Market Fundamentals Soften in the Washington, D.C. Metropolitan Area as the Government Contracts

The office market in the Washington, D.C. Metro region was off to a slow start in 2012, with leasing activity down from last year at this time in both the Downtown and suburban markets. Negative absorption of 452,000 square feet (sf) in the District marked the second consecutive quarter of decreased absorption. The CBD submarket was responsible for most of this as tenants such as the Federal Housing Finance Agency (FHFA) and the Internal Revenue Service (IRS) either vacated space for other submarkets or downsized. At 13.1%, the CBD vacancy rate is at its highest level in 15 years.

The Northern Virginia market also contracted, due in large part to space being returned to the market by the U.S. Army, Air Force and other government agencies in Arlington County as a result of BRAC (Base Realignment and Closure) initiatives. Absorption was negative 1.2 million square feet (msf), with the Crystal City submarket contributing to about half of that. Vacant space in the Northern Virginia office market approached a level not seen since 2003, with 17.5% of its inventory recorded as vacant.

Suburban Maryland was the only jurisdiction to witness some positive market fundamentals.  Despite positive absorption, slow leasing activity in Suburban Maryland mirrored the rest of the region, coming in at about half of last year’s total at this time.

Renewals remained dominant, accounting for 38% of all leasing activity in the Metro region. In some cases, landlords are willing to renew tenants with up to 5 years left on their leases.  Tenants of all sizes continue to negotiate favorable lease terms including contraction and termination rights. The drive towards efficiencies and keeping costs under control has resulted in the “right-sizing” of all types of businesses: legal, non-profit, and … government.

The investment sales market in the District was fairly active during the first quarter, with nine closed transactions representing $979 million in total volume. The top three transactions were completed by foreign investors. With 17 office properties currently on the market, D.C. is poised to have an active 2012. Investment sales in the suburbs, on the other hand, nearly came to a standstill during the first quarter of 2012 with few properties changing hands.

Office market conditions in the region will remain lackluster into 2012, at least through the election, as government continues to downsize while tenants put off making decisions for as long as possible.  Activity will be mainly driven by lease expirations, although government contractors working for health or intelligence agencies may see some growth. Sectors such as technology, education and healthcare will also continue to grow, but not enough to absorb the excess supply of vacant space on the market.

Maria Sicola, Executive Managing Director of Research, Americas, and Paula Munger, Director of Research, Mid-Atlantic Region

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