• Washington Area Office Inventory and Vacancy Rates, and Vacancy Rate Trends Power Point Graphs

The Washington Metro Area Office Market: A Third Quarter 2002 Survey

The Washington area office markets followed three different courses during the third quarter 2002, staying true to their usual performance. Leading the metro area - and all of the United States, for that matter - the downtown Washington, DC market saw a reduction in vacancy from 6.3% to 6% and positive absorption (defined as the net change in occupied space) of 667,223 square feet. Maryland maintained its "steady Eddie" role, posting a slight change in vacancy from 10.4% to 10.6% with positive net absorption of 582,000 square feet. And Virginia, traditionally the most volatile of the three markets, saw a jump in vacancy from 15.9% to 16.9%, along with negative absorption of 818,607 square feet.

In the investment sales market, Washington, DC continued to be a mecca for investors, who snapped up office buildings of all sizes and quality at rising prices throughout the year. Investors have dropped their return expectations by perhaps 100 basis points during the year, leading to capitalization rates in the 7% to 8% range for Class A buildings and prices of $300 to more than $400/square foot. In Virginia, despite the high vacancy rate, stabilized buildings inside the Beltway traded at cap rates in the 8% to 9% range and prices of from $200 to more than $300/square foot, while stabilized properties outside the Beltway commanded prices in the $200 to $275/square foot range.

The decline in the vacancy rate in downtown Washington reversed a nearly two-year trend of small but steady increases from the rock-bottom 3.6% vacancy rate registered in the third quarter of 2000. There was evidence of tenant demand, especially by smaller groups who took advantage of bargain sublets available in Class A buildings. In addition, the federal government indicated that it would be a major player in 2003, both in the District and in the close-in suburbs. At the same time, supply of new buildings during the third quarter was limited to just one building, a 352,000 square-foot build-to-suit at 500 5th Street NW for the National Academy of Sciences.

Other trends evident during the third quarter were:

• Continuing speculative development, though at a lower rate than in previous years. There were two third quarter construction starts: Douglas Development's speculative redevelopment of the old Woodie's department store at 1025 F Street, NW and Boston Properties' 537,454 square foot building at 901 New York Avenue, NW, which was two-thirds preleased to two law firms.


• A move up in quality as tenants took down small blocks of sublet space, resulting in a decline in the Class A vacancy rate from 7.1% to 6.2% during the quarter and a slight rise in the Class B vacancy rate from 6.1% to 6.6%. The amount of sublet space on the market dropped modestly from 1.8 to 1.7 million square feet.


• Continuing absorption of space in new buildings (1,760,411 square feet during the first three quarters) at the expense of relet/sublet space where year-to-date absorption was a negative 1,133,480 square feet. The two largest leases of the quarter were in new buildings: 149,656 square feet to the District government at 77 P Street, NE and 135,975 square feet to the US Environmental Protection Agency at the renovated 1310 L Street, NW. Generally speaking, rates are holding firm though building owners and sublandlords are willing to stretch in some cases, offering increased concessions.

Market trends in Maryland during the third quarter were:

• Delivery of 776,544 square feet in five buildings, about two-thirds of it preleased to Computer Sciences Corporation, Marriott Corporation, and other tenants.


• A limited amount of new construction with 318,305 square feet getting underway in three buildings, one for the US Department of Health and Human Services, another for Marriott, and a small speculative project with just 30,000 square feet.


• Stable activity with no super-size leases and no massive returns of space. The largest lease of the quarter was 66,875 square feet to Advancis Pharmaceuticals at Seneca Meadows in Germantown. Space coming back to the market was mostly due to tenant moves, rather than downsizings or closures. Also, rents in most submarkets remained stable.

In Northern Virginia, after a couple of quarters when vacancy rate increases were flatter than in 2001, the office market took another negative turn during the third quarter. Demand was anemic, as private-sector tenants were hammered by the sluggish economy and expected public sector demand from federal agencies and contractors was slow to materialize. On the supply side, large blocks of space came back from bankrupt or downsizing tenants. There continued to be a marked contrast between conditions inside the Beltway and outside. The Arlington and Alexandria office vacancy rates of 9.6% and 10.9%, respectively, were half those for Fairfax County at 20.8% and Loudoun County at 17.4%, and reflected demand from federal agencies and contractors.

Other Northern Virginia trends were:

• Very high market vacancies in markets like Reston (23.5%), Herndon (33.2%), and Tysons Corner (20.8%) where demand was limited to tenants with lease expirations and space continued to be returned from bankrupt, downsizing, or relocating tenants. Most leases signed were small, the largest for the quarter being Cambridge Associates' commitment to 82,680 square feet at 4100 N. Fairfax Dr. in Ballston.


• Continuing downward pressure on rents outside the Beltway, as sub-landlords competed with prime landlords, lowering their rates and offering concessions like free rent, furniture, and phones.


• A trailing off in supply, as just four buildings delivered during the third quarter with a total of 641,270 square feet, and the complete cessation of new speculative construction.