Savoring the Sweet Spot
At some point in every market shift there’s usually a “Sweet Spot” where opportunities exist before the market adjusts its pricing. Dan Akroyd and Eddie Murphy had an uncanny sense for finding the Sweet Spot on the trading floor of the Commodities Exchange as they bested the Duke Brothers in “Trading Places”.
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In the commercial real estate market, sweet spots are less obvious. They’re tough to spot due to frequently conflicting market data. In fact, a sweet spot requires conflicting market data in order to exist. If all market indicators point in one direction, then the market is either rising or falling as a whole. Therefore, identifying the sweet spot requires as much insight as analysis. Our perspective of the market is that we have continued to enjoy the benefits of a strong local economy while the national economic picture has slowly improved in a number of critical areas. Local demand has been up and down during a period of huge uncertainty from the international economy and lackluster performance of the stock market. The resulting stew has given most owners anxiety, if not an aching gut, over any vacant space.
As tenant representatives, we were relieved to see a bit of negative absorption in the beginning of the year. It is important to note that in the midst of the greatest economic downturn in a generation, the Washington DC Metro Area posted positive absorption for almost 2 full years. In the first quarter of 2012 overall absorption was negative, the vacancy rate bumped up to 13.5% and average asking rental rates were a bit lower. Market demand came back in the second quarter with a modest 850,000 SF of positive absorption and the mid-year vacancy rate eased down to 13.4%.
A quarter or two of weak demand only serves to create more favorable market conditions for our clients. We are experiencing robust transaction activity, as many organizations have opted to take advantage of the market to negotiate new leases well in advance of their lease expiration dates. The moral (and very good news for tenants) is that market uncertainty can create wonderful opportunities.
Landlord anxiety helps fuel the other side of robust leasing activity. As landlords compete for a finite pool of tenants, we have witnessed a new willingness by building owners to engage in negotiations far in advance of a commencement date and increasingly larger concession packages. Negotiating leases 18 months in ahead of the expiration date has become more common and some mid-size (50-60,000 SF) tenants are currently negotiating leases 2 years ahead of their expiration.
The Washington DC office market may not return to the days of 5 Million SF of absorption for a while, but then again it should remain a fairly balanced, tenant friendly environment for the foreseeable future. Some of our reasons for predicting a prolonged sweet spot include:
- City focused demand. DC recorded 620,000 SF of positive absorption in the half of the year, while the suburban markets had 150,000 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
- Investment sales have weakened: Total sales activity is down and cap rates are averaging 7.25% in 2012, versus 6.85% in 2011.
- The demise of Dewey LeBoeuf has not dampened most landlords’ enthusiasm for leasing to law firms. Financial statements will be given more scrutiny, and security deposits may rise, but the legal sector continues to be highly desirable.
- Apartment construction in DC is huge and is accompanied by strong demand for high end retail. “New” vibrant neighborhoods are emerging in formerly transitional submarkets (H Street, NE, 14th Street, NW, U Street, NW, Columbia Heights, etc.).