Uncle Sam to the rescue?

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Print this page by Paula C. Squires

It helps to have a rich uncle. Just ask Washington, D.C.  For years the office needs of the federal government helped create one of the most vibrant real estate markets in the country. 

While other cities suffered during economic downturns, Washington thrived because of the steady flow of business from the government.  But this recession has been different. The nation’s capital is taking some hits, and some real estate firms are looking to Uncle Sam to come to the rescue again.

Brand-new office buildings stand virtually empty on M Street, just around the corner from the Nationals’ new baseball park. Plans for a retail/entertainment venue near the stadium are on hold because of the financing crunch. The story’s the same for a massive redo planned across the Anacostia River in Southeast Washington. 

Meanwhile in the city’s pricey Central Business District — close to the White House — reliable tenants are becoming less reliable. The national law firm of Thelen Reid & Priest LLP closed its doors last year, dumping 80,000 square feet of space on the market.  “The professional service firms have always been a big driver, and they’re decelerating,” laments Thomas E. Finan, the region’s managing director for Trammell Crow Co. “That gives real estate companies pause. After all, they’re the guys who pay the most for space.”

Still, major commercial real estate players remain hopeful. In the greatest wave of economic recovery spending since the Great Depression, the District will get more than $1 billion in federal funds for the construction and modernization of government buildings. 

The activity promises to boost the lagging construction and commercial real estate sectors. As new buildings come online or are renovated, government agencies will swing in and out of space, signing new leases.

Already, several regulatory agencies involved with the bailout of the financial industry have taken 450,000 square feet of space, says Finan. The trend bodes well for Trammell Crow. The company has 1.1 million square feet of office space under construction at two projects. Sentinel Square is going up in NoMa — an up-and-coming area north of Massachusetts Avenue —  while Patriots Plaza is located in Southwest. So far, no tenants have leased space at Sentinel, a 12-story, 412,600-square-foot building that should be ready by June 2010. 

However, an earlier, first phase of Patriots Plaza is up and fully leased to five government agencies.  “We’re highly vested in the government sector right now,” says Finan.  “In the next two or three years, it will be everything,” he predicts.

Are federal funds the answer for real estate? 
Yet, regional economic expert Stephen S. Fuller remains unconvinced that government stimulus funds are the panacea to the market’s woes.  “They think it’s going to be big this year, and it’s going to save them, but it’s not going to be as big as they think.”

The problem? Too much office space in the pipeline. Fuller, director of the Center for Regional Analysis at George Mason University, makes this observation:  “The builders of office space have built more space than has been absorbed since 2005. So, there’s an imbalance. It’s worsened by the slowdown in the economy.” 

Fuller’s figures show that between now and the end of 2010, 9.8 million square feet of new office space will be completed in D.C. at a time when demand is closer to 2.7 million. “The vacancy rate in December was 7.3 percent. In December of 2010, we expect it to be 12.1 percent,” says Fuller.

Out in the suburbs, an additional 15.9 million square feet of office space will come online, he adds, with only 9.2 million of that expected to be absorbed by 2010.

Even with its challenges, the Washington metro area — fourth largest in the country — continues to fare better than other large cities. In fact, it just snagged the second largest commercial lease of the year: 600,000 square feet in four office buildings at AOL’s former headquarters campus in Dulles. Defense contractor Raytheon took the space so it can consolidate all of its Northern Virginia operations. 
Another positive for the market is relatively stable rents. “They’ve gone down somewhat, but not like New York where rents are down by 50 percent in some places,” says David Lipson, an executive vice president and director of Studley’s Washington office.

Studley represents major government and commercial tenants. Lipson says clients can expect to pay a high of $80 per square foot for space in a premium, Class A office building in the central business district. The rate drops to about $45 per square foot in areas such as NoMa. Federal mandates dictate that government tenants pay no more $49 per square foot for office space, so many agencies are located in NoMa.

One advantage of a down market, notes Lipson, is generous concessions. With landlords throwing in goodies like free rent (over several months) and tenant improvement allowances, “tenants can build out new space without money coming out of pocket.” 

Still, companies are being cautious.  “Overall the economy stinks,” says Lipson.  “It’s hard to make a commitment when you don’t know where your business is going to be in five years.”

Green construction a driver
Despite the uncertainty, Louis Dreyfus Property Group just completed a trophy office building that was in the pipeline before the credit crunch.  Lafayette Tower, a 240,000-square-foot speculative building, sits at the corner of H and 17th Street NW, and resembles a giant box of glass.

It is Washington’s first platinum, LEED certified (Leadership in Energy and Environmental Design) office, the highest ranking for a sustainable building. Marble, granite and stainless steel finishes project a sleek, contemporary feel, while a green roof and automated blinds make the building energy efficient. Tenant amenities include a rooftop terrace with striking vistas of the White House. 

So far, only three companies have signed on as tenants, says Sean Cahill, vice president for development for Louis Dreyfus.  Lafayette Tower follows the 2006 opening of another Class A speculative project, 1101 New York Ave.  That building was fully leased by the end of 2008, he says, by such tenants as former Secretary of State Madeleine Albright and the law firm Dewey & LeBoeuf LLP.

Cahill looks to the Washington area’s strong job growth to absorb Louis Dreyfus’ excess space.  “What’s different now than in the 1980s is that we’re not going to fall off a cliff. We don’t have 10 million square feet sitting vacant. It will take one to one and half years to absorb what we’ve built.” 

A reluctance by banks to force foreclosures — which would put properties back on the market — also is helping absorption.  Joseph P. Corish, a lawyer for Bean, Kenney & Korman in Washington, says banks are working more with borrowers during this downturn. “There’s a lot more effort to avoid taking the property back into the bank,” he says.

Washington’s big ace, though, is job growth. According to Fuller, average annual job growth for the metro area during the last 15 years was 45,000 new jobs. From February 2008 to February 2009, that figure dipped to about 12,000 jobs — mostly with additions to the government office work force.

For all of 2009, the Center for Regional Analysis expects a net job growth of 18,000, with the region back to its long-term average of 45,000 by 2011. “Of all the metropolitan areas, we’ve had the least job loss,” notes Fuller. “Federal spending to manage the bailout and the credit crisis will help this economy weather this storm,” says Fuller.

Still, real estate executives don’t deny the pain of this recession.  At the end of 2008, Finan says Trammel Crow reduced staff by 15 to 20 percent in all of its offices. “We’ve had to make some tough decisions like letting people go.”

The company feels fortunate to have two projects under construction at a time when government is expanding. Financing for the projects was lined up from such players as Bank of America before the economic downturn. “You can’t start anything of a speculative value today due to the credit crunch,” says Finan. Overall, he adds, “We think we’re in a pretty stable position to ride this out.” 

Market drivers:
• Positive job growth  
• Federal contracts
• Government stimulus funds
• Green construction

Market Snapshot

Washington, D.C., Metro Area

TOTAL OFFICE: 431.4 million square feet
Vacancy rate: 12.3 percent up
Net absorption: -766,256 square feet
Average quoted rental rate (all classes): $34.04 down
New buildings delivered: 8, totaling 1,036,130 square feet down
Under construction: 11.7 million square feet

Source: CoStar Group Inc.,
first quarter 2009.
indicates upward trend
indicates downward trend

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