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'Eye Of The Storm': D.C. Office Market Worsened In Q4 With Little Sign Of Recovery

The D.C. office market finished its difficult year with another weak quarter in Q4, as the pandemic-induced drop in demand brought vacancy to another record high. 

An aerial view of Downtown D.C. looking up 14th Street

The District experienced 620K SF of negative net absorption in Q4, bringing its total 2020 occupancy loss to 1.4M SF, according to CBRE's year-end market report. The report pegged D.C.'s vacancy rate at a record-high 15.9%, up from 15.4% in Q3.

CBRE Associate Director of Mid-Atlantic Research Wei Xie said Q4 was the worst quarter of the year for the D.C. market. During previous quarters, some deals that were initiated before the coronavirus pandemic had closed, but those had largely disappeared by October.

"Q4 was a quarter of a combination of multiple effects: the waning pre-COVID pipeline on the transaction front, the spike in COVID cases, which really affected touring activity, and tenants' overall decision-making," Xie said, adding that sublease availability also rose in the quarter. "Q4 was really a catch-all from a negative sense."

D.C.'s office market had struggled before 2020, but last year's pain, for the first time, led to a material drop in rents. Overall asking rents in the District declined by 1.4% last year, according to CBRE, and concessions rose by 11%. 

"This is the COVID effect when it comes to pricing, because overall demand has become more muted, and we're seeing for the first time on record a decline in rents," Xie said. "For the most part, base rents have held steady throughout the years even with negative absorption, but this year we have seen a decline in rents, and we've seen concessions rising rapidly."

Xie said she expects the District's slow office demand and downward pressure on rents to continue at least through the first half of 2021. 

"We're in the eye of the storm when it comes to office market real estate demand," Xie said. "I think the second half of the year will bring a sense of recovery and rebound more so than the first half of the year."

The District has experienced a sharp rise in sublease availability as tenants have sought to give back space during the pandemic. This is not only a sign that the economy is in a downturn, but it could also signal a longer-term reduction of office footprints resulting from the remote work shift, JLL Mid-Atlantic Research Director Michael Hartnett said.

JLL's research found 1.6M SF of sublease space was added in the District since March 1, bringing the overall sublease availability to 3.2M SF. The sublease availability totaled 11.7% of all available space on the market, the highest level since 2009. 

"Tenants are actively re-evaluating their footprint strategies, and due to work-from-home policies, that's causing a reduction in how much space they need," Hartnett said. 

Hartnett said he expects the remote work shift will cause sublease listings to keep rising in 2021. 

"That has a direct impact on their current footprint and how much space they need," Hartnett said of remote work. "For tenants with mid- to longer-term leases, they're going to put more space on the sublease market to accommodate those work-from-home shifts."

The types of tenants that have put the most sublease space on the market, Hartnett said, are nonprofits, associations and law firms. Last month, law firm Hogan Lovells retained Savills to help it sublease 100K SF across two floors at Columbia Square in Downtown D.C.

Savills' Q4 report pegged D.C.'s total sublease availability at 3.4M SF, a new high for the market. The report found that D.C.'s Q4 leasing activity was down 40.6% from the prior year. The availability rate, Savills' term for vacancy rate, rose from 18.1% in Q3 to a record 19.4% last quarter. 

"The District has been a tenant-favorable market for over a decade, but the effects of COVID-19 have only amplified these conditions," Savills' report said. 

The federal government has helped spur leasing activity in the District's slow office market, but it has not generated net demand growth. The federal government typically accounts for about 30% of the District's total leasing activity, according to CBRE, but last quarter it contributed 60% of total leased space. 

"Overall, the federal government is not growing in net demand, but they are effective stabilization for the region when it comes to gross leasing activity," Xie said.

A CBRE chart showing net 2020 demand from office market sectors in the District.

The sector that contributed the most positive net absorption in the District last year was technology. Tech firms contributed 104K SF of occupancy gains during 2020, according to CBRE.

"Tech companies had been a bright spot pre-COVID and they continue to be one," Xie said. "We're seeing continued growth coming from that sector. Large West Coast companies continue to expand their presence in the region, and homegrown firms are also posting material growth."

Hartnett said he expects big tech companies will ramp up their lobbying spending this year as President-elect Joe Biden takes office, continuing a growing trend. Over the last decade, big tech companies have increased average annual lobbying spending by 25%, according to JLL. 

"Our projection is big tech will continue to grow its footprint in D.C. as the new administration comes in and there's continued focus on big tech and antitrust issues," Hartnett said. 

The coworking sector, one of the District's major demand drivers in previous years, gave back a significant amount of space in 2020. 

WeWork announced in October it was closing three of its oldest D.C. locations. Spaces closed a Downtown D.C. coworking space, leading to a lawsuit between the landlord and its broker. Israeli coworking firm Mixer last quarter terminated its 30K SF lease at 600 Massachusetts Ave. NW, a deal it signed in June 2019, according to CBRE. 

"That sector started to slow down around the end of 2019. It started before COVID," Xie said. "In Q4 we started to see major closures, not just one-offs, but some of the operators start to revamp their portfolios aggressively."

The Northern Virginia office market also had a difficult 2020, but Xie said she sees more signs of recovery in the suburban market than she does in the District. 

Northern Virginia recorded 365K SF of negative absorption in Q4, bringing the market's full-year occupancy loss to 138K SF, according to CBRE. The market's vacancy rate rose to 19.7%, but it is still below its 2017 peak of 20.9%.

Xie said the rise of sublease availability has flattened in Northern Virginia while it has continued to increase in the District, a sign that the suburban market could be recovering more quickly. 

"There are other regions nationally that are observing that trend as well," Xie said. "It's consistent with what we hear of the different stages of recovery when it comes to downtown versus suburban. Also, I think unlike D.C., Northern Virginia had a couple substantial sources of growth from tech companies, and that really boosted overall fundamentals."

The suburban market has also seen less construction bringing vacant space to the market in recent years. The surge of new construction in the District had contributed to rising vacancy before the pandemic, but Xie said the crisis has slowed down the pace of development. 

No ground-up office developments broke ground in the District last year, according to CBRE.

"With the construction pipeline becoming more disciplined, that will help the overall supply-demand balance," Xie said.