SOUTHEAST SNAPSHOT, JULY 2007

Washington, D.C. Office Market

The Washington, D.C., office market continues to gain steam as strong office-using employment growth and solid rent gains propel the metro area. Several successive quarters of robust tenant demand lowered vacancy in the D.C. market to less than 9 percent last year, but a slowdown in leasing activity resulting from reduced job growth will nudge vacancy higher by year’s end. Local job growth will slow to 48,200 positions this year, a 1.6 percent gain, following the addition of 66,600 jobs in 2006. Of the new jobs projected this year, nearly 32,600 are in office-using employment sectors. Last year, 33,100 office-using jobs were added.

Reduced demand and an uptick in new supply will underpin a 30 basis point increase in the vacancy rate by the end of this year to 9.2 percent. Vacancy in the District will remain in the low-6 percent range. The decline in leasing momentum comes at a time when property owners will face greater competition from new buildings, as projects scheduled for completion this year will increase office stock 3 percent. Overall, approximately 9 million square feet is scheduled to come online by year’s end, up from 8.7 million square feet last year. Approximately 4 million square feet is expected to be delivered in Virginia, compared with 3 million square feet in 2006. Currently there are 105 planned developments throughout the metro, totaling 25 million square feet.

In the District, the 250,000-square-foot 455 Massachusetts Ave., N.W., in the Capitol Hill submarket is slated for completion in the third quarter. Without additional pre-leasing prior to completion, delivery of the project could raise the area’s vacancy rate 100 basis points from its current level in the mid-4 percent range. Nine other projects are under construction in the Capitol Hill submarket totaling 3.3 million square feet and another 11 projects totaling 4.5 million square feet are in the planning stages. The I-270/Rockville submarket has six projects under construction at 1.5 million square feet with another two at 1.3 million square feet in the pipeline. In Chantilly/Centreville, five projects totaling 926,000 square feet are being worked on and another two totaling 256,400 square feet are under discussion. East End has five projects going totaling 1,398,500 square feet and two more totaling 247,000 square feet are planned.

Pre-leasing has also been slow at the 250,000-square-foot Regent in the Ballston submarket in Virginia, and vacancy in the submarket may rise from the low-9 percent range to 10 percent as a result. In Maryland, the 220,000-square-foot Four Irvington Center in Rockville is one of several projects that will add a total of 2.4 million square feet in Maryland submarkets.

Investors should monitor construction and pre-leasing at the submarket level in the months ahead, but should also treat current trends as a temporary, slight imbalance of supply to demand. Demand drivers remain solid, keeping vacancy in the single digits and supporting another year of strong rent growth. Concessions are also being trimmed, with incentives likely to slip to 10 percent of asking rents in the District and to less than 12 percent in Maryland. Marketwide, cap rates range from 6.5 percent to 7.3 percent with institutional grade assets trading for less than 6 percent. Prices should continue to climb modestly based upon greater property income and not as a consequence of cap rate compression. Overall, cap rates appear to have stabilized.

Overall construction activity will slow to meet current demand levels in the Washington, D.C metro region. But office market conditions will remain solid within the Beltway, particularly within the always bustling Capitol Hill submarket. Both private and institutional investors will target properties throughout the D.C., Maryland and northern Virginia region. In particular, transaction velocity in the medical office sector will remain strong, as investors continue to target assets in high-growth areas of Montgomery and Fairfax counties.

— Ramon I. Kochavi is the regional manager of Marcus & Millichap’s Washington D.C. office.


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