The Washington, DC Metropolitan area finished out 2004 with a vacancy rate of 9.1%, down from 10.4% a year ago, and remarkable in comparison to the nationwide average of 15.5%.  In addition to 29.5 million square feet of vacant space, 8.0 million square feet of sublease space contributed to an availability rate of 11.5%, a 220 basis point decline from year-end 2003.  Net absorption reached levels unseen since 2000 as 11.2 million square feet of office space were absorbed across the area, more than 2.2 million square feet of it sublease space.  Leasing activity returned with strength in 2004, particularly in Northern Virginia, which benefits from the growth in the defense sector.  The District continues its reign as the premier downtown office market in the country, attracting investors and developers alike.  In Suburban Maryland, the return of activity signaled a turn-around in market conditions.

Washington, DC

Bolstered by the federal government, Washington, DC’s economy remained insulated from significant yet declining vacancy rates seen around the country in 2004.  At 5.8%, Washington’s was the same as at year-end 2003; still the lowest in the nation.  Availability fell from 7.7% to 7.4% during the year.  2.1 million square feet were absorbed in the District in 2004, on par with 2003’s level of 1.9 million square feet.  The lion’s share of absorption occurred in the East End and Capitol Hill.

Washington’s low vacancy rate is largely attributable to steady demand from non-profit organizations, law firms and government agencies.  Non-profits and the legal industry comprised nearly 50% of tenant demand in the second half of 2004, with non-profits focused on smaller blocks of space in the 5,000 to 25,000 square foot range.  Conversely, law firms continued to concentrate on larger blocks of space in the Trophy and Class A markets.  As a result, rates on premium space crept up throughout 2004 with tenants willing to pay $60 per square foot for premium space and $50 per square foot for second generation Class A space.   The federal government maintains a strong presence in the District as evidenced by the signing of five leases greater than 75,000 square feet by federal agencies in 2004.

Development in Washington continued at a rapid rate in 2004 with 2.8 million square feet delivering in ten buildings.  Sixty-two percent or 1.7 million square feet were preleased.  Law firms exhibited the strongest demand levels, preleasing 27% of the new supply.   The development pipeline through 2007 will remain strong with 6.25 million square feet slated for delivery.  Keeping pace with current demand trends, 14% of this space has already been preleased by law firms while build-to-suits for the federal government account for 22%.

Investors continue to view Washington, DC as the top real estate market in the country due to its solid fundamentals and positive performance.  Competition for properties has been pushed to a new level as we are now seeing prices reach the upper-$600 per square foot range.

Northern Virginia

2004 was an active year for the Northern Virginia office market as vacancy rates declined; absorption increased and sublease space decreased. At year-end, Northern Virginia’s vacancy rate was 10.3% compared to 12.5% at year-end 2003. Availability fell from 16.1% to 13.1% during the year.  6.3 million square feet were absorbed in 2004 in Northern Virginia compared to 4.9 million square feet in 2003.  Sublease space dropped to 4.2 million square feet, a decrease of 1.1 million square feet since 2003. Only 2.8% of the Northern Virginia market is now available for sublease, 300 basis points below its high of 8 million square feet at year-end 2001.

Leasing activity Northern Virginia in 2004 has advanced at a pace comparable to 2000 with transactions surpassing 2003’s level. Demand for office space in Northern Virginia, primarily from government agencies and contractors as well as technology firms is expected to increase further in 2005. In 2004, seven of the top ten leases signed in the Washington metro area occurred in Northern Virginia. Most notable was Corporate Executive Board’s 620,000 square foot prelease at the Waterview project in Rosslyn which was the largest private sector lease transaction ever executed in the Washington metropolitan region.

The strength of the Northern Virginia market is reflected in the number of planned projects in the development pipeline as well as the amount of preleasing activity. Of the 3.9 million square feet in the development pipeline for 2005-2006 in the Northern Virginia market, 60% is preleased.  Several build-to-suit projects totaling 2.0 million square feet are expected to deliver in 2005-2006. Of the speculative buildings underway, totaling 1.6 million square feet, 64% are located in Fairfax County.

Suburban Maryland

The Suburban Maryland office market experienced a surge of activity in 2004, registering 2.8 million square feet of net absorption for the year, contrasted with last year’s negative absorption of 98,441 square feet.  After the slowdown of the last few years, this volume of leasing activity is a welcome sight.  Vacancy decreased 160 basis points from year-end 2003 to 11.6%, the first decline in vacancy since 2000.  Availability fell from 17.3% to 14.6%.  Suburban Maryland has not seen large deals snatch up vacant space like in Northern Virginia, but rather steady, smaller deals, most in the 10,000 to 25,000 square foot range, ate away at vacancy and brought healthy absorption to the recovering Suburban Maryland market.

The most marked improvements were seen in Germantown, where availability dropped 9.2 percentage points during the year to 28.9%.  Most of this decrease in available space occurred in the fourth quarter due to leases by ACS, Weatherbug and Comtech.  The other northern suburbs of I-270 Rockville, Gaithersburg and Clarksburg also saw a return of activity and stronger market conditions in the fourth quarter, pointing to a possible turnaround in these long-suffering markets. 

Closer to the Beltway, speculative development returned to Suburban Maryland in 2004, as both Opus East LLC and Penrose Group plan to move ahead with spec product in Rock Spring Park and King Farm, respectively.  This return of speculative development shows investors are taking notice of the optimistic conditions in Suburban Maryland.

Outlook

The DC Metropolitan area is poised to maintain stability into 2005, thanks in large part to the ever-present federal government and its related contractors.  In the District, the delivery of unleased new product may increase vacancy rates in the short term, however landlords expect government agencies and law firms to absorb the space as growth continues and leases expire.  The General Services Administration has projected a need for three million square feet in 2006 for several agencies.  In Northern Virginia, the addition of 10,000 homeland defense-related jobs throughout the region will have a major effect as government contractors take additional space to house the workers.  Suburban Maryland will continue to attract healthcare and pharmaceutical companies as they finalize their space plans and funding.

Contact – Ann McKenzie, Assistant Vice President, Research Manager