WASHINGTON, DC—Whether DC landlords will admit it or not, a certain percentage of the city's buildings have become, or are becoming obsolete. In this day and age, of course, obsolete doesn't mean the building lacks air conditioning or properly functioning elevators.

Rather, "obsolete" these days means that the property does not have smaller floor plates or an extensive glass line. Certainly lack of robust amenities and an urban location would label it obsolete. Ditto locations that are not convenient to mass transit.

The city and nearby suburbs' share of such buildings is noteworthy, according to Newmark Grubb Knight Frank's Senior Managing Director of Research Greg Leisch and Sandy Paul, NGKF's managing director of National Market Research.

"The rapid obsolescence of B and C properties, some of which cannot be cured, is surprising," Leisch says.

"In my 45-year career I have never seen such rapid obsolescence."

Leisch and Paul won't say exactly how many of the city's buildings fall into this category, because they are still in the process of quantifying them. That will be revealed, they tell GlobeSt.com, in an upcoming white paper.

However, a sense of these still-to-be determined numbers can be gleaned from another white paper authored by Leisch and Paul, which has just been released.

The paper looks at a long-standing trend in the DC area that has accelerated in the years since the recession: the bifurcation of office product.

"There has always been a difference between best-in-class office product and the rest of the market," Leisch tells GlobeSt.com. "Now, though, the differences have become more profound."

One telling statistic, Paul says, is that the share of office leasing by Class A offices has really taken off since the recession.

According to the report, "Since the start of 2008, Class A office properties in the Washington metro area have totaled 18.6 million square feet of net absorption, while Class B and C properties have experienced negative 13.8 million square feet of absorption, with each year reflecting positive net new demand for Class A space and a loss of occupancy in the balance of the market."

To be sure there are other factors driving this bifurcation besides changing tenant preferences. Changing government requirements have had an impact on submarkets, such as the Department of Defense's Base Realignment and Closure program in Arlington and Alexandria between 2011 and 2014. That led to more than 5 million square feet being returned. In Maryland, the Food and Drug Administration consolidated in the I-270 Corridor, returning large blocks of Class B space to the market in North Bethesda and Rockville, the report noted.

That said, tenants' requirements for the best of the best in office space -- or at least as close as they can afford -- is a more fundamental and long-lasting trend for the region.

Tenants are willing to downsize their space to afford trophy or Class A plus space, Leisch says. The white paper notes that trophy assets have consistently seen a higher share of leases attributable to relocations than other classes of office space in Washington.

Bifurcation is also impacting investment sales prices, not surprisingly. What is surprising, though, is the degree.

From 2010 to 2014, Class A office asset pricing on a per square foot basis in the metro area has increased 65.9%.

During the same period, pricing for all classes of office assets combined increased 28.2%. In 2014 alone, pricing increased 13.3% for Class A assets and 10.8% for all classes combined.

"Changing tenant preferences has led to investors being willing to pay very high prices for trophy assets," says Paul.

The PNC Place and Americas' Square trades are two recent deals in which this trend was on full display, he says. It was no coincidence that these thoroughly modern, best-in-class trophy buildings sold over $1,000 per square foot, he says.

Expect more of the same going forward, Paul adds.

"There are a limited number of assets that met the quality that investors are looking for today," he says. "So pricing will continue to rise even while leasing is soft."

Instant Insights /

The Surprisingly Rapid Creep of DC's Obsolete Office Buildings

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