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Federal Spending Increases Could Be A Turning Point For D.C., NoVa Office Market

The D.C.-area office market, especially in Northern Virginia, has suffered years of stagnation following sequestration and a string of short-term federal spending deals. That era has now come to an end, with President Donald Trump Friday signing an agreement that increases defense and domestic spending by at least $500B over the next two years, a deal experts say could be a boon for the region. 

An aerial view of Washington, D.C., taken in 2012

Congress still has to pass detailed appropriations bills for individual government agencies, with a deadline of March 23. Trump Monday released his Fiscal Year 2019 budget proposal, outlining his vision for how money should be allocated under the new, higher spending caps. While the upcoming congressional debate leaves some uncertainty, the agreement to sharply raise federal spending represents a significant reversal that could help undo years of losses in the D.C. office market. 

Federal procurement spending increased continually for three decades between 1980 and 2010, Newmark Knight Frank Senior Managing Director of National Research Sandy Paul said, leading to a major expansion of Northern Virginia's office market. But then sequestration led procurement spending to decline between 2011 and 2013, and increase only modestly since, driving up the area's office vacancy. 

“When you see a bill like the one signed Friday that is going to raise those spending caps, it’s essentially reversing the challenge that we saw from 2011 to 2013," Paul said. "It’s undoing some of those dampening effects.”  

A timeline of the D.C. region's office absorption shows the harmful effect of sequestration.

That change will likely be felt most by defense contractors, which are heavily concentrated in Northern Virginia and stand to benefit greatly from the surge in defense spending. 

In 2017, contractors signed 41 new leases of at least 20K SF, excluding renewals, according to JLL. That is less than half of the 87 contractor leases signed in 2010, the year after the last full-year federal budget was passed. The slowdown in contractor leasing activity has coincided with a series of short-term continuing resolutions and a 28% drop in federal spending on defense contracts between 2011 and 2017. 

"We've been in this endless cycle of continuing resolutions, and that has made it difficult for defense contractors and government contractors to make long-term leasing decisions," JLL Senior Research Analyst Michael Hartnett said. 

Newmark Knight Frank Senior Managing Director of National Research Sandy Paul at NKF's BenchMarks D.C. event in November 2017

Renewed leasing activity from contractors should help boost absorption in Northern Virginia's office market. Northern Virginia had a 19.8% office vacancy rate as of Q4, according to NKF, and it has hovered around 20% for nearly five years.  

“We will see vacancy likely decline in Northern Virginia as a result of this additional spending,” Paul said. “I think a tightening of the market is coming as a result of this law, but we will probably have to wait until 2019 or 2020 to see the full impact.”

Hartnett singled out the Route 28 South submarket as being especially poised for strong growth under the new budget, given its concentration of intelligence agencies. He also said the Dulles Toll Road submarket and Crystal City should be big winners, but he said the added spending should benefit the whole region.

"What you've seen is limited demand and pockets of growth with a lot of winners and losers in this market," Hartnett said. "Whereas if you have more widespread spending increases like we probably will get now, you'll see more of a rising-tide-lifts-all-ships scenario." 

Paul expects the region's office market gains to be heavily concentrated in the Tysons, Reston-Herndon and Crystal City submarkets, but he said the District should also see positive effects. 

"Any time there's an increase in federal spending, the District's office market receives some benefit," Paul said. "There are contractors in the District, particularly in Southwest. To the extent that federal agencies may directly benefit that allows them to take more leased space, which is something we have not seen a lot of recently."