How long before federal expansion comes to a halt?February 28, 2011 6:00 AM
by M.J. McAteer
Few commercial real estate markets performed as well as the Washington metro area in 2010. By year’s end, it led the country in leasing and sales volumes. Only New York City ranked higher in terms of attracting foreign dollars, with Washington coming in at No. 2 as both the best U.S. city and best global city for foreign investment. And it saw a drop in its overall office vacancy from 13.2 percent in the third quarter to 12.9 percent in the fourth.
So what’s in store for 2011? Probably continued momentum with one caveat: All that federal spending stoking the market can’t go on forever. Some commercial real estate experts already are saying that a shift in power to the Republicans on Capitol Hill will soon rein in mega leases by government agencies.
Federal government expansion and the realignment of military agencies and defense personnel stabilized the region during the recession, and those factors continue to be major market drivers for the time being. In accordance with the 2005 Base Realignment and Closure (BRAC) mandate, many government agencies are consolidating and moving into large blocks of space.
While few private projects broke ground in 2010, the feds were busy builders, thanks to stimulus money. “I did a tour of [federal] facilities along the I-95 south corridor,” says Brian Benninghoff, chairman of the commercial real estate development association of Northern Virginia (NAIOP). “It’s like a mini-Pentagon that goes all the way to Quantico.”
The Mark Center at Fort Belvoir in Alexandria, for example, features two new office towers and 1.8 million square feet of space. When it’s completed in September, it will house the Washington Headquarters Service, the entity that provides administrative and support services to Department of Defense agencies. The headquarters and other branches of the DoD are expected to bring 6,400 workers to the center.
With that influx, it’s no wonder that private development is starting to follow in BRAC’s wake. Wood Partners LLC of Atlanta started construction in January on a $68 million, 290-unit luxury apartment complex on a three-acre site six miles from Fort Belvoir.
In addition, Corporate Office Properties Trust plans a speculative office park geared toward defense contractors in Springfield, not far from the new Mark Center.
Another huge undertaking, also at the military base, is a 1.3 million-square-foot medical center that will help replace the venerable Walter Reed facility in the District when it closes in September.
These and other smaller projects in Northern Virginia are all part of the BRAC initiative. The result is a reshuffling of federal space, as some federal tenants let leases lapse in nearby markets such as Crystal City and Ballston in favor of the new space.
A silver lining?
Stephen S. Fuller, director of the Center for Regional Analysis at George Mason University’s School of Public Policy, says this could be a silver-lining scenario: In some cases, the vacated space needs updating, and landlords who take the opportunity to renovate will be ready to snag Class A tenants when a better market arrives.
However, with the stimulus money already allotted and a new, divided Congress on the Hill, that better market can be government-powered for only so long. The federal spending of 2010 is “unsustainable,” says Scott Homa, mid-Atlantic research manager for Jones Lang LaSalle. In the not-too-distant future, he expects the private sector will need to take the helm and steer economic growth.
Several long-delayed projects recently have moved off the shelf. For instance, Quadrangle Development Corp. and Capstone Development LLC are building a $550 million, 1,175-room Marriott Marquis next to the Walter E. Washington Convention Center in Washington. Yet GMU’s Fuller remains skeptical about new growth until the economy gains more momentum. Figures on office space are a bellwether for economic recovery, and he says vacancy rates are still high.
The 12.9 percent overall office vacancy comes from CoStar Group Inc., a D.C.-based commercial real estate research and analytics firm. According to its fourth-quarter report, East Falls Church had the lowest overall office vacancy in the region in the fourth quarter at 7.1 percent, while the Leesburg/Route 7 corridor experienced the highest rate at 18.7 percent.
Region-wide retail rates showed a slight improvement, CoStar reported, going from an average vacancy of 5.4 percent at the end of the first quarter to 5 percent at the end of the fourth. Meanwhile, industrial rates stayed static, starting and ending the year at 12.8 percent.
What everyone seems to agree on is that the market is much stronger now than it was a year ago. “The end of 2010 was a lot better than the beginning,” says David Gast, a senior vice president at CB Richard Ellis. “I believe we’ve turned the corner.”
New jobs will help. A recent survey by Monster.com ranked Washington as the No. 1 market among the top 10 hottest job markets in 2011. As the economy recovers, Monster said, the area will need computer systems analysts and Web developers.
During the 17 months concluding with the first quarter of 2010, the D.C. metro area lost 53,000 jobs, 22,000 of them in Northern Virginia, Fuller says. However, by November of last year, it had added back 19,000 private-sector jobs, again about half of them in Northern Virginia. During 2011, Fuller expects the region as a whole to gain 45,000 jobs, which should bring down commercial real estate vacancy rates by a point to a point-and-a-half.
Jobs inside the Beltway
Most of these jobs will be inside the Beltway. That means that, with the exception of the resilient Reston Town Center, commercial real estate in the Northern Virginia outer suburbs — which was overbuilt and took a hard hit in the downturn — will lag in this recovery. “See-through buildings — meaning empty ones — probably will remain a factor in the outlying suburbs, Fuller says.
Yet Gast of CB Richard Ellis notes some positive movement. He says Time-Warner and defense contractor EADS recently leased a combined total of almost 300,000 square feet near the intersection of the Dulles Toll Road and Route 28 known as Dulles Corner.
Inside the Beltway, where the Northern Virginia market is most durable, a couple of big projects are in the works. The most prominent is a 500,000-square-foot building planned for a site adjacent to the Rosslyn Metro. This project is an anomaly in today’s risk-averse environment because the developer, Monday Properties, is investing $30 million of its own money to lay the groundwork for development when the market turns around. Its goal is to attract investors for a $300 million, 35-story building (which will make it the tallest structure in the D.C. area).
Gast says Boeing also plans to build 325,000 square feet of new space in the Rosslyn area, and Fuller expects that several large new projects in Crystal City and Pentagon City will be announced or begun this year. For speculative building to make a comeback, though, Fuller says, the commercial real estate vacancy rate would need to drop to about 9.5 percent.
Retail, on both sides of the Northern Virginia Beltway is expected to be hit or miss. A new Walmart for Tysons Corner and a new Harris Teeter supermarket for Alexandria are possible. In the District, Wal-Mart may open as many as four stores.
The Springfield Mall, after much uncertainty about its future, plans to renovate its food court and construct movie theaters this spring. Eventual redevelopment plans for the mall include office and residential space.
“Every month is getting better,” Benninghoff says about the capital region market.