Market Overview

The Washington, DC Metropolitan office market ended 2005 with positive net absorption, declining vacancy, increased speculative construction and record investment sale volume. Peak employment growth resulted in strong leasing activity by the Federal Government, defense contractors, law firms and professional service firms. Large blocks of space over 50,000 square feet (sf) remain in very short supply in Washington, DC, representing only 2.6% of the total blocks available. Large tenants are sensing tightening market conditions and are seeking to sign new deals and extensions before rental escalation strengthens further. Transit-oriented development surrounding Metrorail stations, in-fill and town center development, as well as office condominium projects, continue to move forward throughout the Washington Metropolitan area (Metro area) as do several major transportation projects. According to the Center for Regional Analysis at George Mason University, the region had $115 billion in federal procurement spending in 2005 with the region getting 16 cents for every dollar the government spends. The nation's premier investment market attracted a different mix of buyers in 2005 with New York, Australia, China and Japan replacing Germans who are waiting for prices to cool and returns to increase. Sales volume totaled $10.4 billion on 172 transactions in 2005 with sales prices averaging $307 per sf (psf) in the Metro area, up 19.4% from 2004. According to NCREIF, average cap rates for core office assets in the Metro area are 6.6% with Northern Virginia and Suburban Maryland averaging 7%.

Vacancy Rate

As of 4th quarter 2005, the overall vacancy rate in the Metro area was 8.9%, down from 9.3% in 3rd quarter 2005 and 10.5% one year ago. The direct vacancy rate has been below 9.5% since 3rd quarter 2004 and sublease space has been declining steadily, now standing at 1.1%. Class A vacancy rates average 9.3% as of 4th quarter, down from 11.4% one year ago. The Washington, DC vacancy rate remains the second lowest in the nation at 7.3%, with Northern Virginia recording 10.1% and Suburban Maryland recording 9.1%. While vacancy rates are expected to decrease further in Virginia and Maryland in 2006, Washington, DC vacancy rates will rise beyond 8% as new supply outpaces demand.

Net Absorption

Net absorption in the 4th quarter totaled a positive 2.2 million sf, represented by 1.32 million sf in Northern Virginia, 513,478 sf in Washington, DC and 433,115 sf in Suburban Maryland. Law firms, the Federal Government, defense contractors and professional service firms continue to drive leasing activity in the region. Net absorption totaled 12.28 million sf in 2005 represented by 4.24 million sf in Washington, DC, 6.1 million sf in Northern Virginia and 1.97 million sf in Suburban Maryland. Net absorption totaled 10.81 million sf in 2004 led by several large leases over 150,000 sf. Net absorption in 2005 was led by smaller users in the 10,000-30,000 sf range.

Rental Rates

As of 4th quarter 2005, the average asking rent in the Metro area was $30.60 psf, up from $29.92 in the 3rd quarter and up from $29.32 one year ago. Base rents in Washington, DC are $48-$52 with operating expenses now reaching $21-$22 for new Trophy class buildings. Overall asking rents in Northern Virginia average $27.77 as of 4th quarter, up 5.5% in 2005 due to demand from defense contractors and professional services firms. Suburban Maryland overall asking rents are $24.29 with the tightest markets reaching the low $30s. Metro area Class A asking rents average $32.19, up from $31.51 one year ago. Class B asking rents average $27.91, up from $26.40 one year ago. Rent growth of 4% is expected Metro-wide in 2006 with select suburban submarkets seeing higher growth.

Construction Activity

There are 124 buildings totaling 15.9 million sf under construction as of 4th quarter 2005 with a pre-lease rate of 48%, up slightly from 46% in 3rd quarter. Ground breaks totaled 2.66 million sf, 1.13 million sf of which is in the western suburbs of Northern Virginia. Office condominium development is strong in Northern Virginia and Suburban Maryland representing 1.2 million sf of total Metro area construction. Speculative development is on the rise throughout the region, with developers pushing comprehensive plan amendments to allow for increased office construction in undeveloped areas or mixed-use projects at in-fill locations. Approximately 4.9 million sf will deliver to the region in the 1st quarter of 2006 with a pre-lease rate of 35%. The Federal Government currently has several requirements over 100,000 sf for secure, campus-like space with 50-foot setbacks.

Washington Metropolitan Area Office Market Statistics-4th Quarter 2005

Rental Rates As of 4th quarter 2005, the average asking rent in the Metro area was $30.60 psf, up from $29.92 in the 3rd quarter and up from $29.32 one year ago. Base rents in Washington, DC are $48-$52 with operating expenses now reaching $21-$22 for new Trophy class buildings. Overall asking rents in Northern Virginia average $27.77 as of 4th quarter, up 5.5% in 2005 due to demand from defense contractors and professional services firms. Suburban Maryland overall asking rents are $24.29 with the tightest markets reaching the low $30's. Metro area Class A asking rents average $32.19, up from $31.51 one year ago. Class B asking rents average $27.91, up from $26.40 one year ago. Rent growth of 4% is expected Metro-wide in 2006 with select suburban submarkets seeing higher growth.

Market Outlook

As vacancy rates continue their downward trend, rents are expected to rise further with those submarkets inside I-495 and in the Dulles Corridor experiencing the highest increases. Leasing momentum in Suburban Maryland should continue in 2006 with vacancy rates declining to 8% and rent growth of 3-4% expected. Law firms and the Federal Government will remain the primary drivers of leasing activity in Washington, DC with vacancy rates expected to reach 8-8.5% as new product is delivered. Crystal City in Northern Virginia will gain some tenants from Washington, DC looking for lower rents and operating costs. Investor interest will remain high given projected job growth and demand.