Overview
Consisting of over 275 million square feet, the Washington, D.C. metropolitan area posted positive space gains of over half a million square feet in the third quarter, the total absorption year-to-date was 2.5 million square feet as of October 1st. For the third consecutive quarter, the District of Columbia and Northern Virginia both witnessed positive space gains, while the Suburban Maryland market posted negative absorption for the first time this year. The District of Columbia's Class A segment led the region's growth with 634,065 square feet of absorption. In Northern Virginia, several notable tenants took occupancy this quarter including the Federal Supply Service which moved into the former Patent and Trademark Office space at Crystal Plaza 4 and SRA International consolidated its office into its new Arlington location. In the District, the District of Columbia City Government moved into the former IBEW Building. In Maryland, Development Alternatives, Inc. and National Cancer Institute moved into 7600 Wisconsin Avenue and 2115 E Jefferson Street, respectively. Leasing velocity in the metropolitan area shows little signs of slowing as 11 new leases over 50,000 square feet were signed in the third quarter. Some of the larger leases in Northern Virginia were by the Federal Bureau of Investigation and Northrop Grumman. In the District, the Department of Justice and FTI Consulting signed leases totaling over half a million square feet and in Maryland, Giant Food and USEC both signed new leases.

The District of Columbia office market maintained current trends of positive growth in the third quarter 2006 and once again posted strong net absorption and an uptick in rental rates. Totaling 94.4 million square feet, Washington, DC has enjoyed a steady delivery schedule and constant demand which has not caused supply to significantly outpace demand, and has added healthy inventory growth to the city. The third quarter ended with 329,622 square feet of absorption bringing the year-to-date to 865,467 square feet. Given the low vacancy rate that has been maintained in the East End and CBD, net absorption patterns will flow into submarkets where new buildings are being developed, such as NoMa, and Southwest/Southeast. NoMa's third quarter absorption totaled 71,009 square feet and the vacancy rate dropped from the second quarter mark of 15 percent to 13.6 percent. Tenants such as the National Cable and Television Association, which moved into 53,000 square feet of new space at 25 Massachusetts Avenue, NW are leaving more traditional areas to maximize their office space value.

The vacancy rate increased from the second quarter mark of 7.9 percent to 8.9 percent third quarter due largely to new deliveries and sizable relocation activity in smaller submarkets which are particularly sensitive to large tenant move outs, such as the delivery of the Portals Phase III, a 506,608 square feet building, coming online 85 percent vacant in the Southwest submarket. The Class B vacancy rate increased from 5.5 percent to 12.5 percent on the heels of the ATF's departure from 219,000 square feet at 650 Massachusetts Avenue, NW into its newly constructed headquarters at 101 New York Avenue, NE. In Georgetown, the vacancy rate rose as a result of the acquisition and absorption of law firm Swidler Berlin by Bingham McCutchen. Swidler Berlin vacated over 70,000 square feet at 1025 Thomas Jefferson Street, NW. This is a prime example of a smaller market's sensitivity to large tenant activity.

The District's office market continues to be fueled by the federal government and law firms, as seen by some of the top leases in the third quarter. The Department of Justice occupied 461,886 square feet, the Surface Transportation Board moved into 73,899 square feet, FTI Consulting took 94,000 square feet, and Bingham McCutchen expanded its presence, by the aforementioned merger, with a move into another 64,000 square feet at 2020 K Street, NW. Rental rates continue to trend upwards. Overall rental rates increased $.27 to $42.24 per square foot. While Class C rose $2.25 to $34.48 per square foot, Class A and B increased $.02 per square foot and $.26 per square foot, respectively. The flight to quality in DC development trends of both new construction and renovation has created a shrinking Class C market, ironically allowing landlords the luxury of upping rents in lower quality space. With an additional 2.1 million due to deliver by year end, this will put 2006's delivery total at 5 million square feet. This number will put an upward pressure on vacancy rates as well as the average asking rental rates. The slightly elevated vacancy will be of short duration as fewer buildings are scheduled to deliver from 2007 to 2009.

The Northern Virginia submarket, totaling over 123 million square feet, continued to witness positive space gains with 346,565 square feet of absorption in the third quarter. Although not as strong as second quarter's 749,551 square feet, Northern Virginia continues to grow with a year to date absorption over 1.4 million square feet. Class A buildings saw net absorption of close to 400,000 square feet due to tenants such as SRA International taking occupancy of 254,336 square feet at 3434 Washington Boulevard as well as the Federal Supply Service moving into 2200 Crystal Drive. Leasing activity remained strong in the third quarter. In Tysons Corner, Northern Virginia's largest submarket with 22 million square feet, the Federal Bureau of Investigation inked for 165,000 square feet at 801 Follin Lane and KSI Services, Inc. landed at 1751 Pinnacle Dr for 77,729 square feet. Northrop Grumman signed for 145,000 square feet at Washington Technology Park II in the Route 28 South submarket while the U.S. Customs and Border Protection signed at Worldgate Plaza III for 60,435 square feet in Herndon. There are a number of new federal government contractors out in the market for 75,000 to 100,000 square feet as well as large federal users such as the U.S. Department of the Interior.

With over 891,000 square feet of new inventory delivering in the third quarter, of which 47 percent was preleased, the overall vacancy rate increased by 40 basis points to 12.7 percent. Class A vacancy rose for the second consecutive quarter and will continue upward as the 6.7 million square feet under construction is added to the current inventory. Third quarter deliveries included the NRECA building at 4401 Wilson Boulevard which was 40 percent preleased by the Newspaper Association and Plateau Systems Ltd., Independence Center 2, which delivered 100 percent vacant, and 3434 Washington Boulevard, which is fully leased to SRA International. Despite the overall increase in vacancy rate, the Class B segment is starting to tighten as larger tenants opt for the big blocks of relet space which are available as opposed to paying the high costs associated with new construction. For example in Reston, where there is close to one million square feet under construction, Class B vacancy decreased over 70 basis points in the third quarter. This trend will continue as tenants such as Hewlett Packard and InPhonic, Inc. plan on signing for 100,000 square feet and 80,000 square feet, respectively, in the fourth quarter in Class B space. Average asking rental rates rose $.31 in the third quarter to $29.59 per square foot with Class A accounting for 50 percent of the increase.

Suburban Maryland experienced rare negative net absorption in the third quarter. Suburban Maryland's office market, which consists of 56 million square feet, has grown in a consistent and conservative manner. During the third quarter, several corporations downsized and consolidated which resulted in negative 167,392 square feet of absorption. For instance, National Association of Securities Dealers (NASD) vacated roughly 58,000 square feet at 15201 Diamondback Drive and consolidated to an adjacent building which they own. Similar circumstances occurred with several other large tenants such as Verizon, Sprint and Aetna. Giant Foods signed for 53,556 square feet at 8301 Professional Place during the third quarter and will occupy in the fourth quarter. In addition, USEC and Excel Academy signed for 48,000 square feet and 41,000, respectively and will occupy their space shortly.

Other market indicators, such as rental rates, remain strong. Although the vacancy increased by 20 basis points to 10.2 percent, the market continues to see notable demand and attract new tenants due to the value of quality space and affordable rents. Within Montgomery County, the I-270 Corridor has witnessed an economic boost from biotech firms moving into and expanding within the area driven by federal contracts and the research facilities of major universities. During the third quarter, asking rents for Suburban Maryland exceeded the $26.00 mark at $26.05 per square foot.

Development continues to move north along the I-270 Corridor, and over 60 percent of what is currently under construction is in the North Rockville/Shady Grove and Gaithersburg/Germantown submarkets. There are 1.3 million square feet under construction and nearly 12 million square feet of proposed developments. During the third quarter two buildings equaling 128,000 square feet delivered. An additional 235,000 square feet is due to deliver fourth quarter and twice that amount is scheduled for completion in early 2007. When considering volume and quality of construction in Suburban Maryland, overall asking rents are expected to rise