Central Business District (CBD) Submarket Overview
Employment in the CBD is diverse, spanning many sectors from law, to tech, to government. The legal services sector comprises a substantial portion of the submarket’s office demand, and those tenants are occupying less square footage per employee than in previous cycles but remain important anchor tenants that drive new construction. Professional and business services, healthcare, information, and government tenants have a presence as well. And like law firms, those organizations are generally opting to occupy higher-quality space, which is often used as a recruiting tool. Many of D.C.’s marquee employers, including the International Monetary Fund, the World Bank, the National Education Association, the Federal Reserve System, the U.S. Chamber of Commerce, and the U.S. Department of the Treasury, have set up shop here and are unlikely to leave in the near-term, creating a stable base of demand.
Renovations, along with new construction, have been a major factor in the increase of 4 & 5 Star supply in the submarket. Premium real estate in a central location comes at a price, though, and the CBD boasts some of the highest rents in the metro. The combination of high rents and increased competition from submarkets like Capitol Riverfront and NoMa has caused a slowdown in rent growth over the past few years. Still, this submarket is an investor favorite—volume in 2017 reached a cyclical high just below 2007 levels, the previous cycle’s peak. Sales have slowed this year, though, with volume just below $570 million as of early October.
East End Submarket Overview
Vacancies in the East End were roughly in line with the metro average as of late October, though several projects that are anticipated to deliver late this year and early next year could cause rates to spike. Tenant downsizings weighed on demand growth for several years, with net absorption negative in 2015 and negligible from 2016–17, although rates have rebounded this year. Construction activity is ramping up, regardless, with nearly 1.3 million SF delivered as of early 18Q4 and another 1.2 million SF under construction.
D.C. tenants willing to pay higher rents, such as corporate law firms, prefer newer, more efficient space in the East End. Healthy preleasing of new deliveries highlights the flight to quality. Of the 10 properties delivered from 2014–17, eight are at least 90% occupied. The flight-to-quality trend explains why some of East End’s older, 3 Star inventory—which exceeds 8.5 million SF—is being renovated into 5 Star office space. Although buildings offering the newest, most amenitized space are landing big tenants, recent deals include generous tenant improvement packages and prolonged periods of free rent, suggesting that tenants have meaningful leverage. Sales have been relatively stable recently, hovering at just over $1 billion per year.
West End Submarket Overview
Like in the other core submarkets in the D.C. metro, a solid base of anchor tenants and a supply-constrained nature have helped keep vacancies here below the metro average, despite slow leasing velocity. However, several impending move-outs could cause vacancy to jump in the near future. This is a big-footprint submarket, and about 40% of tenants occupy 10,000 SF or more, but many users own the space they occupy. Although firms like Hunton & Williams (191,000 SF) and Vinson & Elkins (81,200 SF) are important tenants, this submarket is less dependent on law firms than the East End or the CBD. Given the relative dearth of such firms and their importance as anchors in new construction, it is no surprise that development has been depressed, despite tight vacancy. At over $51/SF, average asking rents in the West End are comparable to the CBD’s but slightly less than the East End’s. The West End has fewer prestigious tenants than the East End or the CBD, and it also has a smaller inventory and grapples with a higher proportion of owner-occupied inventory. This generally makes sales rarer and depresses volume to far lower levels than its primary competitors.