
  • Rapidly growing companies (especially tech firms) will be challenged to find affordable, short-term (<5 years) options.

 

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Richard McBride Jr.