Federal government cuts will further imperil Virginia’s real estate recovery

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States are bracing for fallout from the failure of a congressional “super committee” to reach a broad deficit reduction agreement in November. President Obama has vowed to veto any attempts to minimize automatic budget cuts now triggered to begin in 2013 unless a large-scale deal is reached, but continued gridlock in Congress makes any such deal unlikely.

Virginia will be disproportionately affected by these budget cuts because of its reliance on defense spending. About 14 percent of the Virginia’s gross state product comes from defense spending, making it one of the state’s key revenue-generating industries.

About $600 billion in automatic defense spending cuts will go into effect in January 2013 as a result of the super committee’s failure. Those cuts will be come on top of a $450 billion reduction in spending already planned by the Pentagon. The cuts will have a big impact on Virginia’s real estate market because of the large number of military installations and defense contractors based here, especially in Northern Virginia and Hampton Roads.

Northern Virginia already has seen falling real estate demand and rising vacancies.  The region recorded an office space net absorption of negative 337,926 square feet in the third quarter, according to a recent Jones Lang LaSalle report. Home to a number of defense contractors, Arlington County led the decline.

A similar scenario is unfolding in Hampton Roads. Year-to-date office absorption there is negative 143,369 square feet, according to a third quarter report from Cushman & Wakefield Thalhimer. Downtown Norfolk and South Hampton Roads experienced steep absorption declines.

These statistics reflect the uncertainty businesses face in those regions. Seeing the cuts coming, they are reducing their work forces and the amount of office space they occupy. As cuts are implemented, the commercial real estate market will take similar blows. 

Federal spending cuts also have begun to send shockwaves through Virginia’s residential real estate market.  That’s because Virginia ranks among the top three states in the country in which federal workers and government contractors work and reside. The state’s home sales took a hit in October, falling 8.6 percent compared with a year ago, according to the Virginia Association of Realtors. Home sales fell especially hard in Northern Virginia, dropping 12 percent compared with the same month last year.

The declining sales trend becomes particularly troubling when it creates a self-fulfilling prophecy. As the federal government cuts back, laid-off employees and contractors are forced to sell their homes. The cuts, however, also make it less likely new residents will move to an area where jobs are being eliminated. 

These federal cuts are not unexpected, and the current economic environment will be reflected in Gov. Bob McDonnell’s state budget. He has indicated the budget will be conservative and take the federal cuts into account. For example, McDonnell recently proposed closing the Virginia National Defense Industrial Authority, a state agency that tracks military and defense issues.

Fortunately, the state has a strong track record of attracting new employers, encouraging job growth and creating a business friendly environment. All of those factors will bolster the state’
s real estate recovery, not to mention Virginia’s broader economy. Despite any action on the state level, though, federal cuts will put additional pressure on Virginia’s already vulnerable real estate markets.

Understanding how to weather this storm will be critical for real estate companies, especially those in the commercial space, including developers, property management firms and brokerages. Real estate professionals should explore a variety of strategies, including three key marketing solutions:

1. Create robust research programs identifying demographic and industry trends that will inform your next move. Research should be a key component of any strategy.

2. Develop incentive programs. As vacancy rates rise and demand falls, offer incentive packages that attract potential tenants or close deals. A popular tool, incentives can help drive business.

3. Consider ways to upgrade or repurpose existing structures. As absorption rates decline, more existing commercial space will become available. Refurbishing or upgrading existing space can be more cost effective than building new space. Likewise, existing properties are typically less expensive to rent than new space. When the commercial real estate dips, showcasing value is paramount.

Federal cuts are coming and they will hit the Virginia real estate market hard, particularly Northern Virginia and Hampton Roads. Real estate companies should position themselves accordingly and craft appropriate strategies. 

,Andrew K. Ryan is a partner at Commonwealth Partnerships, a Richmond-based real estate marketing and research firm.  He can be contacted at akr@commonwealthpartnerships.com.

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