The watchwords for D.C. tenants in fourth quarter, and throughout 2011, were efficiency and flexibility. While many companies opted to renew leases and maintain existing footprints, others relocated and took the opportunity to streamline their operations. This “doing more with less” approach has proven particularly appealing in the face of political uncertainty and economic headwinds and firms are finding they’re able to save significantly on occupancy costs along the way. Writ large, these actions are contributing to an upward trend in availability and are likely to lower the aggregate demand for office space in D.C. for a long time to come.
At the height of the economic downturn, companies were forced to reorganize their operations and create leaner organizations in an effort to reduce financial commitments. This heightened efficiency is now being implemented as a long-term cost-savings strategy and tenants are not eager to alter this new model. The real estate decisions made by law firms, in particular, have been demonstrative of this trend as recent leases have resulted in a net decrease in firms’ occupied space. This is especially telling since new leases typically account for both today’s space needs as well as room for expansion during the lease term. To save on real estate-related costs, several firms have also opted to move ancillary functions (e.g., billing, human resources, etc.) to off-site locations. Most recently, D.C. firms have moved operations to Tenleytown, West Virginia and Ohio.
The District’s largest tenant, the federal government, is the latest adherent to this trend. The GSA is increasingly focused on the efficiency of its leased space. Perhaps the most dramatic example is the planned consolidation of GSA headquarters at 1800 F Street NW. An analysis of the agency’s existing spaces throughout D.C. showed that only 60 percent of the office space was being fully utilized on a given day. By maximizing efficiency, the GSA found that it could go from housing 1,800 employees in the building to 6,200 (a threefold increase). The consolidation of several other federal agencies and a strong push for flexible work arrangements by the government will continue to magnify the impact of this “crunch factor” on the D.C. office leasing market.
Larger tenants moving into less space than they vacated are adding more small to medium- sized spaces to an already sizable inventory. Tenants in this size range continue to have a plethora of options and find themselves in a strong negotiating position that enables them to exact generous concessions in abatement from landlords. Particularly appealing in the face of market uncertainty, tenants are finding themselves able to negotiate more flexibility into their leases, providing options for retraction and expansion within the lease term. Landlords are operating in a very competitive environment and in this atmosphere, the most successful among them are finding that the “little things” matter more and are renewing their focus on things such as the quality of property management. They are also finding that, once mundane, factors such as disclosing asking rents and providing floor plans with online listings can help set them apart from the crowd and give them a better chance of attracting interest from tenants.
“We will not see a lot of transactions in the D.C. region unless tenants have a compelling reason to do so (e.g. pending expirations or a need for considerably more/less space),” says Wendy Feldman Block, corporate managing director of Studley Inc., based in the suburban Washington, D.C., office. “Many are in somewhat of wait and see attitude on the sidelines until they feel more confident about the economy and the impending elections in the fall.”
Leasing Activity up in Northern Virginia as Private Sector Drives Demand
Total leasing volume in Northern Virginia was up dramatically in the fourth quarter, ending the year with the highest quarterly total of 2011. Despite the relative lack of leasing by the federal government, activity in the Virginia suburbs increased by 52.1 percent from the third quarter. The availability rate has continued to climb, rising from 18.1 percent in the third quarter to 18.6 percent to end the year. Overall asking rental rates increased by 2.6 percent, ending the quarter at $30.22 full service.
The private sector stepped up in the fourth quarter, signing a number of significant leases throughout the region. The professional and business services sector and government contractors were particularly active, choosing to upgrade to newer and more efficient space.
Bechtel signed the largest lease this quarter when it took 200,000 square feet at Reston Overlook I & II. The firm will relocate 625 jobs from Frederick, Maryland. NJVC also signed a lease for 123,426 square feet at Plaza East I in Chantilly. The firm will relocate its headquarters from Tysons Corner to the new building, which is currently under construction.
GSA “Saves the Day” in Suburban Maryland
Suburban Maryland also saw a significant up-tick in leasing velocity during the fourth quarter, due in part to one large renewal by the federal government. In total, 1.9 million square feet was leased this quarter, representing a 37.3 percent increase in leasing volume over last quarter.
The Suburban Maryland region was on pace for its slowest quarter of the year before NOAA renewed its 1,000,250 square feet at 1305, 1315 and 1325 East-West Highway. The new agreement will keep the federal agency in Silver Spring for the next fifteen years. This quarter also saw some demand emanating from the private sector, including Meso Scale Diagnostics’s lease for 104,764 square feet at 1701 Research Boulevard in North Rockville and the Children’s Hospital lease for 71,000 square feet at 12211 Plum Orchard Drive in North Silver Spring. The overall availability rate in Suburban Maryland increased by 0.5 percent this quarter and ended the year at 15.5 percent. Overall rental rates totaled $25.94 full service, representing a 0.7 percent increase from the third quarter.
Submarket Focus
As one of the largest submarkets in the region, swings in availability in the East End/Convention Center tend to have a significant impact on the District’s overall market statistics. In the fourth quarter, availability here increased by 1.7 percent overall to 12.3 percent. This is the highest availability since the fourth quarter of 2009. This up-tick is attributable to a handful of large availabilities in the Metro Center area of East End. Several tenants currently located here have signed new leases outside the submarket and their space is being actively marketed. The area is also contending with new supply as the 495,000 square feet of speculative office space at Hines’s CityCenter project is being actively marketed.
The Reston submarket in Fairfax County was a top performer this quarter, landing several of Northern Virginia’s largest leases. Bechtel leased 200,000 square feet at Reston Overlook I & II. Odin, Feldman & Pittleman leased 54,000 square feet at 1775 Wiehle Avenue, representing the largest law firm lease in Fairfax County in the past several years. The availability rate in Reston continues to trend down while average asking rents ended the quarter at $27.33, the highest they have been since the fourth quarter of 2009.
The North Rockville submarket in Montgomery County continued to see improved fundamentals during the fourth quarter, thanks in part to landing the region’s top two private sector leases. Meso Scale Diagnostics leased 104,764 square feet at 1701 Research Boulevard and MSCI leased 51,000 square feet at 702 King Farm Boulevard. The availability rate has decreased significantly over the past several quarters and ended 2011 at 17.3 percent, down from its peak of 24.7 percent in the second quarter of 2010. The average asking rental rate ended the quarter at $27.74 full service, up from the rate of $27.67 one quarter ago.
Outlook
The typical market paralysis shrouding D.C. during an election year will be further intensified this year as tenants adopt a “wait and see” attitude regarding their real estate decisions in light of heightened market uncertainty. Pent-up private sector demand likely exists but in order for this to be unleashed, businesses need to see clear evidence of a sustained economic recovery. Even with new private sector demand, tenants will continue to seek greater efficiency in an effort to save on occupancy costs.
“We always see some uncertainty in an election year in D.C. but this year is unique because the conditions are compounded by a gridlocked congress and a federal government that is contemplating major cutbacks,” says Block. “This political uncertainty trickles down to DC’s private sector tenants – the vast majority of whom have businesses that are either directly or indirectly impacted by government spending.”
Northern Virginia’s availability rate will continue to increase into 2012. Cutbacks in federal spending, coupled with BRAC realignment, will be an ongoing threat to the region. Fundamentals in outside-the-Beltway submarkets are not expected to improve dramatically until completion of the metro extension in 2015. Several spec buildings currently under construction, such as the Lerner project in Tysons Corner, will add new inventory to the region, placing additional upward pressure on space availability.
Suburban Maryland’s recovery will continue at a slow rate as fundamentals are not likely to improve in the near term. The region has experienced limited private sector demand and many tenants are choosing to relocate to Northern Virginia to take advantage of competitive incentives. A very minimal construction pipeline means there is little supply-side risk in this demand-constricted environment.
— Studley's Research Team