After Another Meager Quarter For D.C. Office Leasing, Free Rent Concessions Remain Sky-High
The flight to quality, trophy-class office space has accelerated across the country during the pandemic. But in D.C., tenants are getting uniquely sweet deals.
Tenants signing long-term leases in prime Class-A office buildings in D.C. received an average of 24 months of free rent in Q1, more than the average in Midtown or Downtown Manhattan, in Los Angeles' Westside, or in Chicago or San Francisco, according to new data from Savills.
“The higher availability, the more generous the concessions get,” said Sarah Dreyer, senior vice president of research and data services at Savills. “Owners know that there's just more options for tenants in the market.”
The generous lease terms are a sign of an office market that just went through another anemic quarter. The D.C. office market's vacancy rate remained unchanged from Q4's record-high level of 18.4%, according to data from CBRE. The brokerage firm recorded 47K SF of positive absorption in D.C. last quarter.
Wei Xie, research director for CBRE’s mid-Atlantic region, said the vacancy rate likely won’t reach its peak in the District until later this year, and the market won’t stabilize until 2023 or 2024.
“It's gonna go a little bit worse before it gets better,” Xie said. “In the long run, the pullback in new construction, coupled with the increase in conversion activity hopefully, will definitely help balance supply and demand going forward.”
One of the primary culprits of ongoing high vacancies, according to Xie, is the continued addition of new supply. Two new office buildings are scheduled to deliver in The Wharf in the coming months, along with Boston Properties’ 450K SF office redevelopment at 2100 Pennsylvania Ave.
In total, CBRE expects eight buildings totaling 1.4M SF of office space to complete construction this year. Barring any significant new leases, it projects that will push up the city's vacancy rate.
Still, there are some signs the office market is recovering. In its own analysis, Colliers reported a 10 basis point increase in vacancy compared to the previous quarter, but noted that over the past two years the average change has been a 40 basis point vacancy increase each quarter.
Analysts who studied the market this quarter said the long-term trends indicate Q1 2022 was a disappointing quarter, but they say better days are ahead.
Construction starts declined by 70% since the beginning of the pandemic, compared to the two years prior, according to Xie. She said the majority of offices currently under construction in D.C. are in live-work-play neighborhoods like Capitol Riverfront and the Union Market area.
“We are anticipating a lot less new construction coming online, which would make the limited projects that are in the pipeline right now even more competitive,” Xie said.
Trophy and newer Class-A office stock, often delivering in those trendy submarkets, is seeing positive leasing momentum. The two classes saw a 300K SF positive absorption in the last quarter, according to JLL.
“It really does continue to be flight to quality rather than emphasis on any one particular submarket,” JLL Research Analyst Elsa Wilson said. “Tenants are looking for that nicer space and they’re taking advantage of increased concessions.”
So far, private sector tenants appear to be more ready to take on long-term leases than the General Services Administration, Savills’ Dreyer said.
The GSA, which recently restarted the process of exiting the Hoover building on Pennsylvania Avenue, also signed a 36-month lease renewal for the Department of Labor at 800 K St. NW this quarter.
Meanwhile, Savills recorded 24 leases over 10K SF this quarter, many of them from private sector tenants. That includes law firm Barnes & Thornburg, which signed a 35K SF lease at 555 12th Street NW in the East End that will more than double its footprint.
The Barnes & Thornburg deal may itself be a sign of changing attitudes from law firms. Long a prominent tenant class in D.C., many firms shrunk their footprints post-financial crisis, looking to maximize space while cutting costs.
But CBRE's Xie noted that the legal sector performed well during the pandemic. What's more, 90% of the country's largest law firms have already had the chance to shrink their footprint, and Xie said the cycle may be shifting back toward growing footprints.
"We anticipate that there will be less of the headwind from law firms going forward because of that," Xie said. "Some of the law firms that have cut space previously [are] now adding space back because they cut too deep and law firms in general are doing really well financially."
The GSA may soon share the private sector's renewed confidence in long-term deals, especially as the federal government begins the process of bringing its employees back into the office, Dreyer said.
“We'll see less of these short-term extensions and renewals going forward,” Dreyer said. “I think there's a healthy balance of new, long-term leases in there as well.”
The employment market also appears to be in favor of long-term stability in office leasing if pre-pandemic trends hold. The year-over-year job growth for office-using sectors reached its highest level in a decade in the first quarter, according to Savills, and the labor market continues to be tight.
“Pre-pandemic, that would have potentially translated into more square feet needed in office space to house those employees,” Dreyer said. “I think it's going to be interesting to see how the growth in office-using employment affects it going forward.”