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D.C.'s Office Vacancy Hits Record High While NoVa Market Tightens

Office vacancy is reaching new heights in the District as new supply continues to outpace demand, but market conditions are much better for landlords in neighboring Northern Virginia. 

The two office buildings at Capitol Crossing, 200 Mass and 250 Mass

D.C.'s office vacancy rate rose from 12.8% in Q1 to 13.5% in Q2, a new record high for the District, according to CBRE's latest market report. 

CBRE predicts the vacancy rate could reach 15% by the end of next year based on the massive amount of new office space delivering without pre-leases. Roughly 1.3M SF of office space delivered in Q2, according to CBRE, and another 16 buildings totaling 3.4M SF are expected to deliver by the end of 2020. 

"At this time, the market is as bifurcated as it has been," CBRE Senior Manager of Research Wei Xie said. "You have the haves and have nots ... segments of the market are in high demand, but we have a ton of availability that might not be competitive." 

Developers have continued to build spec office in D.C. because new trophy projects have been able to lure tenants away from older buildings. But the owners of the second-generation buildings tenants are leaving have been hit the hardest, and their struggles to backfill space has pushed up the city's vacancy rate. 

"There is so much new space that the older space will struggle to lease any time in the near future," Newmark Knight Frank Director of Research Bethany Schneider said. 

A graph from NKF's Q2 report showing rising D.C. office vacancy

NKF had similar findings in its Q2 office report, with D.C.'s vacancy rising to 13.6% as 1.3M SF of office space delivered to the market.

Cushman & Wakefield's report pegged D.C.'s vacancy rate at 13.9%. All three reports found the District's vacancy rate increased in Q2 even as the market experienced positive net absorption, with the new demand driven by coworking providers. 

"As these new projects come online, there's typically some leasing left to do," Cushman & Wakefield Senior Director of Research Nate Edwards said. "It's eroding some of the decent impacts we've seen from coworking and technology tenants expanding in the District."

Cushman & Wakefield identified another 1.9M SF of office expected to deliver this year in D.C., with about 50% of it pre-leased. But it expects the supply surge to slow down in the following years, which could reverse the rising vacancy rate trend as long as demand remains strong. 

"We've seen a lot of developers who were initially targeting delivery dates in 2021 through 2023 push their start dates out several years to wait for the near-term wave to deliver and lease up," Edwards said. "We're expecting a little pause from 2020 to 2023 in the East End and CBD."

A rendering of the two 22-story towers Amazon plans for the first phase of HQ2

The picture across the Potomac River looks much rosier for office landlords. Northern Virginia's office market continues to benefit from a lack of spec construction and a major boost in demand that is bringing down its vacancy rate. 

Driven by Amazon signing 585K SF of leases for its second headquarters, Northern Virginia just posted its strongest quarter this cycle. According to CBRE, Northern Virginia recorded 1.6M SF of net new demand in Q2, its highest level since 2006. 

No new office buildings delivered last quarter in Northern Virginia, according to CBRE, and only one 75K SF building is expected to deliver in the second half of the year. This dynamic led Northern Virgia's office vacancy rate to fall more than a full percentage point to 19.3%, according to CBRE. 

"Northern Virginia will have a lot less spec vacant space coming online, and with Amazon driving material growth and existing private sector tenants expanding their footprints, I think the vacancy rate will continue to tighten," Xie said. 

Newmark Knight Frank pegged Northern Virginia's vacancy rate at 18.8% and projects it will drop to 17.8% over the next two years, Schneider said, making it the only part of the D.C. region for which the firm expects falling vacancy. 

"The pipeline in Northern Virginia is much more constrained," Schneider said. "Part of the reason is construction pricing, with the rents being less in Virginia than in D.C., it's harder to get spec ground-up projects to pencil with the rents they'll achieve when they deliver. That's been one thing that's kept the construction pipeline in check in Virginia and has contributed to the decline in vacancy."