Route 28 South Submarket Q4 2018

The Route 28 South office market is much quieter than it once was. Deliveries peaked in 2007, when 14 buildings and 1.8 million SF delivered, but construction since 2011 pales in comparison—only about 720,000 SF completed from 2011–17. One project delivered this year just north of Chantilly and added 480,000 SF to the submarket. Vacancies lingered above the metro average for much of this cycle but experienced a notable decline starting in 2015. They jumped again this year, though: UNICOM Government vacated more than 400,000 SF earlier this year. Even though demand hasn’t been noteworthy, the relatively low rents for high-quality assets could attract tenants. Investment here has dropped for several years but, as of mid-October, has still surpassed the historical average.

Please click on the links below for detailed information on leasing, rental rates, sales, etc.

Route 7 Corridor Submarket Q4 2018

Construction has picked up in the Route 7 Corridor Submarket after a lull from 2010–2012. More than 450,000 SF delivered from 2013–2017, hitting a peak last year, when more than 160,000 SF completed. While no projects are expected to deliver this year, there is about 82,000 SF under construction and anticipated to deliver in 2019. Deliveries of this magnitude are still well below those in construction-heavy submarkets, but the new product is not inconsequential in a submarket that doesn’t typically host much construction.

Demand has consistently outpaced supply here; at about 7%, vacancies are half their 2011 rate and well below the metro average. Some of this growth might stem from the submarket’s proximity to Leesburg, which experienced one of the highest population growth rates in the D.C. metro. Rents, however, have not benefited much from tightening vacancies: They increased modestly in 2015 and recorded the strongest gains of the cycle in 2016 but have sputtered since. At just over $27/SF, rents are just nearing the prerecession peak and rank in the bottom half of D.C. submarkets. On the bright side, low rents make this an affordable submarket for office space. Despite somewhat mixed fundamentals, sales volume in 2016—at about $99 million—set a record, although one sale comprised almost half of the volume. The momentum did not carry over into 2017, when only about $28 million in sales occurred. Slow sales have continued this year as well—as of mid-October, less than $18 million had recorded.

Please click on the links below for detailed information on leasing, rental rates, sales, etc.

Commercial Real Estate 101 Understanding Lease Terms, Chapter 2 – Term

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A lease abstract is a document that summarizes specific, key information from a lease agreement. Leases can be lengthy documents with confusing legalese. Lease abstracts allow users to easily reference and review fundamental lease terms to ensure that both the tenant and landlord are in compliance with applicable obligations, timeframes, etc. This series will go through a typical lease abstract and explain the various terms with emphasis on what is important for a tenant to understand.

In this section, I will go through typical language pertaining to the lease term:

Lease Commencement Date

  • The date on which the lease term begins.
  • What’s important – may be the same or different from the rent commencement date and/or occupancy date. It is the date on which tenant is responsible for complying with all terms of the lease. If the occupancy date is a day other than the first of the month, the lease commencement date will generally be considered to the first day of the following full calendar month.

Rent Commencement Date

  • The date on which tenant’s rental obligation begins
  • What’s important – may be the same or different from the lease commencement date depending on the amount of rental abatement, if any. In triple net leases, tenant is generally responsible for paying triple net charges during the rental abatement period.

Lease Expiration Date

  • The date on which the lease expires and tenant is required to vacate the leased premises
  • What’s important – ensuring tenant complies with specific provisions of the lease detailing the condition in which the tenant must return the property to landlord, requirements to remove any tenant alterations and/or cabling/wiring, etc.

Term

  • The length of time in years and months that tenant shall lease/occupy the subject property.
  • What’s important – the length of the lease term affects many other terms of the lease including but not limited to amount of rental abatement, amount of improvement allowances/scope of turnkey build out, assignment/subletting, etc. Rent will escalate over the term of the lease based on the negotiated escalation rate/method.

Holdover

  • Situation in which tenant continues to occupy the leased premises after the lease expiration date. Lease provisions dictate notice requirements and penalties associated with holdover.
  • What’s important – Tenant may be penalized with increased rental obligations, i.e. 150%-200% of the then escalated rental rate and/or any damages incurred by landlord caused by tenant’s holding over.

User Needs Analysis

After the need for space has been established, a user needs analysis must be conducted. This process captures vital information such as the user’s physical, geographic, budget, timing, and various subjective requirements. The analysis should differentiate between must-have requirements and wish list items. When combined with the financial analysis these criteria ultimately shape the space acquisition decision.

The information that should be incorporated in a needs analysis includes (but is not limited to) the following:

  1. Overview of the business
    • History, business plans, objectives of the tenant’s/purchaser’s company, etc.
  2. Space requirements
    • Space/square footage is needed?
    • Proposed use?
    • Contiguous or noncontiguous space? Can employees/departments be on different floors or even different locations?
    • How many offices, what sizes, windowed, etc.?
    • For industrial users – power, clear height, bay depth, proximity to freeways, railways, etc. requirements?
    • Corporate-required standards?
    • Open area? How many/what size cubes?
    • Length of lease term?
    • Space/employee layout?
    • Growth/contraction projections?
  3. Above-standard requirements
    • Above building standard improvements, i.e. private bathroom?
    • Above building standard finishes, i.e. paint, flooring, etc.?
    • Above building standard security, janitorial services, etc.?
  4. Location
    • Market, submarket, trade area, part of town, etc.?
    • Location of business owner, employees, customers?
    • Building class, type, etc.?
    • Building amenities?
    • Any state or local incentives?
    • For retail users, demographics, traffic counts, zoning?
  5. Timing
    • How quickly does the user need to occupy the space?
    • Existing lease expiration date?
    • Condition of space – as-is or build out required?
  6. Flexibility
    • Termination right?
    • Expansion right?
  7. Parking
    • Required parking ratio?
    • Paid vs. Free parking?
    • Visitor parking?
    • Reserved space?
    • Covered vs. uncovered parking?
    • Specific parking requirements, i.e. trucks, vans, etc.
  8. Budget/cost imperatives
    • Acquisition budget? Annual/monthly rent budget?
    • Financing vs. cash purchase?
    • Factors influencing budget
  9. Deal breakers
    • Personal guaranty required?
    • Major competitor located in same building/area?

Space Acquisition Process (Purchase)

The space acquisition process is affected by numerous factors, particularly the property type and parties involved; making every deal unique. The process to purchase commercial space begins in the same way as the leasing process but diverges after the user needs analysis.

Perhaps the greatest differentiating factor governing the process is the relationship between the two parties. In the leasing process the tenant and landlord enter into a relationship for the duration of the lease term. As a result, landlords incur a certain level of risk and must evaluate which individuals or companies they are willing to accept as tenants. In a sale, the owner is primarily concerned with the buyer’s ability to perform.

Despite the transactional nature of the relationship between the two parties, buyers and sellers do not always behave rationally (from an objective standpoint) and can have markedly different opinions of value. Also because of the permanence of the transaction there are a number of issues that can arise during the due diligence process that can jeopardize a deal. Discoveries of needed repairs, environmental issues, etc. can drastically affect the economic terms or kill the deal entirely.

Still there is a general process that can be compartmentalized into phases. The steps of the space acquisition process for purchasing commercial space are:

  1. Research the buyer
  2. User needs analysis
  3. Market research, including physical tours of buildings.
  4. Letters of intent/Offer letters
  5. Contingent Purchase Agreement
  6. Analyze Proposals
  7. Due Diligence
  8. Closing and Transfer of Title

Space Acquisition Process (Leasing)

The space acquisition process is affected by numerous factors, particularly the property type and parties involved; making every deal unique. Even in situations where two similar tenants, i.e. law firms, are looking to lease similar space (office) in the same market there exist factors that create distinctions between them. One firm may be more financially strong, the other may have more aggressive growth projections, etc. While each lease negotiation has its own characteristics there is a general process that can be compartmentalized into phases. These phases typically occur sequentially but can overlap. The steps of the space acquisition process for leasing are:

  1. Research the company/tenant
  2. User needs analysis
  3. Market research, including physical tours of buildings
  4. Tenant RFPs (requests for proposal), including initial space plans
  5. Landlord proposals
  6. Proposal comparison and analysis
  7. Proposal and counter proposal
  8. Proposal acceptance and lease generation
  9. Lease document negotiation and execution

Manassas Submarket Q4 2018

The Manassas Submarket is expansive, stretching from Yorkshire down to Marine Corps Base Quantico, but nearly all of the inventory is in the northern portion, near Central Manassas. The submarket has one of the highest proportions of 1 & 2 Star inventory in the metro—this asset class comprises more than half of the office stock in the submarket. Vacancy has been below the metro average since 2011 but started a steep descent in 2014 due to several years of above-average demand. This demand can partially be attributed to low rents—Manassas is one of the most affordable submarkets in the metro, and rents haven’t experienced meaningful growth in years. As a result, rents are still well below the pre-recession peak.

The lack of supply has also played a role in declining vacancies: One, 16,000-SF, build-to-suit office property delivered this year, the first new construction since 2013, and no projects are underway. Sales volume occasionally jumps into double-digit territory, but it’s not uncommon for it to stay below $5 million. Sales were particularly slow in 2016, when just $3.4 million was recorded. At almost $7 million, volume in 2017 was better but still failed to break the $10 million mark. As of mid-October, volume for 2018 was at roughly $6 million.

Please click on the links below for detailed information on leasing, rental rates, sales, etc.

You are Terminated: Lease Termination Options

In commercial leases, termination rights dictate the terms under which one party may terminate the agreement prior to the lease expiration date.  They can be independent provisions or one party’s recourse pursuant to a particular event or default by the other party.

When they stand alone, termination rights are negotiated to protect the subject party and/or allow them to pursue a projected course of action.

For example, landlords with plans to redevelop their building in the near future may require that leases contain a termination right after a certain number of years. While they may agree to a 5-year lease with a tenant it could be conditional on the right to terminate after 3 years if market conditions make redevelopment desirable. Landlords must provide tenants with written notice of their election to exercise their right in order to give the tenant the necessary time to find another location.

On the tenant side, companies with plans to sell in the near future may not want a long-term lease on their books as a liability that could decrease their valuation. Still they may be required to sign up for a lease term with sufficient time over which to amortize the costs of any improvements to customize the space to their needs.   In this case, the termination right would include language requiring the tenant to reimburse the landlord for the unamortized costs of brokerage commissions and tenant improvement allowance. Tenant termination rights also come with prescribed timeframes to provide the landlord with written notice of their election to exercise said right.

In addition to notice and unamortized costs, tenant termination rights can also come with additional monetary penalties. These amounts are specific to each landlord and reflect each owner’s calculation of damages and/or lease-up costs. Landlords want rent and do not like their spaces to sit vacant. Therefore, they are reticent to grant termination rights and have an interest in making them as onerous as possible to decrease the likelihood that tenant elects to exercise them.

Quantifying damages outside of unamortized brokerage fees and build out costs can be difficult. A good rule of thumb is to estimate the length of time necessary to lease the space to another tenant based on market absorption rates. Tenants may be able to minimize additional monetary penalties by providing the landlord with a longer notice period thereby giving them the ability to market the space while the tenant continues to occupy the premises and pay rent.

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Route 29/I-66 Corridor Submarket Q4 2018

Despite its location as an outlying submarket in Prince William County without direct access to a Metro  station, the Route 29/I-66 Corridor has more stable fundamentals than many submarkets. Vacancies have declined since 2012, aided in part by a dearth of construction, although several potential move-outs by the likes of Aerojet Rocketdyne, Prince William County, and the McLean Bible Church could cause the most significant vacancy expansion in half a decade. Less than 60,000 SF of space is under construction, and building isn’t expected to pick up anytime soon, since low rents make it difficult for projects to pencil out.

The bulk of recent demand has come from medical office users such as the Center for Vein Restoration, Nelson Dermatology, and the Vision Therapy Center of Virginia. The FBI also maintains one of its primary field offices in the Route 29/I-66 Corridor, across Prince William Parkway from Northern Virginia Community College’s Innovation Park. Despite declining vacancies, rent growth has failed to gain traction this cycle, leaving rent levels well below the pre-recession peak. Sales have been strong, though, with volume setting a record in 2016 at nearly $50 million. Sales were about $26 million in 2017, well above the historical average, but have slowed significantly this year. Most of the trades so far in 2018 have involved smaller buildings trading for a few hundred thousand dollars or less. As of mid-October, volume was just over $7 million.

Please click on the links below for detailed information on leasing, rental rates, sales, etc.

Commercial Real Estate 101 Understanding Lease Terms, Chapter 1 – Basic Information

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A lease abstract is a document that summarizes specific, key information from a lease agreement. Leases can be lengthy documents with confusing legalese. Lease abstracts allow users to easily reference and review fundamental lease terms to ensure that both the tenant and landlord are in compliance with applicable obligations, timeframes, etc. This series will go through a typical lease abstract and explain the various terms with emphasis on what is important for a tenant to understand.

In this section, I will go through the basic information in a commercial lease.

Landlord

  • Name of legal entity that owns the subject property to whom rental payments shall be made
  • What’s important – understanding the ownership entity, i.e. individual, partnership, corporation, etc. and structure, i.e. fee simple, condo, coop, etc. This will impact landlord’s ability to make decisions, concessions, etc.

Tenant

  • Name of the legal entity that is leasing the subject property
  • What’s important – understanding the ownership structure, i.e. individual, partnership, or corporation. This will impact the number of individuals required to sign and/or secure/guaranty the lease. Will also impact other lease provisions such as assignment/subletting, bankruptcy, etc.

Property Address

  • Legal address of the subject property
  • What’s important – property address matches that of subject property

Floor #

  • Floor level of the leased premises.
  • What’s important – floor number matches that of leased premises

Suite/Unit #

  • Suite or unit number of the leased premises
  • What’s important – suite/unit number matches that of leased premises and is recorded by the County in which the property is located for occupancy permit purposes as well as mailing address

Rentable Square Feet

  • The square footage on which the rent is based. May be different from usable square footage depending on type of property and property’s core factor.
  • What’s important – confirmation that the rentable square footage has been measured according to acceptable standards, i.e. BOMA.

Usable Square Feet

  • Not generally included in leases but is the actual square footage of the leased premises not taking into account core factor.
  • What’s important – understanding the difference between the usable square footage and the rentable.

Core Factor

  • Percentage of subject property that is devoted to the building’s common areas (lobbies, rest rooms, corridors, etc.)
  • What’s important – the higher a building’s core factor the less usable area per rentable square feet. The more amenities a property has, i.e. fitness facility, conference facility, etc. and the more square footage they consume will increase the core factor and reduce the leased premises usable square feet.

Pro Rata/Proportionate Share

  • The portion of the subject property occupied by the tenant. Expressed as a percentage and calculated by dividing the leased premises rental square footage by the rentable square footage of the subject property. Tenant is responsible for paying it’s pro rate/proportionate share of operating expenses and real estate taxes over a base year.
  • What’s important – increases in operating expenses and real estate taxes are charged to the tenant as additional rent. A review of the past few years’ operating expenses and real estate taxes is advised.

Business/Building Hours

  • The timeframe in which the subject property is open to the public and heating and air conditioning are maintained at comfortable levels. Office building hours are generally 8:00am-6:00pm, Monday through Friday, and 9:00am-1:00pm on Saturdays. Retail landlords may require tenants to be open for business during certain hours and days of the week.
  • What’s important – if tenant’s business operates after regular business hours then additional heating and air conditioning costs must be considered. Landlords will typically make after hours HVAC available to tenant with notice and at a predetermined cost, which may be subject to change. For retail tenants, negotiating business hours that are in concert with the tenant’s use, business plan, etc. and/or understanding its obligations and ensuring they are in compliance.