D.C. Office Market Posts Strong Q1 With Northern Virginia Leading The Way
The Washington region's office market experienced strong leasing activity and positive net absorption in the first quarter, new statistics show, highlighted by robust demand in Northern Virginia.
The D.C. metro area experienced 1.3M SF of positive net absorption in Q1, according to Newmark Knight Frank, its strongest quarterly performance since 2008. This brought the region's vacancy rate to 15.8%, down from 16.3% at this time last year.
Northern Virginia recorded 2.2M SF of leasing activity in the first three months of 2018, according to Cushman & Wakefield, marking its second-highest quarter in the last nine years.
The surge in new leasing activity was highlighted by two major Boston Properties pre-leases in Reston. The developer signed Fannie Mae for 850K SF at Reston Gateway and landed Leidos for 280K SF at Reston Town Center.
While these deals represent significant wins for Boston Properties, they do not translate to net growth for the region because the tenants are moving from other NoVa offices. Cushman & Wakefield Senior Director of Research Nathan Edwards said this is a problem the area continues to face.
"It is good for Northern Virginia in terms of the amount of large tenant demand that's out there, but it's largely still expiration-driven for the most part," Edwards said. "By and large, the deals are musical chairs. There are a lot of deals hitting the market and what we expect to see is still winners and losers."
The two largest tenants to recently announce relocations to Northern Virginia — Nestlé and Amazon Web Services — moved in last quarter, contributing to a strong net absorption. Northern Virginia had 866K SF of net absorption, its highest quarterly total since Q2 2010, according Newmark Knight Frank's Q1 report, which measures net absorption by move-ins rather than new leases.
"I do think demand is starting to pick up in Northern Virginia," NKF Research Manager Bethany Schneider said. "But basically half of that absorption was Nestlé and Amazon Web Services, which are new to market. We're not going to have that every quarter."
Crystal City has become a winning submarket in recent months. The neighborhood landed the American Institutes of Research for 90K SF at 1400 Crystal Drive, where it will move from two Georgetown offices. Interstate Hotels & Resorts last month signed on for 35K SF at 2011 Crystal Drive, moving from Ballston. JBG Smith, the newly formed REIT and largest real estate company in the region, has focused its attention on revitalizing Crystal City by adding new retail and multifamily offerings.
The Crystal City-Pentagon City submarket recorded 64K SF of positive net absorption in Q1, according to NKF's report, after finishing 2017 with 96K SF of positive absorption.
"It has been modest progress, but for a submarket that was really hurt the last 20 years by contractors vacating space, it's a rather encouraging sign for owners," NKF Senior Managing Director of National Research Sandy Paul said of Crystal City and Pentagon City.
That progress should be boosted by the new federal budget that increased domestic and defense spending by hundreds of billions of dollars over the next two years. Federal spending hikes typically take about 18 months to materialize into new office absorption in the region, researchers agreed. Roughly 12% of federal spending is invested in the D.C. region, Edwards said, which should have a tangible impact on office demand.
"We've seen in the past that the government doesn't hold onto money, they spend it, and it makes its way into the broader economy and the D.C. region is a big beneficiary of those dollars," Edwards said. "The increased new spending could have a really big boost to the region."
Northern Virginia will see more benefit from federal spending than other parts of the region because of its high concentration of government contractors, Paul said. That should help bring down NoVa's vacancy rate, which NKF pegged at 19.2% as of Q1, down nearly a full percentage point from the prior quarter.
The vacancy rate will also be aided by the ongoing conversion of vacant office space to other uses. Perseus TDC last month began construction on its conversion of Alexandria's 200 Stovall St., a 610K SF office building, into 520 apartments with retail.
"As more obsolete office properties are converted to other uses, that should have an impact on lowering the vacancy rate," Schneider said.
While not as robust as NoVa, the District also experienced steady demand in the first quarter. D.C.'s office market recorded 133K SF of positive net absorption in Q1, according to CBRE, following a fourth quarter in which it experienced negative absorption of 259K SF.
D.C.'s new leasing activity was driven by the federal government, with the U.S. Agency for International Development taking 348K SF at Southwest D.C.'s National Square. The move represented a consolidation from one D.C. office and two Crystal City offices, creating positive absorption for the District but negatively impacting the region as a whole, according to CBRE.
Private sector activity also contributed to D.C.'s strong quarter. The IAM National Pension Fund leased 44K SF at 99 M St. SE, a spec office project Skanska is building near Nationals Park. NBC News expanded its Capitol Hill office by about 45K SF, according to CBRE, and law firm Hogan Lovells added 54K SF to its Columbia Square footprint.
"Leasing was strong to start off the year and we think that's going to continue," CBRE Senior Research Analyst Tim Whitebread said. "There are some large deals in the pipeline."