CITY HIGHLIGHT, OCTOBER 2006

WASHINGTON D.C. CITY HIGHLIGHTS
Brian Gill, Geoffery L. Mackler, Matt Laraway, Bob Gibbs and Don Konz

Washington, D.C. Multifamily Market

The apartment market in the Washington D.C. metropolitan area has remained strong during the past 12 months and appears ready to improve further in the next year. The fundamental economics prevailing in the region are strong and are continuing to improve. Last year, approximately 60,000 new jobs were created and employers are on pace to beat that figure this year by 1 to 2 percent. The median household income in the area is more than $70,000, which is one of the highest in the nation. The supply stock of rental apartment units has decreased by 2,600 units during the past 4 quarters. After some years of low growth in effective rents, a rise of 3.3 percent was recorded last year and most sources project anywhere from 5 to 10 percent growth in the next 12 months. Asking rents are highest in the District’s Northwest submarkets, standing at nearly $1,575.

By most accounts, this scenario is a landlord’s dream. But the underlying supply fundamentals remain somewhat distorted. Like many areas around the country, Washington D.C. has been significantly affected by condo developments and conversions during the past few years. Throughout last year and some this year, investment sales were dominated by condo converters, paying upwards of $300,000/unit for existing rentals in some instances. These transactions have all but halted, with condo converters being shut out of the market as condo sales volume (new and resale) is expected to fall to below 10,000 units this year  after posting three straight years of more than 20,000 unit sales. Cap rates, while spending most last year hovering in the 5 percent range, have edged upward towards 5.5 percent.

With supply contracting, rents rising and vacancy falling, a handful of market players are choosing to convert planned condo projects back to rental apartments. In the second quarter of 2006, some 1,600 condo units, mostly in Northern Virginia, were switched back to rentals. This has caused some concern that a glut of rental supply could come back on the market in short order, but so far these concerns have not played out.

The lowest vacancy rates are seen in Fairfax County, Tyson’s Corner and the Dulles Airport corridor in Northern Virginia, where there is expected to be the addition of a new Metro rail line connecting commuters in the area to elsewhere in the beltway. Developers are buying land in the corridor with the anticipation of building new high-density developments near rail stops. In the first quarter of this year, the closely-held Winkler Portfolio was sold for more than $800 million to the JBG Cos. in the largest Washington D.C. multifamily transaction to trade in recent memory. The portfolio included more than 5,000 apartments, mostly located in Alexandria and Fairfax County submarkets.

Other areas to watch include the Anacostia Waterfront in Southeast Washington D.C., where major projects are planned such as the Washington Nationals’ new baseball stadium, the new National Harbor project on the Potomac River in Prince Georges County, spearheaded by The Peterson Companies, and the “NoMa” corridor directly to the north of Massachusetts Avenue, Union Station and Capitol Hill in downtown Washington D.C.

Also in Fairfax County, more development is expected near Fort Belvoir to the south of the beltway, as the recent BRAC realignment will shift tens of thousands of jobs to the military installation during the next 3 to 5 years. Developers are still waiting to see how Fairfax County will address needed upgrades to transportation and thoroughfares around Fort Belvoir to accommodate the influx of commuter traffic.

— Brian Gill is vice president of Arlington, Virginia-based Bonaventure Realty Group and teaches a real estate development course at the George Washington University Graduate School of Business.

Washington, D.C. Retail Market

Town center, mixed-use, and lifestyle are the themes dominating development in the Washington, D.C. metropolitan area. Although this trend of New Urbanism began in warmer climates, demands by area municipalities, unprecedented land costs, and suburban sprawl have driven development of such projects in this four-season region.

The unrivaled success of Reston Town Center in the 1990s has ushered continued vertically oriented development in this market. New arrivals include Fairfax Town Center in Fairfax, Virginia, the Town Center at Parole outside of Annapolis, Maryland, and Leesburg Village Center in Leesburg, Virginia. Conveniently positioned, these centers provide residents easy access to work, daily needs, restaurants, and entertainment. As a result of high-energy costs and hectic lifestyles, mixed-use centers are appealing to those who wish to avoid commuting to traditional urban/employment hubs. Outer ring towns like Leesburg, Culpeper, and Fredericksburg, Virginia, are becoming vibrant employment/residential/ retail centers in and of themselves. Consequently, savvy developers are claiming sites in West Virginia to the west and areas once thought of as suburban Richmond to the south.

Although communities are lobbying for legislation limiting big-box category killers, these retailers have succeeded in piercing the veil by offering café amenities, international foods, natural organic foods and an overall more upscale shopping experience. And big box retailers, like Target for example, have introduced two-story stores with structured parking in this market.

 As the population in the greater Washington, D.C. region continues to boom and commuting distances increase, these mixed-use projects will flourish. Consumers will increasingly demand more sophisticated services with ease of access. In reality, this is not a trend because it is the future.

— Geoffrey L. Mackler is a principal with H&R Retail, Inc.

Washington, D.C. Industrial Market

The industrial market in the Washington, D.C . region is concentrated in two locations, the Baltimore–Washington Corridor (BWC) to the north of the city and the Dulles Corridor to the west of the city in Northern Virginia. Both of these areas are attractive to industrial development because of their proximity to major transportation centers, interstate highways, ports and airports.

The BWC is located between Baltimore and Washington off of Interstate 95. The BWC supports a base of 60.8 million square feet of industrial space of which more than 67 percent, or 40 million square feet, is bulk (24’ or greater) industrial space. The BWC has always been one of the East Coast’s healthiest bulk distribution markets with historically low vacancy rates, limited new construction and the immigration of tenants from the Baltimore–Washington suburbs. The market’s ease of access to Interstate 95 (I-95) and the rapid growth of the Baltimore/Washington International Airport (BWI) has and will continue to attract a strong creditworthy tenant base.

The BWC is beginning to feel the impact of the Base Realignment and Closure program and the growth of Ft. Meade and the National Security Agency. Local, regional and national developers continue to jockey for land positions around the BWI. Nearly all significant tracks of land have been acquired, forcing developers to resort to non-traditional assemblages in which they purchase several smaller parcels from businesses and/or homeowners and work through the planning and/or re-zoning process. This lack of available ground has resulted in a continuous rise in land prices in and around the airport. Land comparables for industrial-zoned land have officially cleared and maintain a level above $300,000 per acre. This pricing, when coupled with necessary site work, yields a building that demands rents higher than have been seen in the marketplace, with bulk rates in and around the airport from $5.50 to $6.50 per square foot, triple-net.

In addition to an increase in rental rates, the scarcity of land and the rise in rental rates is pushing developers to modify some pre-existing development plans. Some developers, including Cabot Properties and Liberty Property Trust, have modified existing development plans to service both the changing land cost as well as the changing tenant mix. Both of these developers shrewdly recognized that the local market they were building into on Coca Cola Drive was becoming more employee intensive. It was also becoming slightly more high profile because of its location and visibility. Cabot modified its two-building plan and built one office building, leasing it 100 percent to Verizon Wireless for a call center. Liberty Property Trust modified its two-building plan, reducing its original total of 257,000 square feet to 226,000 square feet, and increasing the parking ratio and glass line to appeal to a more high profile tenant mix. Liberty has already leased 50 percent of its first building to high-end clothier Dynamic Designs and broke ground on the facility at the end of August. Currently, the most active developers in the BWC are Preston Partners, Seefried Properties, Cabot Industrial, Liberty Property Trust and Merritt Properties.

As land prices have increased in BWC, industrial developers that desire large tracks of land have begun heading north along I-95 into Harford and Cecil Counties.  In addition to land prices being more attractive to developers, rental rates and labor pools have grown more attractive to the user pool in these communities. The most active developers currently in this market are Liberty Property Trust (580,000 square feet existing and a 1.1 million-square-foot development site), Champion (1.2 million-square-foot Trade Center at I-95 site), FRP Development (380,000 square feet at Lakeside), and Emory Hill Development (1.2 million square feet at Chelsea Road).

In addition to Harford and Cecil counties, developers are beginning to pay attention to the Hagerstown area in Washington County. This location allows developers to take advantage of the intersection of Interstates 70 and 81 providing access to the I-81 Corridor that runs through Central Pennsylvania and West Virginia. Hagerstown is a proven distribution hub and home to such tenants as Tractor Supply, The Home Depot, Federal Express, Staples and Mack Truck/Volvo.

Investors and developers with an appetite for bulk buildings should follow suit and head north to Harford and Cecil counties or west to Hagerstown. Investors looking for redevelopment opportunities or more complicated assemblage developments can continue to search the BWC for opportunities. The decision depends upon their investment criteria and, most importantly, their patience.

The Northern Virginia industrial market, which began to develop in the mid-1980's, today consists of approximately 73.4 million square feet of warehouse and flex buildings.

New construction is occurring but primarily for warehouse/flex condominiums. Economic deterrents currently exist that make it difficult to build warehouse and flex buildings for lease. Current industrial land prices, in the Dulles North and South submarkets, exceed $9 per square foot, which makes it challenging to justify new development at current market rental rates.

The leasing market is seeing more activity due to the recent rise in interest rates. The vacancy rates are extremely low in this market. As a result, more developers are looking to build speculative buildings for lease. The rental rates are beginning to increase due to the spike in construction prices and land prices.

This year has shown modest absorption and declining vacancy rates. The economic outlooks for the Washington metropolitan and Northern Virginia areas are promising. Unemployment is low, business growth and spending are on the upswing. These factors, coupled with the demand for space will lead to more spec development.

— Matt Laraway is a vice president in CB Richard Ellis’ Baltimore office, and Bob Gibbs is  first vice president in CB Richard Ellis’ Tysons Corner, Virginia, office.

Washington, D.C. Office Market

As the weather cools in Washington D.C., the office market appears poised to stay hot. In fact, a look at market vitals indicates direct vacancy in the downtown submarkets approximates 6.3 percent on an inventory of approximately 125 million square feet. Office vacancy in the suburbs varies greatly depending on the submarket, but the current rate of 8.5 percent is reasonably low on an inventory of approximately 250 million square feet. Rental rates vary too, but average approximately $42 full service per square foot downtown and $27 full service per square foot in the suburbs. At the newest properties in the central business district (CBD), rental rates exceed $50 triple net per square foot.

A hot market notwithstanding, what’s really generating the buzz in the cation’s capital is new development. And nowhere is new development more evident than in the city’s Southeast submarket with several out-of-the-ordinary forces are spurring the activity. Local real estate mogul Ted Lerner’s purchase of the Nationals and the commencement of construction of the team’s new stadium, as well as the General Services Administration’s (GSA) relocation of the Department of Transportation and opening up of the antiquated SE Federal Center to redevelopment, has developers from all over the country snatching up land, making plans and queuing up tenants to occupy the once neglected neighborhood. Some of the national players include Forest City Enterprises, whose 5.3 million square feet project at the Southeast Federal Center is underway; Monument Realty, currently demolishing a city block to make way for phase one of the 2 million-square-foot mixed-use Ballpark District; and Lincoln Property Company, actively marketing three buildings at its Maritime Plaza. Local developers too, including the Donohoe Companies, the JBG Company and the Peterson Companies, have building sites ready to go, mostly clustered around the Navy Yard Metro station. If the forecast holds, ultimately more than 20 million square feet of office and thousands of apartments and condos will be built.

In the CBD, nearly 3 million square feet of space currently is being added to the existing inventory, including several new projects near the city’s new state of the art convention center. The Louis Dreyfus Property Group’s 400,000-square-foot (1101 New York Avenue) at 1101 New York Avenue is scheduled to deliver 65 percent pre-leased in January 2007; Tishman Speyer’s (1099 New York Avenue) at 1099 New York Avenue is now underway after recently landing a lead tenant, and the JBG Company has 300,000 square feet available at 1101 K Street. A recent major deal in the area is the Department of Justice’s lease of 174,160 square feet of office space in Blake Real Estate’s 1100 L Street NW building.

In Arlington County, Virginia, ongoing infill and redevelopment of older properties continues to transform the county into a new urban core. In particular, Vornado’s repositioning of the Crystal City submarket since the departure of two U.S. Government agencies has been very successful. The outer suburbs in both Northern Virginia and Suburban Maryland are also busy. Defense contractors, biotech giants and a second wave of technology firms are the big demand generators along the Tech Corridors of Interstate 270 and the Dulles Toll Road and in edge cities like Reston, Virginia. Looking ahead, developers are eyeing Tysons Corner, Virginia, for another building boom to correspond with the expansion of Metro, Washington D.C.’s commuter rail.

With the long run of rising property values and good market vitals, out-of-towners have come to buy real estate. The most recent example is Tishman-Speyer contracting for the more than 5 million-square-foot Washington D.C.-area portfolio from Carr America (Blackstone Real Estate). Earlier in the year, Duke Realty completed its purchase of the Mark Winkler Company’s multi-building portfolio and local firm Westfield Realty aligned its 3.5 million-square-foot portfolio with Trison Properties.

— Don Konz is associate vice president of Washington, D.C.-based Donohoe Real Estate Services/CORFAC International.

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