Sales Prices For Developable Land Soar In DC

Washington, DC maintained its position as one of the nation’s tightest office markets during the third quarter. Availability rates, leasing activity and rental rates remained relatively constant, while sales prices for buildings and developable land continued to soar. Tenants are experiencing rising prices and the boundaries of what are considered acceptable areas for relocation are broadening.

The overall availability rate for the third quarter was 7.0%, up from 6.8% during the previous quarter. The Class A availability rate rose by 0.3 percentage points (pp) to 7.7%. Leasing activity increased during the third quarter to nearly 1.8 million square feet (msf), up from 1.2 msf in the second quarter. Leasing activity continues to be driven by growth in the region’s primary industry groups, which include the federal government, law firms and associations. Year-to-date leasing activity totaled 4.4 msf. Quarter-on-quarter, the overall rental rate rose from $39.79 to $40.67, and the Class A rental rate increased from $44.60 to $45.47 psf.

In the District, nine buildings have been delivered in 2005. These buildings total 3.1 msf, of which 68% is leased. Two buildings account for the majority of the available space. The entirety of 500 12th Street SW, delivered earlier this year, remains empty; and 395 E Street SW, delivered this quarter, is only 17.8% leased. A total of 22 buildings currently under construction will add 6.2 msf of inventory to the market. Of this space, 49% is pre-leased.

Large space users continue to have limited options, while mid-sized tenants have many. Only 18 buildings offer contiguous blocks of space of 100,000 sf or greater. Of these, only nine are Class A buildings. Tenants seeking less than 30,000 sf, on the other hand, can choose from more than 700 options.

The investment market in the District remains strong, and building prices continue to increase to new levels with each sale. Land prices also continue to escalate to unprecedented levels, with the ceiling for the last sale becoming the floor for the next. Dreyfus’ $80-million purchase of 801 17th Street NW, a 21,827-sf property, computes to $367 psf of development capacity, before any additional cost for demolition. This virtually doubles the highest price paid for office land in the District to date. The phenomenon of skyrocketing land prices is taking place throughout the city, including areas with limited office space such as the Northeast and Southeast. In these submarkets, high land prices will likely lead landlords to project rental rates now only attainable in the core areas of downtown.

The astonishing prices being paid for land are primarily the result of a dwindling supply of developable space. Very few prime sites are available – and virtually all plots are already controlled by a developer. Consequently, the boundaries of what tenants currently consider acceptable locations will continue to expand.

The Washington, DC office market remains competitive, with both sales and leasing activity thriving. Intense competition is expected to persist in the investment market for the foreseeable future, with prices trending toward unprecedented levels. If the past is any indication, government agencies, law firms and associations will continue to drive demand.

Market Tightens in Northern Virginia

The Northern Virginia office market continued to see steady improvement during the third quarter. Despite the intense speculation surrounding the potential impact on the market of the Base Realignment and Closure (BRAC) recommendations, leasing activity increased, availability rates remained relatively flat and rental rates increased modestly.

Overall leasing activity increased in Northern Virginia during the third quarter to nearly 3.2 msf, up from 2.6 msf during the last quarter. Year-to-date leasing activity was 9.1 msf. The overall availability rate was 12.1%, down slightly from 12.7% during the previous quarter.

The Class A availability rate was 11.2%, down by 0.7 pp from the rate in the second quarter. The overall rental rate rose from $25.66 to $26.40 psf, while the Class A rental rate increased from $27.38 to $28.34 psf.

Market conditions are tightening in Northern Virginia despite delivery of 18 buildings since January 2005. These buildings added 2.3 msf of inventory to the market. Of this space, 78% is leased. Thirty-four office buildings totaling 5.4 msf are currently under construction, of which 49% is preleased. Additionally more than thirty office condominium buildings are under construction, and many buyers are in the market for such space. For large tenants seeking space in Northern Virginia, 25 buildings offer contiguous blocks of available space of 100,000 sf or greater. Of these, 15 buildings are Class A.

The BRAC recommendation process was designed to create efficiencies in space use and increase security for Department of Defense (DoD) agencies throughout the United States. The process has been lengthy, but recent events have pushed the recommendations closer to implementation. After four days of deliberation and voting in late August, the Commission finalized its report and submitted it to President Bush on September 8. After concurring with the Commission’s report, the president sent it to Congress on September 15 for review. By law, Congress has 45 legislative days to accept or reject the report in its entirety. If the report is accepted, it then becomes law. According to the report:

“Of the 190 DoD recommendations, the Commission approved 119 with no change and accepted another 45 with amendments; over 86% of those proposed by the DoD. The Commission rejected 13 DoD recommendations in their entirety, significantly modified another 13, and made five additional closure or realignment recommendations on its own initiative. Of DoD’s recommended 33 ‘major’ closures, the Commission approved 21, recommended realignment for seven, and rejected five. In addition, the Commission recommended one for closure rather than realignment for a total of 22 major closures.”

In the long term, it is expected that the implementation of the BRAC recommendations will take place over a number of years and have a slow impact on the Northern Virginia market. Construction of new facilities on military installations will undoubtedly take time and money. The DoD will need to seek Congressional approvals, and appropriations will be required to fund the new construction and agency moves. The implementation of the BRAC recommendations should be a long, arduous process, easing the overall impact on the region.

Despite the outcome of the BRAC recommendations, Northern Virginia is expected to continue to see improvements throughout the remainder of 2005. Leasing activity is expected to remain strong, and availability rates should continue to decline. As the market tightens, rental rates will continue to rise.

Suburban Maryland Maintains Stability

The office market in Suburban Maryland, consisting of Montgomery and Prince George’s Counties, has proved stable quarter-on-quarter. This stability can be attributed to the market’s diversified tenant base, coupled with historically low supply and a dearth of new developments. The overall availability rate remained relatively stable in the third quarter, while leasing activity increased and rental rates remained flat.

The overall availability rate has hovered around 12.0% since the beginning of the year, slowly falling from 12.6% in the first quarter to 11.9% in the third. Leasing activity increased during the third quarter to nearly 1.6 msf, up from less than 1.0 msf during the previous quarter. Yearto- date leasing activity was nearly 4.0 msf, up 37% from a year ago. The overall rental rate rose modestly from $23.45 to $23.58 psf.

With the limited supply and lack of new development, options for tenants in the Suburban Maryland market are significantly reduced. Only 13 buildings offer contiguous blocks of available space of 100,000 sf or greater, and only four of these options are in Class A buildings. In contrast to the limited supply of large blocks of space, ample opportunities exist for smaller tenants. Over 900 options are available for tenants seeking less than 30,000 sf. Five projects have delivered since year-end 2004. These buildings total 250,000 sf, of which 79% is leased. Currently, five buildings are under construction, which will contribute an additional 866,124 sf to the market. Of this space, 52% is preleased.

Montgomery County makes up the larger segment of the Suburban Maryland office market. Increases in overall leasing activity have contributed to the county’s consistent performance. Posting 1.3 msf during the third quarter, Montgomery County outperformed Prince George’s County (304,770 sf). Montgomery County’s office market is tight, and it is expected to experience increases in rental rates as a result of the lack of available quality space.

Although the Suburban Maryland office market has shown some movement, it remains relatively stable. Optimism is increasing that the office market is well positioned for a rebound. The slightest up-tick in demand will result in a decline in availability rates and an increase in rental rates.