Key Themes in Washington Area Commercial Real Estate Market, Transwestern & Delta Associates, February 2013

Transwestern and its research affiliate, Delta Associates, held a "trendlines" event in February on the Washington area commercial real estate market.  Delta highlighted six themes for the market this year:

#1: Washington realized vulnerability during 2012.

 . . . years of deficit spending caught up with politicians by 2010 when a new wave of budget-conscious representatives was elected to the 112th Congress. This group seems bent on controlling expenses even at the cost of national economic growth. So the mood for the foreseeable future seems to be to rein in spending – and with it, Federal dollars spent in the Washington region. Nowhere is that seen more clearly than in procurement spending in the Washington area. . .

#2: Despite vulnerability, the private sector made gains during 2012 due to extraordinary regional strengths.

Despite vulnerability, the private sector continued to create jobs in the Washington metro area during 2012. During the 12 months ending November 2012, the private sector in the Washington metro area grew 27,600 new jobs . . . Public sector job growth retreated during this period, growing 6,700 new jobs. . . .

#3: Demand for commercial real estate will be less than we are used to.

Economic uncertainty, demographic shifts and the rise in technology have impacted the Washington metro area commercial real estate market. . .  Although economic uncertainty may decline in the years ahead, demographic shifts and the rise in technology will have a continuing impact on the demand for all types of commercial real estate.

In the period ahead, Delta Associates believes the following trends will impact office demand, keeping the annual average hovering around 4.5 to 5.5 million square feet per year:

• GSA pullback: GSA accounted for approximately 65 percent of total Washington-area leasing activity during 2010; . . . Delta expects GSA leasing activity to remain around 10 to 15 percent of office market demand in the near future.

• Densification: Tenants (both private and public) are changing the way they utilize space. Changes in the nature of work and how tenants use office space are driving the reduction in the amount tenants lease. In 2000, the average square footage leased per worker was approximately 197 square feet. . . .  It is expected to decline to approximately 182 square feet by 2015. Tenants are increasingly consolidating offices, leasing less space per worker due to hotel and telework programs and right-sizing office space due to staff reorganization and technological changes in the work place. (Emphasis added.)

#4: Barriers to entry for developers – and other businesses – are easing, adding to competition.

 Combined with reduced demand for space, something that has been building for several years, local competition among economic development authorities (EDAs) has been heating up. 

In a time of broad-based budget cutting, public officials know that they must broaden their tax bases in order to be able to continue providing the level of service that residents demand. This means making their jurisdictions more appealing to firms that are creating jobs. . . . (Comment:  This means that EDAs are subsidizing developers to attract their business, shifting an increasing share of the increasing property tax burden to residential property.)

#5:  These trends portend a foreseeable future that is more competitive – and will result in higher vacancy rates, lower rent growth rates and a continuing flight-to-quality.

The reset balance between supply and demand is likely to raise vacancy rates and suppress rent growth in the period ahead. . . . (Emphasis added.  This also means that commercial real estate "cap rates"--the key basis for their real estate property valuation and, therefore, their property tax contribution, will be weak.  Homeowners will have to make up the budget shortfall through increasing real property tax rates in the continuing absence of County spending cuts.)

#6: Success will go to those with deep pockets, a sensible capital structure and best-in-class design, management and marketing at superior locations. 

The champions of the future are those who best resolve the current mismatch between old designs or existing product and new tenant requirements – and who do it well at superior locations. . . The best way to distinguish a project in the period ahead will be by connecting the design to the needs of the targeted user; this principle applies to all product types, but especially to office and apartment development – the two product types where competition will be fiercest.

 For the full press release, please click here.  

The Delta "Trendlines TwentyThirteen" report is available here.   This report is comprehensive and balanced.  We recommend it for its well-researched and presented analysis of the state of the Washington commercial real estate market.