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Winning Half Of HQ2 May Not Be Game Changing For D.C. Office Markets Outside Arlington

Developers with large office portfolios in Arlington have been rejoicing over the last week about the demand Amazon will bring to the county with its National Landing campus. But researchers and brokers think the effects of the split second headquarters may not reverberate throughout the region's office market as was expected when the full HQ2 was on the table. 

A rendering from November 2018 of the north section of National Landing, including parts of Pentagon City and Crystal City

"Clearly some micro-markets like Crystal City, or National Landing, will tighten and rent conditions which have been soft will become more favorable for landlords, but I don't see this announcement impacting Reston or Tysons or the CBD," Savills Studley Corporate Managing Director Jon Glass said. 

The Crystal City-Pentagon City submarket, or the area Amazon is branding as National Landing, will undoubtedly see the largest direct benefit from the tech giant's move. The submarket currently has a 15.5% vacancy rate with 2.2M SF of available office space, but a study from Transwestern and Sage Policy Group projects its vacancy could fall to 7.2% by the end of Amazon's phased move-in.

Amazon's agreement with Virginia said Phase 1 of the move, which would include all of the promised 25,000 jobs, is expected to start next year and last until 2030. A potential second phase of the HQ2 move could add another 12,850 jobs between 2030 and 2034. 

The number of jobs Amazon will add each year is thus a small fraction of the D.C. region's average annual employment growth of 43,000 jobs a year, Newmark Knight Frank Senior Managing Director of Market Research Greg Leisch said. 

"This is good, but it's not course-altering," said Leisch, speaking last week at NKF's Benchmarks event. 

An aerial view of Arlington's Rosslyn-Ballston corridor

The nearby Rosslyn-Ballston corridor could also experience some spillover effects from companies wanting to locate near Amazon. The Transwestern study projects its vacancy rate could fall from 20.3% to 16.1% 

The much-needed drop in vacancy in the Crystal City-Pentagon City and the R-B corridor submarkets will impact the market dynamics in those areas, with Transwestern projecting annual rent increases of 4% to 5% and 2% to 3%, respectively. This would gradually shift those markets to the landlords' favor as companies vie to locate near Amazon and the supply dwindles.

But the major nearby office submarkets of Downtown D.C. and Tysons have also experienced elevated rents and tenant-favored conditions for several years, and it is not clear that Amazon will have a meaningful impact on those areas.

"I think [the impact] will certainly be localized toward Arlington and the R-B corridor, but I think from a D.C. and Tysons standpoint, it has yet to be determined," said MakeOffices CEO Zach Wade, also a principal at MRP Realty

An aerial view of D.C.'s Central Business District and East End.

The office market in D.C.'s Central Business District currently has 3.4M SF of available space, and developers continue to build new projects with large chunks of available space. Transwestern projects its vacancy rate will decrease from 8.2% to 8.1% as a result of Amazon HQ2

Similarly, in the East End submarket, which has 5.6M SF of available space and more development underway, Transwestern projects vacancy will decline from 11.7% to 11.6%. 

Northern Virginia's other office markets outside of Arlington are also not projected to see a meaningful decrease in vacancy. Transwestern projects vacancy in the Old Town Alexandria and Eisenhower Avenue corridor submarkets will fall from 10% to 9.9% and from 16.1% to 16%, respectively. It also projects only slight impacts on Fairfax County, Loudoun County, Montgomery County, Prince George's County and other suburban areas. 

Throughout Amazon's 14-month-long search for a second headquarters, jurisdictions were under the impression it would be all or nothing; a 50,000-job, 8M SF HQ2 or a complete loss. The D.C. region was seen as a front-runner for HQ2 with three of its jurisdictions among the 20 finalists and countless analysts pegging it as the odds-on favorite. Regional leaders frequently said that any D.C.-area jurisdiction winning would be a boon for all of its neighbors. 

But Amazon ultimately chose to cut HQ2 in half and award Northern Virginia with at least 25,000 jobs and 4M SF of office demand, giving the rest to New York's Long Island City.

It will still make Amazon one of the D.C. region's largest employers, and stakeholders agree it is much better than winning nothing, but the seismic shift a 50,000-job HQ2 would have sparked for the region is now more of a sequestered bump. 

"If the entire HQ2 were to land in D.C., landlords would be way more bullish than what they may start to become as a result of the actual announcement," Glass said. "Now with the ripple effect, you're going to have companies that could go to New York, Nashville or here, rather than if it was all in one location, the ripple effect would be more dramatic because they would all go to one area." 

Still, developers and landlords remain optimistic about what Amazon's choice could mean for D.C. over the long term. While it may not have as big of a direct impact, HQ2 could boost the perception of D.C. as a tech hub, leading other large companies to move to the area.

"What I believe is more significant [than the economic impact] will be the impact on our regional brand," Leisch said. "For future corporate retention and attracting, making it easier next time to attract Hilton or Volkswagen or Nestlé." 

Office landlords expect this brand improvement could impact office demand in Downtown D.C. and diversify the market away from government-related tenants and toward more private sector employers and technology companies. 

"My view is that Amazon is going to create new drivers for demand and new types of companies and industries that typically have not had a big presence in the D.C. market," Rockrose's Ted Traum said. "It certainly is going to create new pockets of growth and demand in the CBD and throughout the District."

WashREIT CEO Paul McDermott and Boston Properties' Senior Executive Vice President Ray Ritchey

Boston Properties Senior Executive Vice President Ray Ritchey said D.C.'s tech sector has lagged behind other submarkets his company works in, such as San Francisco, Los Angles and Boston. But he has seen in those markets that tech companies tend to cluster near each other, and he thinks Amazon's move could help create that critical mass in D.C., leading to more demand growth for office space down the road. 

"I think people are going to be anticipating demand more than actually experiencing demand," in the short term, Ritchey said. "But if there's a perception that D.C. is a tech hub, validated by Amazon, it may become a reality that D.C. becomes a tech hub." 

One of the bright spots of Downtown D.C.'s office market has been the Class-B segment. As developers continue to renovate older office buildings and bring them up to the Class-A level, the stock of Class-B properties with affordable rents has shrunk. This has led some value-conscious tenants to cross the river for cheaper rents in Crystal City and other parts of Arlington. But the Amazon effect is expected to bring up rents in those submarkets, potentially making the downtown Class-B segment even more in demand and more attractive for landlords. 

"As Amazon begins to occupy space, the demand [in Crystal City] could be stronger and allow those landlords to push rents, which I'm sure owners are looking to do," Stream Realty Managing Director Matt Pacinelli said. "That may limit the opportunity for Crystal City as a cost alternative to downtown ... and then the continued tightening of the Class-B space downtown should occur." 

Amazon is also expected to have a positive impact on D.C.'s coworking sector. Startup founders could be more likely to locate their companies in the D.C. area to be close to Amazon, and the tech giant could help create a future generation of entrepreneurs who will call D.C. home. Wade, whose D.C.-based coworking company operates eight spaces in the area, said this growing startup scene will support a strong coworking market for years to come. 

"There's a 100% chance it will have a positive impact as it relates to additional demand for coworking space," Wade said. "Companies that are doing business with Amazon, and a lot of the smart people at Amazon spinning out and starting businesses, when you have that amount of smart people, it's very good for the entrepreneurial community."