CITY HIGHLIGHT, OCTOBER 2010

WASHINGTON D.C. CITY HIGHLIGHTS
Thomas Long, Brian Coakley, George Labarraque, Leonard Howell, David Feldman, Michael Pratt and Steve Combs

Washington D.C. Industrial Market

The overall vacancy rate for the greater Washington, D.C., Industrial market totaled 13 percent based on an area wide inventory of 205 million square feet. This is up slightly from the last two quarters as well as the previous year. Rental rates for mid-year 2010 averaged $9.15 per square foot, lower than last quarter and the previous year. Both rental rates and occupancy rates for close-in markets were substantially greater. Examples of this would be Rockville, Maryland, at $11.09 per square foot and a 6.7 percent vacancy. In northern Virginia, the Interstate 395 corridor experienced a 7.6 percent vacancy rate and a rental rate of $11.02 per square foot. Conversely, the outer suburbs continue to be much softer with substantially greater vacancy and very competitive rental rates. Examples are Frederick County, Maryland, at 16.4 percent vacancy and an average rental rate of $5.64 per square foot. The Dulles, Virginia, industrial market was 16 percent vacant with an average rental rate of $7.90 per square foot.

These disparities in rate and occupancy force business owners in the Washington area to seriously consider the greater occupancy cost, in the form of both rental rate and real estate taxes, associated with closer-in locations. Also considered in these decisions are commuting and “truck time,” as the D.C. area’s inadequate highway infrastructure has made for an average commute time of forty minutes, second only to Los Angeles or New York City. It should be noted that due to the lack of heavy industrial and distribution operations in the greater Washington area, average warehouse tenant size is significantly smaller than most industrial markets. Of total warehouse tenants in the area wide market, 70 percent are smaller than 25,000 square feet.

Due to the aforementioned lack of size in the existing building inventory, most large consolidations of industrial or flex users require a build-to-suit. A most recent example of this would be a major aerospace contractor in the Dulles, Virginia, market that will be relocating into a new single building totaling 130,000 square feet, since there were few, if any, existing facilities able to accommodate its combination flex/warehouse requirement.

The name of the game being played between commercial brokers, their tenants and the majority of landlords is “blend and extend.” Market-savvy tenants, with the help of their brokers, are taking advantage of lower renewal rates and concessions packages not seen in years. Tenants are renewing their leases two to three years prior to their currently scheduled termination date.  Most landlords are happy to accommodate by rolling back the rents, especially those landlords with first trust debt in the form of a CMBS loan. Thousands of these loans are scheduled to come due in the next two to three years. Landlords are girding themselves for this by shoring up their rent rolls in a weak market that has a dearth of industrial tenants actively looking to expand or incur the cost and expense of moving.

There is very little new industrial development, due primarily to the lack of industrially zoned land. The cost and time required to secure entitlements for development through building permits makes new construction in close-in submarkets extremely difficult to justify. The few opportunities for new industrial or flex development will likely be infill in nature. A good example is Jackson-Shaw out of  Dallas, Texas. The Brick Yard, located in Beltsville, Maryland, is the redevelopment of a 100-year-old clay brick mining and manufacturing facility formerly owned by the Washington Brick Company. Located on Route 1 north of Beltsville, Maryland, the project has already sold several built-to-suit properties. At full build-out it will total 650,000 square feet of light industrial on 60 acres.

— Thomas J. Long, SIOR, is a vice president and Brian K. Coakley, SIOR, is a senior vice president with Donohoe Real Estate Services/Corfac International in Greenbelt, Maryland.

Washington D.C. Office Market

During the second quarter of 2010, the District of Columbia’s office market suggested continued signs of recovery. Net absorption was the highest since before the recession began. This was a result of significant growth by the federal government, which is expected to continue through the remainder of the year. The overall health of tenants is improving, and tenants are more likely to relocate as they take advantage of higher market concessions and lowered rents.

Renewal activity has significantly decreased from a year ago; 87.5 percent of the total top transactions in the second quarter of 2009 were renewals, compared to 22.6 percent in the second quarter of 2010. Overall leasing activity has also increased from the same period last year. There were 31 transactions greater than 15,000 square feet during the second quarter, an increase from the eight transactions one year ago.

Requirements from the federal government’s General Services Administration (GSA) project continued gains in net absorption. A reduced amount of new supply coming online coupled with continued elevated GSA leasing means the overall vacancy rate will likely level off by the end of 2010, if not decline slightly.

Regardless, with more private sector tenants making real estate decisions one to two years before their leases expire, there is a possibility of a slight slowdown in private sector leasing as savvy tenants have taken advantage of aggressive deals far ahead of their natural lease expirations. Following nine consecutive quarters of rising office vacancy in the District, the overall vacancy rate fell during the second quarter by 0.6 percentage points from 12.0 percent to 11.4 percent. Specifically, NoMa achieved the largest decline in vacancy over the quarter, falling from 21.3 percent to 17.1 percent.

Over the quarter, a few federal government tenants grew within the District. Among them, The Securities and Exchange Commission (SEC) leased approximately 200,000 square feet at 700 2nd St. and 980,000 square feet at Constitution Center at 400 7th St. The U.S. Customs and Border Protection leased 85,000 square feet at newly delivered 90 K St., and the GSA’s new headquarters location pre-leased the entire delivery at Constitution Square at 1275 First St.

Overall direct asking rental rates ended the second quarter of 2010 at $50.27 per square foot on a full service basis, while Class A asking rates were $51.49. Asking rates continued to remain elevated due to high concession packages. Trophy asking rents averaged $65.65, primarily due to premium space in the Capitol Hill submarket at 300 New Jersey Ave., with asking rates in the mid $80s on a full service basis for the top floors.

Demand in the District grew to over 1.1 million square feet during the second quarter, leading the District of Columbia’s office market into a recovery in 2010 The federal government continued to be a major driver as it accounted for over 83 percent of net absorption achieved during the second quarter.

— George Labarraque is a vice president and Leonard A. Howell, LEED AP, is a senior leasing associate with Donohoe Real Estate Services/Corfac International in Washington, D.C.

Washington D.C. Multifamily Market

A healthy local economy will continue to support strong demand for rental housing over the remainder of 2010, helping to retain the Washington, D.C., metro area’s stature as the top apartment market in the country. However, the nascent recovery will encounter setbacks in its early stages, evident by a small increase in marketwide vacancy in the second quarter. Indeed, job creation was strong in the first half of this year, but the pace of private-sector employment growth flagged at the end of the second quarter. Employment growth will proceed at a more measured pace in the second half as private-sector employers remain cautious amid a mixture of positive and negative signals from the economy. While vacancy will decline this year, the ongoing construction of new rentals presents a potential obstacle. New units typically are absorbed quickly, but the current recovery in demand has only started and remains susceptible to sudden economic shocks, potentially putting upward pressure on vacancy.

Washington, D.C., apartment fundamentals have been strong compared to those in other metro areas. However, despite robust job creation, demand did not keep pace with supply growth in the second quarter, as metrowide vacancy climbed 30 basis points to 6.3 percent. Vacancy was unchanged in the first half of 2010, with net absorption of more than 3,200 units slightly exceeded by completed units. In the District, vacancy rose 30 basis points to 6.4 percent in the second quarter, as approximately 100 units became vacant in the period. Vacancy was also up 30 basis points year to date. Vacancy increased 30 basis points during the second quarter in both Maryland and Virginia to 6.6 percent and 6.0 percent, respectively, although the performance was slightly stronger in Maryland. Vacancy rises were functions of supply growth; in Maryland, apartment demand ticked up 0.7 percent, while a 0.6 percent bump was registered in Virginia. A modest easing in completions over the remainder of 2010, accompanied by continuing, albeit slower, job growth, will result in a 40-basis-point drop in vacancy this year to 5.9 percent.

Driven by larger increases in Maryland and Virginia, metrowide asking rents inched up 0.7 percent in the second quarter to $1,348 per month and also were up 1.1 percent year to date. Effective rents gained 1.2 percent in the quarter to $1,272 per month, pushing down concessions; year to date, effective rents rose 1.8 percent. In Virginia, concessions fell to 5.2 percent of asking rents in the second quarter as effective rents increased 1.6 percent to $1,340 per month and asking rents advanced 1 percent to $1,413 per month. Asking rents in Maryland were $1,254 per month in the second quarter, a gain of 0.9 percent, while effective rents rose 0.7 percent to $1,171 per month. Asking rents in the district inched up only 0.1 percent in the second quarter to $1,385 per month, but concessions fell 120 basis points to 4.6 percent of asking rents due to a 1.4 percent rise in effective rents to $1,321 per month. Asking rents will increase 2.9 percent this year to $1,370 per month, and effective rents will advance 3.8 percent to $1,297 per month.

Fueled by motivated buyers and accessible financing at favorable terms, investment activity will remain centered inside the Beltway over the coming quarters. In the District, apartment operators became active buyers in the first half, accompanied by developers and condo converters, who remain driven by a projected shortage of condominiums in the next few years. Demand for properties with under 100 units and boutique assets containing 30 units or fewer remains strong, with cap rates estimated in the low-6 percent range. Overall, cap rates inside the Beltway compressed up to 100 basis points in the past six months. Local banks generally have stepped up to finance assets where the purchase price supports the resale of converted units. Preferred areas for conversion-oriented investors include established neighborhoods such as Dupont Circle and areas in transition where properties are proximate to the metro. Strong job creation will drive housing demand in Maryland and Virginia, but investors can require cap rates up to 200 basis points higher than for properties inside the Beltway.

— David Feldman is the regional manager of the Washington, D.C., office of Marcus & Millichap Real Estate Investment Services.

Washington, D.C., Retail Market

While most people residing outside the Nation’s Capitol associate power and politics with the Washington, D.C., region, insiders understand the unparalleled passion that exists for our four professional sports teams. With that metaphor in mind, this is what you should know about retail in the land of the Capitals, Nationals, Redskins and Wizards.

New Sheriff in Town

A new head coach for the Washington Redskins spurred a significant change in personnel — including the starting quarterback – providing optimism for a team that had been moving in the wrong direction for several years. The period through 2008 and 2009 was a time when the retail industry was going backwards in this market as well, although conditions were worse in the suburbs than the city. Everywhere, it became increasingly difficult to close deals, as asset managers, property owners, lenders and retailers scrutinized deals more closely than ever. Capital was unavailable for retailers and real estate financing was non-existent.

Overall, the slight dip in rental rates was not as dramatic in the Washington, D.C., region. The banking crisis and recession led to a virtual halt in bank leases and their inflated rents, while apparel retailers’ sales and their stock prices tanked. An influx of fast-casual hamburger joints, yogurt shops, cupcake purveyors and bakeries took over as the opportunities arose, while Starbucks remained on the sidelines, recovering from injuries inflicted by the stock market and consumers’ desire for a cheaper cup of coffee elsewhere.

New York-based restaurant operators saw opportunity in the D.C. market and targeted high-traffic venues around Verizon Center in Chinatown. Buildings in Dupont Circle, which were never previously considered for restaurant uses, were re-fitted to support venting. Throughout the country, leasing agreements were restructured after-the-fact with rent reductions, and most landlords played ball since a tenant paying lower rent was better than no tenant at all. Today, more retailers have fixed their problems as a result of the market downturn, and landlords are less apt to reduce rents as demand for retail space increases.

The Phenom

Attendance at Washington Nationals games was typically two to three times larger when the highly-touted pitcher Stephen Strasburg took the mound.  These larger crowds also translated to more sales of food and memorabilia in and around the stadium.

Forever 21 aggressively expanded within the city, taking approximately 60,000 square feet of space at the former Woodward & Lothrop Building along the F Street corridor. The retailer only adds to the hightened sense of excitement being felt around the city.

New Faces

Long-time Capitals owner Ted Leonis now owns the Washington Wizards. Based on his reputation with the Capitals, Leonis’ buy sparked renewed interest and there is more hope for the teams, which translates to bigger crowds.

We see a strong analogy specifically in the Georgetown area. The retail downturn was a blessing in disguise for some companies who were unable to weather the storm created by the recession. The result was the closing of under-performing stores, which created timely opportunities for stronger operators on a national and international scale. English retailers Allsaints and Barbour, Apple and True Religion from California, and the now Italian-owned Brooks Brothers’ 20,000 square foot flagship are examples.

This new outlook will pay dividends in D.C. We believe there will be more “game changers,” as big-name international and U.S. franchises come to D.C. and create an impact like did Apple did to Georgetown, Forever 21 did to F Street, and Whole Foods and Target did to Logan Circle and Columbia Heights — the way a star athlete does for his team. 

MVP

Winning is good for everyone. The Washington Capitals – with the sport’s most exciting star in Alex Ovechkin – have shown that in recent years with a string of sell-outs to prove it. This success not only helps the team, but it also positively impacts retail – particularly on the east end of town where retailers such as Urban Outfitters or LOFT and restaurants such as Rosa Mexicano are reaping the rewards of more traffic along 7th Street.  Harris Teeter is also showing interest along Navy Yard near the new Washington Nationals ballpark.

Winning teams and winning retail snowballs. You can witness patrons of Shakespeare Theatre spending money in local restaurants and bars alongside jersey-wearing sports fans by Verizon Center, and you can see new residential buildings having success along the southeast waterfront in Navy Yard next to the baseball stadium. Grocery stores, restaurants and fitness clubs scout sites there, and retail in general won’t be far behind. Where residential goes, restaurants and retail is soon to follow, and where retailers go, so go more retailers. Large blocks of land have been snapped up for future development in this area.

— Michael Pratt and Steve Combs are with the Washington, D.C. metropolitan office of KLNB Retail.

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