Activity in the District of Columbia's office market settled to a steady pace this year, yet remained active enough to sustain high occupancies and healthy rental rates. The overall vacancy rate stabilized, and at 7.6% in the second quarter, remains the lowest in the nation. Not surprisingly, average direct asking rents for all building classes set another milestone at $42.12 per square foot (psf) in the second quarter. One weakness is the slowdown in leasing activity. Approximately 2.5 million square feet (msf) of new leases was executed to date, lagging the 3.5 msf that is typically completed for a comparable period over the past 10 years. As a result, overall absorption dipped to 613,716 square feet (sf) in the first half of this year.

One catalyst for this market's resilience is the resurgence of activity in lower-grade properties in the second quarter. Notably, the two largest transactions to date involving Chemonics International (253,000 sf) and the General Services Administration or GSA (115,000 sf) typified the situation. Consequently, overall vacancies fell most steeply over the quarter for class B (from 6.6% to 5.8%) and C (from 8.2% to 6.7%), which in turn, caused a surge in rents.

By comparison, class A properties were underperformers in the second quarter, as large blocks of space from private firms were released to the market. Conservation International placed its 105,609-sf headquarters for sublease with plans to relocate in Northern Virginia. Meanwhile, law firms such as Dorsey & Whitney LLP and Weil Gotshal & Manges LLP have also been looking for sub-tenants to backfill their spaces. Compounding this is the delivery of three buildings that added 522,935 sf to available space - inclusive of Morrison and Foerster's 77,000 sf that the law firm was to take at the newly-delivered 1700 K Street. On the upside, current average direct asking rents for class A at $47.54 psf still remained the second highest on record.

While signs of a slowing demand have emerged, the District's office market strength is still undeniable, helping to fuel a construction spree going on its third straight year. Currently, the development pipeline is approximately 5.2 msf, and is likely to intensify with nine projects in the works this year which could add over 2.0 msf. Speculative projects total 3.2 msf, and are nearly 30% pre-leased.

The District remains an indelible hot spot for investment sales in the country. Prices burst to new records once again, appreciating over 60.0% from one year ago to an average of $466.00 psf. All building classes showed double-digit annual price gains, with class A rising most rapidly from a year earlier at 80.0% to $582.00 psf in the second quarter of 2005. Overall, sales of properties valued at $10 million or more totaled $1.5 billion through June.

The District can look forward to finishing another solid year. C&W anticipates strong employment growth to buttress tenant demand. Even with the potential drag from the base realignment and closure proposal, the District stands a good chance of sustaining its low vacancies.

The recovery in Northern Virginia's office market remained intact in the first half of 2005, characterized by a more sustainable pace of improvement in occupancies and rents. Vacancies reached new lows since the second quarter of 2001 at 11.5% for overall and 9.9% for direct, thanks to significant occupancy gains in Fairfax County and the City of Alexandria. Asking rents rose across the board, up at an average of $2.00 per square foot (psf) for class A and $1.00 psf for class B this year.

Rising employment remains Northern Virginia's buoy of growth. Over 30,000 jobs were created through April of this year so that employment reached new heights once again. With such strong underpinnings, tenant demand continued to mount in virtually every submarket - causing overall absorption to stage gains for the ninth consecutive quarter. Crystal City/Pentagon City is one of the two submarkets that suffered a sharp decline in overall net absorption, as the U.S. Patent and Trade Office completed its move to Old Town Alexandria in the second quarter.

However, the momentum of leasing activity has noticeably waned this year. The volume of new leases executed through June ratcheted down to 4.2 million square feet (msf) from the 8.0 msf recorded in the first half of 2004. Leases over 30,000 square feet (sf) continued to be major drivers, accounting for 40.0% of total volume. Even so, this slower pace is respectable by historical standards - in line with the 10-year average. Another encouraging note is that the region appears to rely less on federal activity. Large leases were generated by a broad range of private-sector tenants: ITT Industries, KBR-Halliburton, American Trucking Association, and Network Solutions.

Despite the sustained rebound in demand since 2003, office construction remained under control. One fully-leased building came online in the second quarter, and approximately 3.6 msf was under way through June, with markets having single-digit vacancies among the most active areas for new construction. Speculative projects totaling 3.4 msf dominated the pipeline, but to date, nearly half has been pre-leased.

On the investment side, office building sales have never been stronger. Through June, transactions valued at $10 million or more totaled $2.3 billion, just shy of $2.4 billion posted for all of 2004. This is courtesy of Beacon Capital Partner's recent acquisition of Westfield Realty's 10-building, 2.4-msf office portfolio in Northern Virginia for $402.00 psf. Notably, this is the largest transaction recorded for the region, which accounted for nearly half of this year's sales volume. Overall, average prices have soared by over 50% from a year ago to $303.00 psf, with the Beacon deal estimated to have contributed half of this increase.

While long-term challenges loom - including the possibility of substantial tenant move-outs from the proposed base realignment and closure process and mounting government fiscal problems, Northern Virginia's office market is not in danger of a broad demand decline. C&W expects the current demand recovery to transition to normal levels. Barring any shifts in policies, federal expenditures should fuel steady job creation in the area.

Second-quarter data portray a stronger picture for the Suburban Maryland office market, with recovery continuing to gain traction. Overall vacancies continued their descent, slipping 0.9 percentage points from the first quarter to 12.0% - the lowest in 3.5 years. Direct vacancies have even reached market equilibrium, as close-in markets in Montgomery County now post single-digit direct vacancies. All this is welcome news, as this portends that rent recovery could be at hand. Already, asking rents for prime large blocks of space, as well as some class B properties in both Montgomery and Prince George's Counties, have ticked up from the first quarter.

The strength primarily comes on the heels of a strong job market in Suburban Maryland. Non-farm industries added over 7,000 jobs to their payrolls this year, allowing the unemployment rate of 3.4% in Montgomery County and 4.7% for Prince George's County to remain below the national average (4.9%).This favorable economic backdrop has set the healthy pace for demand, with cumulative overall absorption trending up to 596,407 sf this year.

Moreover, widespread employment gains are contributing to broad-based leasing activity - which totaled 1.9 million square feet (msf) to date. Notably, the financial, insurance, and real estate sectors boosted leasing activity- thanks to a vibrant housing market. Even the telecommunications sector has been fairly active in taking down space in this market. World Space and PBI Media LLC represent media companies that have leased over 50,000 square feet (sf) so far this year. Meanwhile, the government and its cadre of contractors that include biotech companies were pivotal to executing large transactions this year: Celera Genomics Corporation (112,053 sf), National Institutes of Health (83,567 sf), and Lockheed Martin (two separate leases totaling 74,513 sf).

The lack of new product has also played a key role in supporting higher occupancies. Through June, only two buildings have delivered, while four projects remained under construction and renovation - in which only 76,300 sf and 130,650 sf will be available in the remainder of 2005 and 2006, respectively.

The rebound in investment sales activity this year also indicates that the Suburban Maryland market is on solid footing. So far this year, transactions totaling $10 million or more rose to $474 million - nearly 60.0% above levels posted in the same period last year. Average prices have also soared to $234.00 per square foot (psf) up 65.0% from one year ago. Much of this bounce reflects significant price gains in class B properties - where average direct asking rents also climbed most rapidly.

The big news during the quarter was, of course, this market's potential to benefit from the proposed round of base realignments and closings (BRAC). Notably, Suburban Maryland is expected to gain 2,000 personnel largely originating from closed facilities in Northern Virginia and the District. With the proposed addition of nearly 8,000 civilian jobs, the state of Maryland is expected to emerge as the biggest winner in BRAC - not only regionally, but also nationally. This has the potential to strengthen its office market, and further enhance its reputation as a top-notch research center.