Because Cash Is King, D.C.'s Government-Heavy Office Market Could Retake Its Throne

Capital markets activity has slowed significantly during the coronavirus crisis, but two commercial real estate leaders in the D.C. market expect a rebound, and they see prime opportunities for investment. 

Cushman & Wakefield Vice Chairman Bill Collins, who last week received CREBA's award for being the region's top sales agent, and Stonebridge founding principal Doug Firstenberg, who has major developments underway throughout the region, see near-term opportunities in federal government-leased assets and land for development. 

The two executives, speaking Wednesday on Bisnow's Town Hall webinar, said they see D.C. as one of the best-positioned markets in the world for the long-term recovery. 

Collins said D.C.-area office buildings with leases with the General Services Administration, the federal government's procurement arm, are more attractive than they have ever been. Many office buildings the GSA leases throughout the region are single-tenant properties with long-term leases backed by the U.S. government, making them safe bets. Collins said many investors analyze these assets by comparing their yield to that of the 10-year Treasury, and he said the spread has never been wider. 

"If you could get 500 basis points above the 10-year through this real estate, that would be double what it's ever been," Collins said. "So in a world where cash flow is king, and I think that's going to be the case for a while, it provides an opportunity we've never seen."

Firstenberg has developed several GSA-leased office buildings in the region, and he remembered working with Collins to sell one of them during the Great Recession. Stonebridge in June 2010 sold Two Constitution Square in NoMa, fully leased to the Department of Justice, for $305M to Northwestern Mutual. 

"While the crisis was still working its way through, the quality of that income, a 15-year, flat government lease for 100% of the building in an emerging market on Metro, it was just a jewel of an asset," Firstenberg said. "We turned around and sold that building right away and got a good cap rate."

The Bethesda-based developer said he expects those types of investment opportunities to be available during the economic crisis that is arising because of the coronavirus.

"People are going to have money to invest, so the market will bifurcate in my mind, and the really good-quality assets that are in certain segments of our market are going to be very attractive," Firstenberg said. "And we're going to look to create more of those assets because they're time-tested in providing that security investment."

In addition to existing office assets, Firstenberg and Collins said they see opportunities to buy land for future multifamily development. 

"Counterintuitively, what we're finding is great pieces of land are actually very desirable," Collins said. 

"Whoa, don't be telling people this, Bill," Firstenberg joked in response. 

While the economic forecast for the next year is cloudy, Collins said he can confidently predict demand will be back to normal levels three years from now, the delivery timeline most developers would be looking at when considering a new project. 

"If I can buy a great site today, plan it, put it in production one or two years from now, delivering three or four years from now, I think you're going to be in a world where No. 1, demand is going to be there, and No. 2, costs are going to go down," Collins said. 

Collins expects construction costs, which have risen to all-time highs in recent years, will fall during this crisis because a slowdown in new development starts will alleviate pressure on labor and material costs.  Firstenberg agreed with Collins' assessment, but does have concerns about supply-chain disruptions. He said development yields have been tight in recent years and he believes they will begin to rise. 

"The margins upon which we've been developing in the last 12 to 24 months, the squeeze that it's taken, is going to change," Firstenberg said. "It's not going to move 100 basis points, but I think we can get back to where a good, stabilized number can be achieved."

Much of their confidence in investment and development opportunities stems from the belief that D.C. will weather the coming economic storm better than most cities.

In 2008, the D.C. market was seen as the No. 1 market in the world for investors because of its stability, according to a survey from the Association of Foreign Investors in Real Estate's annual survey. As the expansion continued for years, it dropped to 15th.

"When you spend a couple trillion dollars, someone has to oversee that," Firstenberg said of the federal government stimulus. "I see D.C. as a place that its historical strength is going to come through again."

Collins said the D.C. market is well-positioned because it contains economic clusters that are poised to remain stable or grow during the crisis, such as government contracting, cybersecurity, technology and life sciences. 

"If you look at our makeup today and going forward, there isn't a better place to invest in the world in my belief," Collins said. "No place has the confluence of all these things happening. I think it could be greater than it has been historically because we're hitting on all cylinders. There's a lot of good news."

While there may be good news, Collins and Firstenberg expressed concern in the near-term about consumer spending and the hospitality and retail sectors. 

"While we're better positioned, we're not immune," Firstenberg said. "If we don't get consumer activity back, if restaurants aren't viable, we can't withstand the world not functioning. It's very important we start to hit on these other cylinders."

And while their long-term outlook may be positive, Collins noted that it is still very difficult to close capital markets transactions in today's environment. 

"It's 80% or 90% of deals are basically on pause," Collins said. "The other 10% or 20% were already in the pipeline, whether that's a financing or sale, and to the degree that you had a large, at-risk deposit, you're moving forward."