Tenants Taking Advantage of Near-Optimal Market Conditions

Savills Studley Reports
2014 1Q - Washington, DC
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Tenants in Washington, DC continue to leverage near-optimal market conditions in their favor. Facing market forecasts that offer little prospect of substantial growth in demand for office space, landlords in the District have firmly prioritized longer-term stability over short-term revenue. This is evidenced by a willingness among many landlords in the District to entertain lease restructures well in advance of a tenant’s lease expiration. These restructures often align a tenant’s rent with current market rates and/or provide for a reduction in the amount of space leased in exchange for an extended lease term. Concurrently, landlords seeking to attract tenants to vacant space continue to offer concessions such as free rent, tenant improvement allowances, and the assumption of existing lease liabilities at or near record high levels.

Following a historically low level of leasing activity in 2013 that registered nearly one million square feet below the long-term historical average, quarterly leasing activity increased 15.8% during the first quarter of the year but remained 10.6% below the five-year average. A majority of the largest transactions during the first quarter were government leases and mostly comprised renewals or relocations in which the tenant took less space than they had been leasing. The rightsizing of federal tenants is expected to continue as the government seeks to achieve goals outlined in the ‘Freeze the Footprint’ directive issued one year ago by the Office of Management & Budget.

Class A average asking rents were 4.7% higher from the same time last year, a result, primarily, of the addition of higher-tier Class A space to the market due to the impending departure of a few large law firms that are moving to newly-constructed trophy buildings. The number of large blocks of space over 100,000 SF in the District grew to 28, up from 24 during the previous quarter.

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Major lease transactions in Washington DC 2014 Q1

Leasing activity appears likely to increase in the quarters ahead as more tenants examine potential opportunities to reap the benefits of the current leasing environment and a few large pending leases are finalized. However, the large blocks of Class A space returning to the market are likely to put additional upward pressure on availability rates.

Opportunities Plentiful for Tenants in Northern Virginia

Leasing fundamentals in the Northern Virginia region remained very much in the tenant’s favor to begin 2014. Despite a measure of clarity emerging in the market following the bipartisan budget agreement, office-using demand remained subdued throughout the first quarter. Over-all leasing activity declined by 3.9% relative to last quarter and posted the lowest total since the third quarter of 2011. Short term renewals, early lease restructures and consolidations continued to dominate the leasing landscape putting upward pressure on Northern Virginia’s over-all availability rate, which ended the quarter at 21.3%.

Washington DC Trailing Class A leasing activity Q1 20142014 Q1 Class A availability rate trends in Washington, DC, Virinia and Maryland

A rebound from the muted demand levels experienced in the region over the past two-years is not likely to occur in the near-term as Northern Virginia’s traditional demand drivers, federal agencies and government contractors, continue to shed space in response to increased pressure to cut costs. Of the seven GSA prospectus-level lease requirements active in Northern Virginia, all but two of the agencies are proposing to take less space. These proposed consolidations would result in a combined 8.7% decrease in occupied space over the next several years. Government contractors also continued streamlining their footprints during the first quarter. By taking less space and signing shorter leases, government contractors are better able to control costs amid a constrained procurement environment.

The shrinking presence of both federal agencies and government contractors has been a major contributor to the elevated availability rates experienced throughout most of the region. As Northern Virginia’s inventory of available space continues to increase, tenants will find greater opportunities to lock in favorable lease terms and generous concessions.

2014 Q1 Class A rental rate trends in Washington, DC, Virinia and Maryland2014 Q1 Class A rental rate trends in Washington, DC, Virinia and Maryland

Suburban Maryland Office Fundamentals Continue to Soften

The Maryland suburbs saw very little growth to begin the New Year as over-all leasing activity decreased significantly, dropping by 36.2% relative to last quarter. The region’s availability rate continued to increase ending the first quarter at 19.2%, a 1.4% increase from the same quarter, last year. In Montgomery County, elevated vacancy rates prompted County Executive, Ike Legget, to introduce M.O.V.E., a rent assistance program designed to attract small and mid-size firms to the County. In the face of tepid demand and rising availability, the region’s over-all asking rent dropped slightly to $25.07, a 0.7% decrease relative to last quarter.

Submarket Focus

Leasing activity in Washington, DC’s Capitol Riverfront submarket was 19% higher than the previous quarter, primarily due to the decision by the National Labor Relations Board to relocate their headquarters to 1015 Half Street, SE. The submarket’s Class A availability rate reached its lowest level in 18 months at 14.4%. Additionally, class A average asking rates increased in the Capitol Riverfront 1.4% from the previous quarter.

The Reston submarket posted a strong performance to open 2014 as direct vacancy decreased by 1.6%, ending the quarter at 14.4%. Reston experienced an uptick in demand as over-all net absorption ended the quarter at 232,562 sf. Also during the first quarter, the Fairfax County Board of Supervisors voted to adopt a revised Master Plan positioning Reston as a growth area for years to come. Under the revised plan, redevelopment in the Reston submarket could more than double over the next 25-30 years.

Germantown gained some momentum during the first quarter of 2014 as the submarket’s over-all availability rate declined by 1.8 percentage points. Asking rents increased slightly ending the quarter at $24.82 per square foot. The submarket also landed several of the region’s top leases. DRS Technologies will consolidate several suburban Maryland locations into 133,140 square feet at 1 Milestone Center Dr. JDSU, who previously occupied 1 Milestone Center will relocate to 45,726 square feet at 20250 Century Blvd. Worldshine International also signed a 10-year lease during the first quarter. The firm will occupy 17,691 square feet at 20420 Century Blvd.

Commercial real estate transaction barometer - Washington DC and Northern Virginia


As two traditional drivers of office space demand in Washington, DC – law firms and government agencies – continue to right size and return space to the market, availability rates are likely to remain elevated and opportunities for tenants will continue. Without a replacement to sufficiently fill this gap in office space demand, average asking rental rates are likely to remain flat and tenant concession levels should remain at their historic highs for the foreseeable future.

Northern Virginia’s office market will see little change throughout the year as availability is expected to continue trending upward in the face of a shrinking federal presence and subdued demand from the government contractor sector. Over-all rental rates are expected to remain flat for the near-term as rent recovery is not likely without significant growth from a new industry sector such as tech, healthcare or education. Tenants will continue to retain leverage for the foreseeable future as space efficiency measures, early lease restructures and federal spending cuts become a more permanent part of the landscape.

Suburban Maryland will experience weakening fundamentals throughout the remainder of 2014. Limited private sector demand and federal contraction will continue to put upward pressure on the region’s availability rate. Asking rental rates are expected to remain flat in response to weak employment growth and subdued leasing velocity. Despite historically low levels of new office construction, the Maryland suburbs are not likely to see demand ramp up enough to significantly reduce the region’s growing inventory of available space.

Market Highlights

Availability Rates Rise

Washington’s Class A availability rate (15.1%) rose quarterly by 0.7 pp. The Class A rate in Northern Virginia (22.2%) was unchanged. In Suburban Maryland, the rate inched up by 0.5 pp to 22.5%.

District Asking Rents Increase

In the District, Class A asking rents, $54.44, soared by 10.9% quarter-on-quarter. Class A asking rents in Northern Virginia, $32.30, fell by 1.2%. In Suburban Maryland, the Class A rate, $26.20, dropped by 1.8%.

Leasing Grows in DC, Maryland

Class A trailing four-quarter leasing in the District, 4.3 msf, jumped by 12.1% for the quarter. Class A volume in Northern Virginia decreased by 3.2% to 8.3 msf. Suburban Maryland’s Class A activity, 3.0 msf, rose by 1.7%.

More Large Blocks

The number of large contiguous blocks of space (100,000 sf or more) in Washington increased to 28 from 24 last quarter. In Northern Virginia, the number of blocks declined from 73 to 69. The number of blocks in Suburban Maryland grew from 26 to 31.