Rockrose Development played a game of chicken—a calculated game of chicken—as it negotiated for its latest buy in the Washington, DC area this spring, eventually scooping up a CBD office asset, 1776 Eye St. NW, for $119.6 million. The asking price had been $140 million, but between contract and closing, a fortuitous (for Rockrose) event happened: the main tenant, Nuclear Energy Institute, decamped, opening up a 50,000--square-foot hole.

Rockrose knew this was a possibility, and in fact was quite pleased at the turn of events. It got the building at a lower price and with the opportunity to add value.

In a way, the company is still playing that game of chicken, since vacancies in the DC area show little sign of budging. They averaged 11% at year-end, according to Jones Lang LaSalle figures. Rockrose will have its hands full filling the space...or will it?

Craig M. Deitelzweig, head of the office division for New York City-based Rockrose, doesn't think so, but he acknowledges the need for caution. "We're being fairly conservative underwriting rent growth," he says. "For value-add assets, such as 1776 Eye St., we're underwriting for rents after improvements are done and we're not figuring on any market growth this year." In 2012, the firm projects 3% to 5% growth in rents with a continuation of growth through 2016.

Meanwhile, 10 or so miles away in Wheaton, MD, Robin Williams and Dean Sigmon, SVPs of Transwestern's Mid-Atlantic multifamily group, are listing Glenmont Crossing, a 199-unit, garden and townhome community near a Metro stop.

The property has a lot to be enthusiastic about. It's one of the few in the area with townhomes, it's transit oriented, near a major park and a grocery store. However, this is a community in a suburb that tends to be blue collar and straddles the Beltway. Still, the brokers expect Glenmont Crossing to generate several bids, eventually selling in the mid $30-million range, an excellent price for the area. Given the way apartments have been trading, it probably will.

An investor in a Washington, DC CBD office asset that is cautious about rent growth? A suburban multifamily property poised for a bidding war? The answer to both questions is yes, and for brokers active in the area, none of this is news, but outsiders can wonder how the nation's capital got to this point. Home to one of the most stable and secure employers in the world—the US government (recent shake-ups at GSA not included)—the district's office market can best be described as lackluster in terms of occupancy and rent growth. Yet multifamily, which also requires a steady local job market, is booming.

The answer to this seeming conundrum is complex and multi-layered. Thanks to the GSEs, financing is easier to obtain for multifamily. Plus, local demographics are in favor of apartments, which are performing well despite the slow economy. On the office side, it's still a tenant's market.

However, the crux of the dichotomy between office and multifamily is this, according to a recent analysis by Cassidy Turley: even though local employment is approaching levels last seen in 2008 (nonfarm payrolls reached 3.011 million in January 2012) leasing remained stagnant due to continued rightsizing in the public and private sectors and move-outs related to the Base Realignment and Closure plan.

Metro DC leasing was negatively impacted in Q1, despite the employment rate, and general traction exhibited in the economy, according to comments made in the report by Jeffrey Kottmeier, Cassidy Turley's vice president and director of research.

Congress' move to tighten its budget, (not to mention that it's an election year) has businesses on tenterhooks right now. Then there's BRAC, for which the region had admittedly been prepping for years. The majority of BRAC lease expirations will take place this year and next, but there's still a question as to how many tenants will actually vacate space or renew in place.

None of which, of course, can be applied as blanket statements; each submarket has its own story. Office vacancies are almost nonexistent in, say, Rosslyn, VA, but that is not the case in Herndon or Alexandria, VA. Pricing for office in the CBD or East End is as solid as oak; not so, however, for a class B or C apartment building in Greenbelt, MD. Apartment rents in northwest DC are high and availability is low—other areas of the city are more competitive for renters.

The true wild card, potentially overshadowing BRAC in significance, is this: both multifamily and office are grappling with blind spots as they make projections. For multifamily, many in the area suspect that the pipeline is too robust. Meaning, a number of properties coming to market on paper are simply going to die at some point in the entitlement or finance process.

Delta Associates predicts that 12,472 units will come on the market this year, and 10,887 in 2013—a significant increase from the typical 5,800 units that are added in any given year. However, it notes that not all of these units will be delivered.

Office, meanwhile, has its own blind spot—the question of rent growth. Most investors, like Rockrose, are taking a conservative approach, especially after Standard & Poor's downgraded US credit last summer.

In some cases, they're being pleasantly surprised. Last year Rockrose bought another DC office building at 1150 18th St. at a distress price of $43 million. Purchased out of special servicing, the 180,000-foot property traded at a 25% discount from the last time it was sold, in large part because of its high vacancy. However, the firm recently inked a lease for $8 a foot more than it had incorporated into its underwriting when it bought the building, Deitelzweig says.

"We estimate the cap rate to be 10% now," he notes, "and it's been less than a year since we acquired it."

At the end of the day, though, multifamily is the sector on the upswing of the cycle. "In the past six months, we've seen office investors, clients of the firm, move out of the office asset class and into multifamily," Sigmon says. "Multifamily simply offers better long-term stability and less risk."

The range and type of investor interested in DC multifamily is diverse, with buyers lining up for A-, B-and even C-grade products, says Ari Firoozabadi, president of the Greysteel Co., a nationally focused, locally headquartered investment sales advisory firm. Not surprisingly, the core and core-plus asset class is hotly competitive since it offers a preservation-of-capital strategy as well as an inflationary hedge, he says.

Affluent families, REITs and institutional investors, some partnering with foreign equity, are the dominant core buyers, according to Firoozabadi. "The estimated year-one yields fall into the 3.95% to 5.2% range," he says. "Financing is cheapest for A properties. Interest only is again available to improve near-term cash flow at compressed spreads."

The B class also has a slew of buyer types, he continues, many of which overlap from the A class, such as institutional investors, funds, REITs and private buyers. In this case, they are betting on estimated year-one yields of 5.4% to 6%, Firoozabadi says. Indeed, if these properties are well located, their yields are considered to be very stable as the top line for rent per square foot in core submarkets, such as Downtown DC, continues to reach and even exceed $3.50 to $4 per square foot.

In many cases, buyers have cheerfully given up on the competitive A class in search of well-located value-add plays. Equity Residential, for instance, has allocated capital specifically for such investments, Firoozabadi says, pointing to the REIT's recent purchases of Chase at Bethesda (MD) Metro, 1500 Massachusetts Ave. NW, in the District and another asset it is said to have under contract in Bethesda. Financing is relatively easy to procure, given the abundant equity allocated to such deals.

Private buyers, nonprofits, private REITs, opportunistic/distressed buyers and lowincome housing tax credit developers comprise the buyer pool for working class apartments. Here, estimated buyer-projected year-one yields are in the 7.5%-to-9% range. "Investors seeking this asset class are entrepreneurial, nonprofit, mission-driven or employ a fee-based strategy," Firoozabadi says. "Agency lenders, nonprofit and bond-financed, as well as balance sheet regional/community lenders, are the predominant financiers of this asset class."

When stacked up against the investors vying for almost any quality of apartment building, demand for office in the area may seem paltry. Yet there's no mistaking the pull Washington, DC has, and will likely always have, for core office investors, says Scott Homa, research director for JLL. "There remains a strong appetite for highquality, long-term leased office buildings," he relates. "Stabilized assets continue to command exceptionally low cap rates given the broader interest rate environment and relative lack of investment alternatives."

But there've been shifts in investment patterns, he notes. Office investors are far less tolerant of risk in buildings with significant lease rollover. This is a post-post-crash development that began after the initial enthusiasm for product in 2010, he says.

"When our office market was experiencing rapid growth in 2010, investors were willing to underwrite rent growth and assume aggressive expectations in terms of backfilling vacant space," Homa explains. "Since office has lost velocity (most notably after the midterm elections and political push for austerity) rents have stagnated and investors are viewing buildings with vacancy exposure more cautiously," he says.

In short, as Rockrose and many other office investors illustrate, expectations for future rent growth have been tempered.

The reason multifamily is an attractive alternative, Homa concludes, is because demand is nearly universal, while calls for office space in the District and nearby areas are very much on a case-by-case basis, such as in non-traditional uses like technology and higher education.

Yet unlike multifamily, the office pipeline is starkly clear; very little product is coming. That will eventually balance out market conditions and create more leverage for landlords, Homa says, but in the interim, tenants will have the upper hand in negotiations.

Of course, the unexpected could always speed up this process, he adds, including unforeseen growth drivers. Unfortunately for office owners, few investors are willing to take a chance on that "maybe" when multifamily represents a sure bet.