New Construction Portends Higher Office Vacancies in 2021
WASHINGTON, DC, January 2, 2019 – With strong job growth throughout the year and fourth-quarter net absorption of 913,000 square feet (sf), the Washington, DC, region’s office market closed 2018 on a strong note, according to Cushman & Wakefield’s quarterly office report. This close to 2018 brings the yearly absorption total to 2.4 million square feet, the most net absorption the region has seen since 2010. Despite the strong regional statistics, there is evidence that the various markets in the region are in transition. The District of Columbia office market continues to be impacted by the record amount of new construction delivering with additional leasing left to achieve, but investors and developers in core submarkets in Northern Virginia and Suburban Maryland, on the other hand, are benefiting from both a lack of large quality existing available blocks and limited new construction options.
“The Washington, DC Region office market had a strong close to 2018 but faces some headwinds going into 2019 and even 2020,” said Nate Edwards, Cushman & Wakefield Senior Director and DC Region Research leader. “In the District of Columbia, the government and non-profit sectors continue to take a hard look at their traditional enclaves in the core submarkets in the CBD and East End and are taking advantage of opportunities in lower cost emerging submarkets downtown and in the case of the non-profits, even office space in Arlington County, Virginia. Meanwhile, large law firm demand for new construction has led to an unprecedented amount of construction in the District.”
Another potential near-term headwind facing the DC Metro is the outcome of the 2018 midterm elections as the change in leadership in the House of Representatives leadership is assured. “The gridlock that could result has the potential to dampen growth in the region as it did when the Tea Party wave took over leadership of the House in the Obama Administration’s first term, resulting in a stagnation and ultimate loss of regional office-using jobs by the years 2013 and 2014 and we are already seeing early evidence of the gridlock as the government shutdown has entered its second week,” Edwards continues. “Although this change is from the other end of the political spectrum, a contentious environment with the House flip is highly likely to continue for at least the remainder of the Trump Administration’s first term.”
Overall in 2018, the Washington, DC Metro economy continued to grow at a brisk pace, adding 49,100 new positions to payrolls from January through November 2018. The region is set to have its fourth consecutive year of annual job creation eclipsing 50,000 jobs, well above the long-term historical average of 38,000. Industry sectors fueling growth are led by Professional and Business Services, which has added nearly 16,000 jobs through November; followed by Construction (9,300); Hospitality (7,300); Retail (3,000); and Financial Services (1,700 YTD). These gains were offset by the loss of 4,800 positions in the Federal Government.
For DC proper, net absorption totaled 833,000 square feet for 2018, and while it was slightly below the average annual net absorption for the past 10 years (900,000-sf annual average), bright spots emerged. The fourth quarter of 2018 was the most active of the year in terms of new absorption with 450,000 sf, over half of the net new absorption total. Four submarkets eclipsed 100,000 sf of total net absorption in the fourth quarter – Capitol Hill/NoMA, East End, CBD and Southwest. Market-moving deals for the year included Fannie Mae’s 780,000-sf move to the District Center project in the CBD, Facebook’s 150,000-sf initial lease and expansion in the East End and 530,000 square feet of new coworking deals. Positive net absorption was offset by federal and legal sector downsizing and several significant Class B not-for-profit entities leaving the District of Columbia to relative value plays in Arlington County.
In the Virginia and Maryland suburbs, several significant deals transacted in 2017 and 2018 took down existing, large blocks, and additional new construction will be needed to house several large tenants that will need to occupy space in the next 36 months. Deal activity for existing space has come from a diverse range of sectors—tech firms Appian, FireEye and OneWeb; federal contractors including Akima and CSRA; federal agencies such as Customs and Border Protection; and not-for-profit organizations such as the Center for Missing and Exploited Children and the American Institutes for Research. Vacancy rates tightened a bit over the year in the suburbs, with Northern Virginia starting 2018 at 21.6% and finishing the year at 20.3%. Suburban Maryland finished the year at 18.4%, down from 19.4% to start 2018.
“With strong leasing in the next wave of development resulting from large deals by Marriot, Host Hotels, Fannie Mae, Leidos, and others, additional new development will be needed to serve other users in a true ‘flight to quality’ market, especially with a certain eCommerce giant’s announced site selection in Northern Virginia,” said Michelle Huneke, Associate Market Director, Research Services. “While the large user end of the market is clearly tightening, there is still much work to do to shore up the smaller user space. Currently, the median deal size in Northern Virginia is 5,500 sf and in Suburban Maryland 3,500 sf. Tysons Corner, Reston/Herndon and the RB Corridor all have at least 80 options for a 5,500-sf user, while Bethesda/Chevy Chase has 40.”
For the District of Columbia office market, new construction without concurrent preleasing raises many issues for the next few years. Office vacancy rose from 12.4% at yearend 2017 to 14.1% to close 2018. With additional deliveries on the horizon – including 2.6 msf of current vacancy out of 4.1 msf of total deliveries in the CBD, East End and Capitol Hill in 2019 and 2020 (37% leased) — District of Columbia core Class A vacancy rates are expected to close in on or possibly eclipse 20% by 2021.
Adding to the distress in the CBD and East End is the increased competition these markets are seeing from emerging markets in NoMA, the Capitol Riverfront and the Wharf. Large federal agencies including the Department of Justice, the Peace Corps and the Federal Election Commission; not-for-profits such as the Urban Institute, the American Psychological Association and the National Association of Broadcasters; and legal sector and lobbying firms such as Fish & Richardson, Van Scoyoc and the latest, Williams & Connelly, have all relocated out of the core market over the past two years.