D.C. Office Market Ends 2019 With Whimper Amid WeWork Pause
D.C.'s office market experienced a slow 2019 that became even worse toward the end of the year as one of the main demand drivers — coworking providers — hit the pause button.
The District recorded just under 1M SF of net absorption in 2019, according to Newmark Knight Frank, but only about 74K SF of that was recorded in Q4. NKF Research Director Bethany Schneider attributed this in part to a lack of new D.C. activity from WeWork in Q4, after the company signed a string of major leases ahead of its failed IPO in August.
"Demand was fairly muted," Schneider said of the last three months of the decade. "For the first three quarters of 2019, coworking was really driving a lot of that demand, and with the news of WeWork’s failed IPO, coworking growth really slowed across all companies, not just WeWork."
Savills also recorded a decline in D.C.'s leasing pace last quarter that it attributes in part to a coworking slowdown. The coworking sector represented 15% of the District's net growth in Q3, according to Savills, but in Q4 it was just 3%.
"This is really the first quarter that we're seeing the fallout of what has been going on with WeWork's struggles, and it was a quarter of no WeWork leasing, which is something we haven't seen in the last year or two," Savills Vice President and Head of Americas Research Sarah Dreyer said.
JLL found the District recorded negative absorption of 157K SF in Q4, caused in part by the U.S. Citizenship and Immigration Services completing its relocation to Maryland. JLL Senior Research Director Michael Hartnett also saw stagnant new demand for D.C. office space that he attributed to coworking providers hitting the brakes.
"Since 2015, coworking has driven 45% of D.C.'s occupancy growth; that's a tremendous number," Hartnett said. "What we've seen is a complete slowdown in that. They've reached 2.8% of D.C.'s occupancy and I think it's capped at that, and we're beginning to see the leasing activity slow down."
Hartnett also said the District's office market has been hurt by a lack of large companies moving into the city. The city's booming multifamily market and growing population of highly educated young people haven't coincided with large companies moving in to pull from the talent pool, a surprising development, he said.
"We haven't seen any real new entrants into the market," Hartnett said of the District. "It has been a lot of historically D.C. tenants who are relocating or renewing."
Two of the sectors that traditionally provide the backbone of D.C.'s office market, government agencies and law firms, didn't produce strong demand growth last year, Schneider said. She said government leasing was slow and while there were some law firm relocations, they primarily downsized from previous offices.
“With those two primary drivers being muted for a while, coworking was replacing that, but with that also slowing, there doesn’t seem to be many demand drivers downtown," Schneider said.
New office deliveries in Q4 continued to add more supply to the market, including at least one building that delivered fully vacant.
Property Group Partners' 539K SF building at 250 Massachusetts Ave. NW — the second phase of Capitol Crossing — delivered with no tenants. JBG Smith's 271K SF building at 1900 N St. NW delivered with 73% occupancy, according to NKF.
These deliveries contributed to a rise in D.C.'s vacancy rate from 13.7% in Q4 to 14.2% at year-end, according to NKF.
"It was a slower quarter for leasing overall, and when you add in the deliveries, it's a pretty significant uptick in the vacancy rate," Schneider said.
The District has another 3.7M SF of office under construction, according to NKF, and roughly 40% of that space is pre-leased.
"We will certainly see vacancy continue to rise with the deliveries this year," Schneider said.
CBRE also recorded rising office vacancy in Q4, with the District's vacancy rate reaching an all-time high of 13.9%. The firm found D.C. experienced negative absorption of 17K SF during Q4.
"The vacancy rate is the highest on record for D.C., largely due to a large building that delivered 100% vacant," CBRE Senior Manager Wei Xie said. "On the demand side, it's also the first quarter we've had in a while without a major coworking lease."
Xie said she expects D.C.'s vacancy rate will continue to rise this year as more buildings deliver with large blocks of available space. But she said she sees a supply slowdown coming that could begin to bring down the vacancy rate between 2021 and 2023.
"We think the vacancy rate will peak and the construction pipeline will become more tapered, and that may actually push up the demand for Class-A and trophy assets," Xie said.
D.C.'s asking rents have experienced a slight uptick, but when concessions are factored in, the effective rents have remained flat or even dipped slightly, according to Savills.
"The amount of options continues to drive concessions up," Dreyer said. "New product drives up asking rents, but I consider rents flat, and the market is definitely tenant-favorable."
The District's struggles come as its neighbor across the Potomac River continues to improve its office market. Northern Virginia experienced 996K SF of positive absorption in Q4 and 4M SF for the full year, according to JLL.
"It's fascinating how different the two markets are right now, Virginia versus D.C.," Hartnett said. "Watching a suburb like Virginia continue to beat out the city makes it a tremendous outlier when you compare it to other markets around the country."