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The Shutdown May Have Stalled D.C.'s Investment Sales Market As It Was Ready To Take Off

The longest-ever government shutdown forced hundreds of thousands of federal workers across the D.C. region to go without pay and cost the region's economy over $1B, and one top capital markets broker says it is slowing the pace of investment in D.C.'s office market. 

Avison Young Managing Director of U.S. Capital Markets John Kevill

Avison Young Managing Director of U.S. Capital Markets John Kevill said the shutdown has made sellers hesitate to bring buildings to market and forced investors to be more careful about buying in D.C., but he still expects the market will rebound and ultimately surpass last year's deal volume. 

"Because of the shutdown, there's been some pause in a few deals being brought out just to let things settle down," Kevill said. "I do think deal volume will build a little more slowly at the beginning of the year than may be typical." 

In its newly released 2019 Commercial Real Estate Forecast, Avison Young projects investment sales volume in the D.C. region this year will surpass last year's total. The D.C. region finished 2018 with about $21B of investment sales volume, and Avison Young projects it will finish higher this year. It cites the availability of supply and a growing variety of capital sources, including funds taking advantage of the new opportunity zone program, as reasons deal volume will be strong this year.

Despite the uncertainty from the shutdown, Kevill said the fundamentals of D.C's economy remain strong, and the investment sales market is well-positioned to have a positive year. 

"The good news, recognizing the shutdown is unfortunate and certainly slows spending, is that there's no question the government is still paying their rent, the jobs are still there and when things return to normal, the economic engine is still running," said Kevill, who spent years brokering D.C. investment deals for Eastdil Secured and JLL before moving to Avison Young in 2016.

Investors may be more cautious than normal to buy properties in D.C., but Kevill believes when they take a closer look at the market's dynamic, they will be pleasantly surprised about the growth of its private sector. 

"There is no question that investors are wary of negative news and are probably going to want to study it a little bit more," Kevill said. "But what you find is because of the shutdown, as investors really dig into how the government is affecting this region, they're learning things that are positive. People are systematically learning we're becoming less dependent on the government from a growth standpoint as a region." 

Avision Young forecasts D.C. office vacancy will rise this year, while industrial vacancy will continue to fall.

A growing technology and coworking sector has driven positive absorption in D.C.'s office market, with the region gaining 2.7M SF of occupancy last year, according to Avison Young's report. But the surge in new development has created a supply-demand imbalance that is expected to keep the market in tenants' favor. Avison Young predicts the region's office vacancy will rise from 14.6% to 15.1% by year-end. 

This dynamic has made it difficult for office landlords to raise rents, Kevill said, but some owners with the right type of product in prime locations have been able to achieve rent increases. 

"Even though you may see an overall increase in vacancy rates, what you're seeing is where properties are able to capitalize on trends, you're seeing rental increases," Kevill said. "Where you're seeing robust amenities, transportation and live-work-play environments, you're seeing energy around the tenancy and seeing rental growth." 

A rendering of the 190K SF industrial distribution facility Transwestern plans to build in Springfield, Va.

The region's industrial sector has also seen increased construction, but its vacancy rate is moving in the opposite direction of the office market.

Industrial construction in the D.C. region last year increased by 156% over 2017, Avison Young's report found, but 81% of incoming supply was already pre-leased.

That strong demand comes from a variety of users, from Amazon to Frito Lay, seeking distribution facilities near the dense, wealthy population center of D.C. The leasing activity is bringing vacancy rates down: At the end of 2018, industrial vacancy was down from 7.1% to 6.1%, according to Avison Young, which projects it will fall to 5.8% this year. This dynamic is giving industrial owners a greater ability to raise rents than their office-owning counterparts, Kevill said, and has created strong investor demand in the sector. 

"Anywhere in Metro Washington with properties where there's some type of industrial use, even flex properties, rents are tightening and there is absolutely demand from investors," Kevill said. "We're seeing new participants in the space."