CITY HIGHLIGHT, OCTOBER 2004

REAL ESTATE OUTLOOK POSITIVE ON CAPITOL HILL

The Washington, D.C., commercial real estate market is healthy in all sectors. New projects are being developed and, with job creation on the rise, the outlook for the city and surrounding areas is positive.

Industrial

The industrial real estate market in the Washington, D.C./suburban Maryland and Baltimore region is seeing a renaissance of new development with seven new projects under construction and/or planned for 2005 and 2006 delivery. Previous years saw an exodus of Class A industrial tenants from this region for “greener pastures,” which offered large footprint industrial buildings with lower rental rates. These new industrial projects should finally bring Class A industrial tenants back to the area.

There are several reasons for this spike in new development. First, the “greener pastures” are much less available. Land availability along Interstate 95 from Washington up through Philadelphia is extremely limited and prices are now reaching the same level as available land in the Washington area. Industrial land prices range from $150,000 to $250,000 per acre or $13 to $17 per buildable square foot. Second, there is a growing appetite for investment in industrial product in this area. This capital has provided both the funding for new development and an exit strategy (disposition) for speculative developers. Partially fueling the investment appetite is the area’s healthy market dynamics with a 9.4 percent vacancy rate. Net absorption is steady and rental rates are climbing, with average effective rental rates for Class A buildings at $5.95 per square foot net and $4.85 per square foot net for Class B buildings. Fully leased Class A and Class B buildings are selling for sub-8 cap rates, and $80 per-square-foot prices. The area’s retail sector and the federal government continue to drive the market. Defense contractors have acquired industrial space both for storage and redevelopment into inexpensive office space. As the economy continues to improve, we are seeing more and more corporate users expanding their operations. The Home Depot, for example, continues to search for 400,000 square feet near Washington with literally no options that size in existing buildings or build-to-suits.

— James Lighthizer, senior vice president, CB Richard Ellis

Retail

Current retail property capital market conditions are the strongest they have been in the Washington-Baltimore metropolitan area and in the U.S. in the past 20 years. The demand for shopping center investments is extremely strong across all retail property types and classes. Grocery-anchored neighborhood and community centers, regional power centers, regional malls, unanchored strip centers and mixed-use projects with retail components are attracting strong investor interest and are subject to a competitive bidding environment. This demand is strong for both core and value-add retail opportunities. Both are trading at a premium to their historic pricing levels.

Nationally, demand for retail investment properties is being driven by low interest rates, the availability of debt and equity capital, the lack of attractive alternative investments, and the fact that retail properties as an asset class have historically delivered one of the most stable and reliable returns of all the real estate property types.

In the D.C. metropolitan area, demand for retail investment properties is particularly strong for several reasons:

• Extremely low retail vacancy rates. Infill areas of Fairfax and Montgomery counties have retail vacancy rates of less than 2 percent.

• Zoning and land use controls that restrict future retail development and prevent overbuilding.

• Strong regional economy that consistently outperforms the US average.

• A long, consistent history of retail rental rate growth.

Capitalization rates for well-located, well-anchored, stabilized shopping centers range from 6 to 8 percent. Pricing for the very best neighborhood centers is now more than $275 per square foot. The capitalization rate trade range is a much broader and less meaningful benchmark for value-add retail properties. This range has been as broad as 7 to 12 percent depending on a number of factors, including occupancy, physical condition, remaining lease terms, tenant credit, trade area competition, and total cost for redevelopment plan execution and center stabilization. As-is cap rate, stabilized cap rate, replacement cost, interest carry cost during redevelopment and risk adjusted development return hurdle rates are all factors that investors evaluate in pricing value-add shopping center opportunities.

The combination of strong pricing and demand are resulting in higher than normal shopping center sales volume. The active investors include pension funds, real estate investment trusts, high net worth individuals, offshore investors and opportunity funds.

The pipeline of retail properties on the market, under contract and coming to market in the third quarter continues at a high level. The strong demand and increased investment sale activity for shopping centers in the Washington-Baltimore metropolitan area is expected to continue through the remainder of 2004.

— William Kent, executive vice president, investment properties – institutional group, CB Richard Ellis

Office

The Washington, D.C., office market reached mid-year 2004 with strong leasing, investment and retail activity. With 108 million square feet of existing competitive inventory and another 6 million square feet under construction, the city has maintained an enviable vacancy level in the mid-single digits. Market analysts are keeping a close watch on the northeastern portion of the East End market, a notable, emerging micro-market. A third of all new construction is concentrated within a few blocks of the newly opened Convention Center. Currently at 9 percent vacant, speculative construction could force the East End’s vacancy rate above 10 percent for the first time since 1997. Once considered a fringe location, quality sponsorship and first-class construction have attracted law firms. The turning point for this micro-market came with Boston Properties’ construction of 901 New York Ave. Additional development by Louis Dreyfus Property Group at 1101 New York Ave. and by JBG Companies at 1101 K St. will benefit from being anchored on the east by 901 New York’s success.

Net absorption surpassed the 2003 total of 900,000 square feet and reached 1.5 million square feet by July. As in 2003, lease renewals remain the biggest competition to new construction and five of the largest deals completed thus far this year were renewals. At the same time, large law firms that inked their last deals in the late 1980s and early 1990s and are now facing expansion constraints are fueling the demand after 6 years of single-digit vacancy rates and 13.4 million square feet of net growth downtown. These law firms, wishing to deliver from both a national and international platform, are finding a presence in the nation’s capital imperative. Short of a major terrorism event, Washington will maintain its stable occupancy.

Class A asking rents continue to climb, rising from $43 to $44 per square foot in the first 6 months of 2004 — yet fierce competition has enabled savvy tenants to secure large concession packages from some landlords that have included free rent — not seen with any frequency since the early 1990s — and assumptions of lease liability.

The vibrant investment market is continuing the blistering pace set in 2003. More than $1.3 billion worth of property has changed hands during the first half of 2004 with five transactions in excess of $100 million. At present there are relatively few properties formally being offered for sale downtown, fueling an increase in speculative off-market activity. Only the staunchest of long-term investors are turning a deaf ear to the sound of investors clamoring for product. Several properties that changed hands only a year ago are back on the market and poised to provide their short-term owners significant profits.

— Jay Olshonsky, managing director, CB Richard Ellis’ Washington, D.C., office

Multifamily

With the overall health of the market still being at very desirable levels, the pipeline of new product in Washington, D.C.’s multifamily market is substantial. Luckily, demand for rental housing is keeping with this supply mainly due to two reasons: jobs and conversions. The D.C. metropolitan region is still leading the nation in new job creation, a trend that is not temporary as it has lasted for several years and is expected to continue, according to Stephen Fuller of George Mason University.

Furthermore, as an alternative to rising single-family home prices, the condo conversion craze continues to strengthen the health of the market by depleting the inventory of new units. Additionally, many former apartment sites are being converted to condominiums before construction begins, thus further lessening the number of units coming on line. One apartment developer has been quoted to say, “I have been as successful selling my property at the entitlement stage as I have after stabilization.”

There have been several major mixed-use projects that have either taken steps to become a reality or achieved recent recognition. The formation of the Anacostia Waterfront Development Corporation shows D.C.’s desire to move ahead on the redevelopment of the Southwest Waterfront area after years of being on the drawing board. In Virginia, a vibrant downtown area will be created with the massive Potomac Yards mixed-use development. The first stage of the project will include a 479-unit condo project developed by Comstock and 386-unit luxury high-rise developed by Camden as well as a Harris Teeter and more than 600,000 square feet of office space. The area’s most recent development of significance is putting Prince Georges County, Maryland, on the national map for mixed-use developments with the announcement of the $3 billion project called Rosewood. Just 120 miles east of Washington, the project will be situated on 480 acres and is reported to eventually contain 6,000 residential units.

Two different trends are taking place around the Metro region. The first is based on demand for housing and the second is based on supply of land. As noted by the recent, huge surge in housing growth in more infill or urban population centers, potential residents are drawn toward the live/work/play areas with easy access to retail and public transportation. Areas that demonstrate this trend in Maryland are Bethesda, Rockville and Silver Spring; Alexandria and Arlington in Virginia; and lastly the District itself. The demand is high for predominantly high-rise living where residents can walk to restaurants, shopping and the Metro.

The second trend is evidenced by the availability of land for development in submarkets with pent-up demand located in an environment that is receptive to development. In Virginia, this has been demonstrated near the Fairfax Towne Center and throughout Eastern Loudoun County, while in Maryland, this is evidenced by several developments in Anne Arundel County.

— Drew White, Cushman & Wakefield’s capital markets group, apartment brokerage services, Washington, D.C.

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