The Washington, D.C., Metropolitan Region is unique among American markets. As our nation's capital, Washington serves as a focal point for our country both politically and economically. When combined with Baltimore, the city is the hub of the fourth largest population center in the U.S. As the capital city of the world's largest consumer and commercial market, it attracts lawmakers, tourists, students, business and commerce from all over the world. Some economists have dubbed Washington a "recession proof" city. It is more insulated than most of its competitors from typical economic volatility by the stabilizing influence of the federal government as the area's single biggest employer. Metropolitan Washington receives over 12 percent procurement of all federal government contracts. This is nearly quadruple the amount received by any other area in the country.

From the Great Depression until the 1990s, the size of government continually increased, bringing a parallel increase in government employment and population into the Washington area. However, due to the increasing growth in the telecommunications, high-tech and bio-tech industries in the last twelve years, the employment and residential population of the Washington suburbs have exploded.

There are over 5,000 firms in the Washington region involved in the technology industry that employ over 500,000 people and generate over $100 billion in annual revenue. In northern Virginia alone, there are over 2,500 firms with 230,000 workers in the technology sector. And despite the recent retrenchment in the technology industry, the Northern Virginia Technology Council (NVTC) expects technology employment to increase 50 to 100 percent by 2010. If so, the need for office space, housing and shopping centers will only continue to increase. And again, as this sector grows, so will the need for law firms, accounting firms, consulting firms and other ancillary services.

The boom over the last four years hasn't only been confined to the telecom, Internet and dot-com craze. This also happens to be the hottest of times for the biotechnology industry. In Montgomery County, Maryland, biotechnology companies such as Genetic Therapy, GeneLogic, Human Genome Sciences, EntreMed and MedImmune encircle the National Institutes of Health in Bethesda. In fact, 200 of Maryland's 300 biotechnology companies are located in Montgomery County.

Overall, given the confluence of several key factors - including northern Virginia's position as the second largest technology market, suburban Maryland's position as the nucleus of the world's biotechnology industry, the stabilizing force of the federal government and some of the highest household income levels in the country - it is no wonder that greater Washington, D.C., is widely considered to be one of the top real estate investment climates in the world.

Office

By most measures, the Washington, D.C., market continues to out perform other urban real estate markets. The steady improvement in the Washington market over past years is attributable to Washington's fundamental economic health and a dramatically improved administrative and fiscal environment. This has resulted in sustained stable demand for all classes of office space. A survey of leading Central Business Districts (CBD's) throughout the country shows that Washington continues to maintain the highest occupancy rate.

Apart from the traditional reasons that have attracted office tenants to downtown Washington, a number of developments in recent years have further enhanced Washington's regional, national and international image:

t Completion of the highly successful MCI Center which, as an urban entertainment center, has created significant "after-hours" vitality.

t As a center for international politics and commerce, Washington, D.C., is home to 158 foreign embassies, over 150 international business councils and 236 foreign-owned corporate headquarters.

t Completion of the renovation and redesign of the main terminal of Washington's National Airport, which greatly facilitates access to downtown. The airport was renamed the Ronald Reagan National Airport. In addition, legislation was passed in 1999 to remove a 1,250 mile flight barrier. Now direct flights are available to many West Coast cities, including Los Angeles, Seattle and Phoenix.

t Completion of the 1.5 million-square-foot Ronald Reagan Building (1300 Pennsylvania Avenue), which serves a dual purpose as the new Federal International Trade Center and home of the U.S. Environmental Protection Agency and Agency for International Development.

t Construction of the new $650 million convention center, which will further revitalize the downtown area and re-establish Washington, D.C., as a major convention destination.

In addition to these projects, Washington's political situation has been stabilized through the election of Mayor Anthony Williams, who quickly earned praise from the District's business leaders. In fact, Washington, D.C., has maintained a budget surplus since 1998 - the first in recent memory.

In the face of a slight economic downturn, Washington, D.C., is demonstrating its steadfastness as a healthy commercial real estate market. In the first half of 2001, vacancy decreased while net absorption was high, surpassing 1.4 million square feet. Additionally, development projects totaling more than 3 million square feet scheduled to deliver during the remainder of 2001 are already 80 percent preleased. Overall, at 4.7 percent, the market vacancy has declined slightly from year-end 2000. A few submarkets experienced more significant decreases, such as CBD and Uptown, which dropped to 4.2 percent and 3.1 percent, respectively. So, while most other downtown markets in the U.S. feel the effects of a slowing national economy, Washington, D.C., continues to show its strength as a well-balanced and dynamic market. And, while the market may not be able to continue the pace set over the past three years when it averaged an annual absorption of over 2.5 million square feet and rent growth exceeding 6 percent per year, by no means is a decline anticipated.

The record setting pace of the northern Virginia office market has finally slowed down. Given the pullback in the technology sector, the northern Virginia market has experienced dramatic changes over the last 9 months. With a slowdown in leasing activity during the first half of 2001, vacancy rates have increased more than 4 percentage points since the end of 2000, and are now 8.5 percent. While net absorption was an astounding negative 2.3 million square feet in the first quarter, deliveries of substantially preleased buildings have helped improve net absorption to negative 1.6 million square feet at mid-year 2001. This represents a substantial decrease from the 1.9 million square feet of positive absorption during the fourth quarter 2000 alone, and more than 8.7 million square feet absorbed during all of 2000. While sublease space accounted for 30 percent of total vacant space in the fourth quarter 2000, available sublease space now accounts for 47 percent of total vacant space. And while the rapid decline in northern Virginia may appear daunting, it appears the worst may be over. For instance, after the vacancy rate worsened by more than 4 percent over the first quarter of 2001, it increased by less than .5 percent over the second quarter. The market-wide vacancy rate of 8.5 percent is still considered healthy by national standards.

Although the high-tech and dot-com sectors have experienced a decline, there remain rays of hope that should mitigate the damage in northern Virginia. For example, since over one-third of the northern Virginia tech business sells to the federal government, many of the technology firms clustered in northern Virginia are less susceptible to an economic downturn. The Bush Administration, which is publicly committed to allocating more capital to technology, will provide continuous support to this sector.

This year began at a slower pace than 2000 for suburban Maryland, as last year's record setting net absorption dropped to a negative 430,732 square feet in the first half of 2001. As a result, vacancy has risen to 7.6 percent, an increase of 1.7 percent since year-end 2000. Over 24 percent of all vacant space is sublet space, more than double the amount on the market at year-end 2000. The slowing market has also caused potential tenants to be reluctant to finalize transactions in hopes that rental rates might decline.

Retail

The Washington, D.C., area has a strong and diverse economy and one of the highest average household income levels in the country. As a result, Washington and its suburbs are typically on top of retailers' lists of target locations. Zoned sites large enough to accommodate neighborhood and community shopping centers are scarce. When a site does become available, several retailers usually compete for the limited anchor space.

The Washington, D.C., Metropolitan Area has a history of formidable land use planning and zoning controls that limit the supply of shopping center sites. As a result, the area has not experienced retail overbuilding seen in some other areas of the country and continues to enjoy low vacancy, high tenant retention, and growing rents. With overbuilding held in check and some of the highest household income levels in the country, the Washington, D.C., area has been a haven for retailers.

Tysons Corner, Virginia, is home to Tysons Corner Center, one of the most prosperous malls in the country. Rents at in-line stores reach $70 per square foot while per square foot sales for in-line stores average approximately $580 per square foot. The 2.1 million-square-foot mall, which attracts more than 21 million shoppers per year, is currently being marketed for more than $600 million.

Over the last four years, downtown Washington has revitalized its image as a 24-hour city, which has resulted in renewed interest in living downtown. City streets in the CBD and East End submarkets are buzzing on weekend nights. While Georgetown used to be the only hotbed of nighttime activity, urban retail is now hot again in the financial districts. Retail shops and restaurants continue to open locations in downtown Washington. What's more, the D.C., government is gaining success in bringing big box retailers to D.C. to serve the city's vast population.

Multifamily

With a strong local economy, including job growth that is more than twice that of the nation, the multifamily market in Greater Washington, D.C., continues to set the benchmark for the entire nation. And despite a downturn in the technology sector that is affecting northern Virginia, multifamily vacancy rates remain below 2 percent across the area. It is no wonder that market studies continuously rank Greater Washington, D.C., as the top multifamily market in the country.

In downtown Washington, multifamily rental rates continue to reach new highs, with some high-end units hitting rental rates of $5,000 to $7,500 per month. Traditionally, D.C. has had the highest rents in the metropolitan area for Class A units, averaging over $2.60 per square foot, while the northern Virginia suburbs are typically in the $2.00 per square foot range. Rents in Montgomery County, Maryland, typically top out at around $1.80 per square foot.

In northern Virginia, projects under construction are primarily concentrated in the more established in-fill areas inside the Capital Beltway. In contrast, Maryland has only one project under construction inside the Beltway, and that is a conversion of an existing office building to multifamily use.

While planning and construction continue in the Virginia and Maryland suburbs, there is still a dire lack of Class A units in downtown Washington. However, over the next 36 months the number of Class A units could more than double, reaching over 5,000 units. With an additional 15,000 units planned for construction in the suburbs, some market participants wonder if an oversupply will result. Still, even with the addition of these planned units, vacancy is projected to stay below 5 percent. So, while landlords may have to stop compiling waiting lists for their units, the market will hardly be oversupplied.

Investment

The current market for office investments is a study in contrast. The downtown Washington, D.C., market remains very active. In fact, given its diverse and stable tenant base, including the presence of the federal government, downtown Washington has actually gained favor over the last six months as other major metropolitan areas have faltered. A wide variety of investors, both private and institutional, are aggressively seeking opportunities, albeit at slightly higher capitalization rates than seen in 2000. In fact, over $700 million in transactions have closed so far in 2001, ahead of the pace seen at the same point last year.

While most Class A buildings trade at prices easily exceeding $300 per square foot, some assets are surpassing the $400 per square foot mark. 1300 Eye Street (Franklin Square) and 2001 K Street are both currently on the market for prices exceeding $400 per square foot. In 2000, the Warner Office Building, located at 1299 Pennsylvania Avenue, sold for close to $400 per square foot to BHF Bank-DIV.

While downtown Washington, D.C., remains active, the northern Virginia market has drastically cooled. The retrenchment in the technology sector has practically closed the pipeline of sales activity for office properties in northern Virginia. Most notably hurt has been the tech heavy Reston/Herndon submarket, where the vacancy rate has risen from 5.4 percent to 11.2 percent in just 9 months. And while many markets inside the beltway remain unscathed by the technology woes, they are suffering from "guilt by association" by the investment community. Investors and lenders alike have put up caution flags over northern Virginia office properties despite the strong viability of many submarkets.

There is a significant amount of capital in the market today for shopping centers. Many pension funds and other institutional investors are under-allocated in retail. These investors are targeting grocery-anchored neighborhood and community shopping centers in supply-constrained areas with strong demographics. With available capital outpacing the supply of this type of property, prices have held steady. Insignia/ESG's Capital Advisors Group closed several transactions for grocery-anchored strip centers in late 2000 at capitalization rates below 8.5 percent on first year income. This pricing is holding up in 2001.

Demand also remains strong for shopping centers where there is an opportunity to add value through renovation, expansion and re-merchandising. The underlying retail supply and demand fundamentals of the Washington area make these a highly sought after investment by entrepreneurial investors, many of which have institutional capital partners.

Because the multifamily market has been so strong, investors have been reluctant to part with their Class A assets, perhaps hoping to time the top of the market perfectly. In the last 12 months there were four times as many Class B units sold as Class A units.

Given a metro-wide vacancy rate under 2 percent and investor's strong appetite for multifamily product, sales prices per square foot continue to climb. In three recent sales transactions three properties located in Herndon, Virginia - Ashford Meadows, Windsor at Lion's Gate, and Oakwood Dulles - sold for prices averaging approximately $145,000 per unit.

Peter Brohoski is managing director of brokerage services for Insignia/ESG. R. William Kent, Lee S. Alexander and John Sheridan of Insignia/ESG also contributed to this article.


©2001 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.