SOUTHEAST SNAPSHOT, MAY 2012

Washington, D.C. Industrial Market

Coakley

Washington, D.C., has weathered the recession better than most submarkets, with minimal employment loss and some gains, as well as in terms of market vacancies and rental rates. The recovery is slowly moving forward and rental rates are still flat while vacancy is tightening. However, it is still a tenant’s market for industrial and flex space occupiers.

The Greater Washington, D.C., industrial market is different from most other industrial markets in the United States. D.C. is not a town known for its manufacturing base. One can divide the industrial inventory of roughly 207 million square feet into two categories:

• Government Contractor, national distributor, food service and related users, with larger bays and higher ceilings

• Service providers to the overall market, e.g., HVAC, swimming pool, plumbing, heating, and roofing supplies, with smaller bays and lower ceilings that are typically located in closer in suburbs

Other noteworthy data points:

• At approximately 35,000 square feet, the average industrial building is small compared with the average in other markets.

• Unlike inventories in many major Midwestern and Northeastern markets, D.C.’s industrial inventory does not include a large segment of properties that can be characterized as functionally obsolete.

• Due to our lack of inventory of larger buildings, users will likely be forced to resort to a build to suit and pay premium rental rates if they require space greater than 150,000 square feet

Market Drivers

REITS and well-funded private owners have been extremely aggressive during the last 2 years. Tenants of national or regional stature with strong financial statements can get significant reductions in base rate as well as substantial build-out dollars. More often than not, build-out dollars are concessions, not amortized over the term, or a combination of both. The ability to offer these dollars, with or without amortizing, enables the REITs to snag the best tenants. Private owners who are typically less well capitalized are often unable to compete. This results in their signing tenants with less credit. If a private landlord does have some money to throw at a deal, the odds are the costs will be amortized, since the tenant may not have the credit to give the landlord confidence to put dollars at risk in the event of a tenant default.

Many close-in industrial properties are being up-zoned to flex and/or service center as many former industrial locations become gentrified and rental rates have increased to the point of being quasi-retail. Many of these have lower ceilings making them less desirable for today’s users who rack and stack products.

Most new industrial development of any size can only take place in the outer suburbs. Hagerstown, Maryland, is located at the intersection of Interstate 81 and Interstate 70, 72 miles northwest of the D.C. area. Winchester, Virginia, is located at I-81 and Routes 7/50, 17 and 11, 70 miles west of the D.C. area. These two hubs have an abundance of industrially zoned land and relatively cheap labor to accommodate the development of true industrial and distribution facilities. Close to D.C., both Dulles and Baltimore-Washington International (BWI) airports have some inventory of land still available for development. Both areas are well situated to take advantage of airport-driven/logistic users as well as conventional industrial users.

When larger users want to consolidate, it will likely require a build-to-suit development. A recent example is Rockwell Collins in Sterling, Virginia, and near Dulles Airport. The company grew over time into five different buildings. There was not one building available over a 3-year period capable of satisfying their need for 178,000 square feet. A build-to-suit was developed by New Boston Fund facility at Trans Dulles Centre III, 22640 Davis Drive in Sterling. The two-building complex was occupied in November 2011.

Vacancy and Rental Rates

The overall vacancy rate for industrial space in the D.C. market ended the first quarter at 11.7 percent, down slightly from 12.2 percent at the close of the fourth quarter last year, according to CoStar Group. The overall industrial inventory is comprised of warehouse and flex space. First quarter vacancy of warehouse space was 10.3 percent while flex space was 14.6 percent.

The submarkets with the some of the better activity are closer to D.C., including Merrifield, Virginia, which ended the quarter with 6.37 percent vacancy; Silver Spring, Maryland, at 10.3 percent vacancy and Beltsville, Maryland, at 11.7 percent vacancy. Conversely, Frederick County, Maryland, which is approximately 30 miles north of D.C., increased its industrial vacancy rate to 17.3 percent.

While the vacancy rate is trending downward in most of D.C.’s submarkets, rental rates for the period were a bit flat. The overall industrial rental rate declined to $8.97 per square foot on an annualized basis, from $9.13 at the close of the fourth quarter 2011. Warehouse space ticked upward to $7.58 in the first quarter from $7.56 in the fourth quarter last year, and flex space fell slightly to $12.14 from $12.32 in the previous quarter.

Recent Transactions

As noted earlier, the D.C. market isn’t known for large industrial deals. For example, in the first quarter this year the top three leases were Cosmos Granite & Marble’s lease for 36,540 square feet, Montgomery County Fire Chief for 33,451 square feet and Chris Rodriquez Installers for 29,000 square feet. These leases were completed in the Route 28, North Rockville and Newington submarkets, respectively.

Forecast

We expect D.C. to remain a tenant’s market for industrial space through the end of the year with rates and occupancies slowly climbing with the resurgence of demand overall. With the pressure on the federal government to minimize public sector growth, the government contractor sector is not likely to expand and thereby drive big-bay industrial space occupancy.

— Brian K. Coakley, SIOR, is senior vice president with Washington, D.C.-based Donohoe Real Estate/CORFAC International

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