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D.C.'s Delivery Deluge Keeps Office Vacancy High, But Experts Foresee Development Slowdown

Demand for D.C. office space continued to grow moderately in Q3, but that trend has been overshadowed by the influx of office buildings delivering with large blocks of available space, keeping the vacancy rate at record levels

The 655 New York Ave. NW office project comprises a huge new office building and more than 70K SF of retail space.

The deliveries will not slow down in the near future, with a host of under-construction buildings set to finish in the coming quarters, but experts see a drop in the number of groundbreakings that should slow the supply surge over the long term. 

The District still has 4.2M SF of under-construction office space, according to CBRE. Roughly 1.7M SF of that is expected to deliver in Q4 alone, and just 45% of that space is pre-leased. CBRE expects this will increase D.C.'s vacancy rate from its already elevated mark of 13.3%. 

"Unless we somehow manage to have a ton of positive absorption in the next quarter, the vacancy rate will go up as a result of this amount of deliveries," CBRE Senior Manager Wei Xie said. "We expect the vacancy rate will rise above 15% by the end of next year."

Cushman & Wakefield pegs D.C.'s vacancy rate at 14.2%, up from 13.9% the prior quarter. And it expects a near-term increase in vacancy with a total of 4M SF expected to deliver this year. 

"When we're looking at downtown, the biggest concern recently has been supply," Cushman & Wakefield Vice President of Research Nate Edwards said. 

But over the long-term, Edwards and other experts foresee a slowdown in construction that will bring the supply-demand balance closer to equilibrium. 

"We're nearing the end of the big supply cycle," Edwards said. "It falls nearly in half over the next three years ... that's going to get [vacancy] more in line with historical norms as supply tails off and absorption will remain typical."

The construction site for The Wharf Phase 2 in Washington, D.C.

JLL Mid-Atlantic Research Lead Michael Hartnett also sees this supply slowdown coming. He said the total amount of office supply coming to market between 2016 and 2019, including ground-up construction and redevelopments, is 18.7M SF. But between 2020 and 2022, he predicts that supply total will be 4.7M SF.

"It is starting to taper off as we look out over the next few years," Hartnett said. 

Edwards attributed this development slowdown in part to rising construction costs, which have made new development deals harder to pencil and made spec projects seem even riskier

"With the rising cost of construction, it's just more expensive to build," Edwards said. "Developers who are looking at starting projects over the next 24 months aren't able to build the return on cost they had been in the last three to four years ... The result of that scenario is the amount of spec construction is really going to fall off the cliff in the next three years."

Newmark Knight Frank Director of Research Bethany Schneider partially attributed the oncoming supply slowdown to developer concerns about a looming recession. 

"There is a general consensus in the market now that D.C. might be facing a supply issue going forward, and developers are monitoring that closely," Schneider said. "Between that and the economic place we're in — we're late in the cycle and there's been more talk about a potential recession in the next year or two — those factors combine to make it less likely developers would move forward on a spec project at this point."

A slowdown in supply should help bring down the vacancy rate, as long as demand continues to grow. The District recorded 141K SF of positive net absorption in Q3, according to NKF, led by WeWork and other coworking providers leasing large blocks of office space. 

"We're seeing relatively stronger demand to what we had seen a few years ago," Schneider said. "Coworking has been the primary source of demand this year."

Whether coworking providers such as WeWork can continue to fill up their spaces and expand their footprint remains to be seen, but some other sources of demand are also beginning to emerge in D.C.

CBRE's report found 103K SF positive net absorption in Q3 from technology firms, separate from coworking spaces. This was led by Tableau, which was recently acquired by Salesforce, expanding its footprint by 42K SF at 1801 K St. NW to a total of 63K SF, according to CBRE. Additional tech companies growing their footprints were GiveCampus, Aquicore and TransitScreen

"That is another promising sign," Xie said of the tech company expansions. "If you look at the composition of the positive absorption, it's not just coming from one place. Previous quarters had coworking, but more and more we're seeing diverse sources of growth."