Closing 2012 with a Slower, Bumpy Ride
When you’re driving off-road, slowing down is the best way to navigate hazards without destroying your suspension. Of course, the kind of vehicle you’re driving also makes a huge difference in the ease at which you can make your way through the tough spots. Fortunately for the Washington, DC Metro Area, we are the Ford Bronco of markets…equally adept at tackling the most brutal off road conditions as well as cruising on smooth pavement. Like the Bronco’s robustness and versatility, the DC market continues to stay ahead of its pursuers, in spite of dealing with the obstacles in your path.
DC’s year-end terrain challenge was lower demand and significant negative absorption (-769,000 SF overall) driving vacancy rates up again to 13.5%. The 4th Quarter numbers clearly illuminated a few features in the current landscape:
- Plenty of smooth pavement remains in Downtown DC, with no change in the vacancy rate (9.5%) and 135,000 SF of positive absorption.
- Suburban markets require all terrain tires, slogging through negative 904,000 SF of absorption and straining to overcome a vacancy rate that has increased to 15.4%. Suburban vacancy rates increased by 40 basis points since the 1Q2012.
- The Federal Government’s foray into the “Fiscal Badlands” http://www.mcbrideres.com/newsandinsights/?p=1074 has especially affected government contractors. Reductions in government spending on defense reduced GDP as well as contractors’ need for office space. Northern Virginia’s office market has been taking the brunt of these fiscal follies.
For the year, the Washington, DC Metro Area market was positive, if underwhelming, posting 273,000 of absorption. Vacancy rates went up, then down and up again since year end 2011, ending almost exactly where they were a year ago. In truck terms, you might think that we’ve been spinning our wheels, but in reality, we’ve been making our way up and down some pretty steep terrain. It just happens that after four quarters, the market is looking at a statistical déjà vu.
Meanwhile, Investment Sales have been revving. Washington, DC real estate continues to be viewed as a safe haven for real estate investors and the Federal Reserve’s policies of keeping interest rates low have continued to drive cap rates down, averaging 6.81% in 2012 compared to 6.96% in 2011. We don’t see how interest rates could go any lower in 2013, but then again we’ve been surprised by the Fed’s continued ability to further lower rates over the past few years.
Stats aside, how has the terrain changed over the past 12 months? As tenant representatives, our impression is that while there’s still plenty of space out there, finding “good pieces” has become increasingly difficult. It’s as if the churning of the market over the past year has enabled tenants to trade up for newer models, leaving their old places sitting on the sales floor. Good space can still be found, but it takes a bit more work to sift through the competition. The bright side is that landlords with vacancies are even more anxious to find tenants.
Landlord anxiety has also been fueling another ongoing trend: longer windows of opportunity. As landlords compete for a finite pool of tenants, there is a new willingness by building owners to engage in negotiations far in advance of a commencement date and increasingly larger concession packages. Tenants with 10-15,000 SF are frequently negotiating leases 18 months in advance of their expiration date and mid-size (50-60,000 SF) tenants are able to negotiate leases 2 years ahead of their expiration.
What Does It Mean?
- We expect to see favorable market conditions for our clients continue throughout the coming year.
- Net absorption is likely to remain flat, but robust leasing activity should continue, as many organizations opt to take advantage of the market to negotiate new leases well in advance of their lease expiration dates.
- Low interest rates continue to make purchasing an excellent opportunity. Purchasing isn’t the best strategy for everyone, but if your company has a long term horizon and relatively stable needs, it can be an attractive option.
- The suburban markets will suffer the effects of the Fiscal Badlands until the Federal Government ends its budget impasse and demand grows elsewhere in the private sector.
The Moral: The right vehicle can bring you to the beach after outrunning the police. The DC market may not always provide the smoothest of rides, but it keeps carrying the load.