D.C. Office Vacancy Keeps Hitting New Highs As Private Sector, Government Tenants Shrink
The pain the D.C. office market has faced in recent years isn't letting up, new third-quarter numbers suggest, as tenants continue the well-entrenched trend of decreasing their footprints.
In the three and a half years since the pandemic hit and remote work became normalized, tenants have consistently signaled that they are interested in reducing their square footage and moving to higher-end space. Experts say the resulting trend toward high vacancy on display again in Q3 won’t be letting up anytime soon.
“Between economic headwinds and expectations of continued trends and densification, I think we can probably expect to see a little bit more vacancy,” CBRE Mid-Atlantic Research Director Stephanie Jennings said in an interview with Bisnow.
“We're in a really dominant trend right now. I think the expectation is that we'll probably be in this flight-to-quality position for a little while,” she added.
The third quarter saw a number of large private sector tenants taking chunks out of their footprints. As a result, the District saw 287K SF of negative net absorption last quarter, according to CBRE, an increase from Q2, when 239K SF more space was vacated than leased up.
Last quarter, health insurance provider CareFirst BlueCross Blue Shield gave up 140K SF as it renewed its NoMa lease, shrinking to less than a third of its prior size. Global health nonprofit FHI 360 downsized to 30% of its square footage in a move from its northern Dupont home — on the boards to be converted to residential — to 2101 L St. NW in the West End, exchanging its 200K SF for 60K SF, according to JLL's quarterly report.
Law firm Kelley Drye & Warren signed a lease to shed 42K SF in a move from Georgetown’s waterfront to The Wharf. The firm announced it will take 65K SF in one of The Wharf’s Phase 2 office buildings, a 40% reduction from its previous space.
"After careful evaluation of our office needs and a full exploration of options for both a redesigned existing space and locations for a potential new space, we are convinced that this new space will give us exactly what we want to create a modern, collaborative, and enticing office setting for our team in a vibrant location," Kelley Drye & Warren D.C. Office Managing Partner Alan Luberda said in a release.
The firm’s move represents a trend that JLL Mid-Atlantic Researcher Michael Hartnett saw solidify this quarter.
“We're starting to see more lease volume growth in waterfront neighborhoods, like The Wharf and Navy Yard/Capitol Riverfront,” Hartnett said. “So that's something to watch for, especially as tenants continue to strive for those mixed-use experiences and environments.”
It’s a trend he said was especially apparent in Q3.
“We’ve seen that in other quarters, but not consistently," he said.
Along with the private sector, the federal government has also continued to shed space, an effort that has been ongoing for a decade but has been accelerated since the pandemic started.
The National Labor Relations Board plans to cut its footprint by 40%, a government solicitation notice indicated in July. Meanwhile, the Department of Justice is set to reduce its footprint in a NoMa office building by about 150K SF with a new lease in 2025.
The federal government occupies 20% of D.C.’s office inventory, Hartnett said. And with 48% of federal leases coming due within the next five years, he said more shrinkage is in store, especially for Class-B and C office space, where federal offices are generally housed.
“So you pull all those numbers together and it starts to tell a narrative around the vulnerability of a large share of D.C.’s inventory due to the federal rightsizing and givebacks,” Hartnett said. “That won't be felt immediately in the next 12 to 24 months, but over the next five years, we'll start to see more of an impact on D.C.'s inventory and D.C.’s vacancy.”
According to JLL, 59% of the third quarter's leases were renewals, and of those, roughly 20% were short-term extensions by tenants relocating soon.
“There's a lot of indecision in the market, between sky-high interest rates affecting building owners and the values of their buildings and how much they can afford to continue to put into deals versus continued reluctance of return to office from some tenants,” CBRE Executive Vice President Kevin Howard said. “It is just creating a market that is just very tenuous.”
Amid all the distress at the lower end of the market, trophy buildings tell a different story, analysts said. The trophy segment saw 11.8% vacancy, according to CBRE’s Q3 data.
“You do find competition for some of these spaces,” Jennings said of the trophy segment.
Experts said they expect that trend to persist as tenants continue to search for high-quality space and as the development pipeline is at a 30-year low, with only one ground-up trophy construction in the works, Skanska’s 17xM, and another substantial renovation of 600 Fifth St. NW into a trophy office building.
“From a supply perspective, the top end of the market is tightening,” Hartnett said.
But that doesn’t solve the problem of the supply of older Class-B and Class-C buildings that fill streets downtown, in areas that depend on office activity for their economic livelihoods.
“I think at the end of the day, there's going to be just winners and losers within each submarket, and a rising tide will not really lift all ships,” Hartnett said.
“There's going to be challenges for a lot of those buildings that are lacking tenant demand and don't have the criteria to convert,” he added.