WASHINGTON, DC-The area is in for increasing office vacancy rates within the next eighteen months or so, thanks to a large number of spec offices under development and no sign of users interested in taking up large blocks of space as law firms and the US government once did, according to an analysis by JLL. Unfortunately, DC's spec activity is particularly ill-timed given where the city is in its lease expiration cycle over the next 24 to 36 months. The bottom line is that “by 2018, there could realistically be a 3% to 5% increase in vacancy rates,” JLL Market Research Director Scott Homa told GlobeSt.com.

Before we dive into the numbers, it is important to note that there is a sharp contrast between what is happening in the District and what is happening metrowide. Northern Virginia's pipeline has increased as well, but as Homa noted, “the vast majority of that construction is build to suit.”

DC's pipeline, by contrast, is dominated by spec construction, barring a few prominent build to suit projects such as Fannie Mae's headquarters.

And to add insult to injury, most of the spec construction is largely trophy or class A space but the shortages in Class B and Class C space are driving up rents, Homa said. “ I think we can expect to see a loosening of top rates and tightening up of bottom rates and then, ultimately, a convergence.”

Here are the numbers that led Homa to his conclusions:

Developers broke ground on eight new projects downtown during Q2 2016, six of which were on a speculative basis, bringing the total under construction inventory to 4.7 million square feet.

The majority, or 80.2%, of the District's supply pipeline is concentrated the core CBD and East End markets.

Groundbreakings in the suburbs have been more restrained, and are generally well pre-leased, with 87.3% of active construction projects in Northern Virginia represent build-to-suits, relative to just 31.7% in Washington DC. Development activity in Suburban Maryland remains at a virtual standstill, with just 258,888 square feet under construction and no pre-leasing.

Don't Blame the Developers

It would be easy to assign blame to the developers for this brewing mess but they have been caught up in these larger trends as well, Homa said.

For starters, there was relatively restrained activity for a couple of years after the recession, he said. “Call the current activity a reversion to the mean, or compensation for the relative slowdown of recent years.”

Also, as Newmark Grubb Knight Frank argued last year, a good portion of DC's office market is quickly becoming obsolete and must be replaced with product that meets today's office users' needs.

It has been assumed that the strong local economy would provide the demand but that has not been the case. New trends in office usage have limited to a surprising degree absorption, Homa said.

Chasing Yield

Perhaps the biggest driver behind the development in the District is a situation the never-ending chase for yield, coupled with investor cash that has been sitting on the sidelines for ten or more years.

“Development projects have biggest returns, but also they also involve the most risk,” Homa said.

“Current pricing for trophy assets means an investor can get a 5 cap rate. So, the pro forma numbers look appealing but clearly they are predicated on attracting actual tenants.”

Instant Insights /

DC's Office Supply-Demand Equilibrium Is Seriously Out of Whack

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