Washington, DC West End Submarket Q1 2019

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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 below the metro average, despite slow leasing velocity. However, several impending move-outs could cause the vacancy rate 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 $50/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 more rare and depresses volume to far lower levels than its primary competitors. But 2018 proved there is still interest in a submarket like West End.

Leasing – The flight-to-quality trend is alive and strong in D.C. but that may work against the fortunes of the West End since its aging office inventory is more skewed toward 3 Star space than that of its primary competitors. But declining vacancy, which has otherwise failed to spark significant rent gains, is so tight in 3 Star properties that the submarket is potentially on the cusp of a recovery. The West End is coveted by tenants because it’s the gateway to some of the District’s premier office corridors, like K Street and Pennsylvania Avenue, which bodes well for long-term stability.

As a result, the West End boasts a diverse tenant base, including prominent companies such as law firm Squire Patton Boggs and GSA tenants like the Department of State. Additionally, former President Barack Obama’s lease in the World Wildlife Fund building at 1250 24th St. NW helped bolster the submarket’s profile.

Absorption in 2017 was the strongest since 2011. That year, the 459,000-SF Square 54 completed, and several high-profile tenants including Hunton & Williams, Vinson & Elkins, Danaher Corporation, and Boston Properties moved in. Absorption in 2017 was primarily driven by a single lease, the 92,000-SF move-in by the Aspen Institute into 2300 N St. NW. Demand slowed again last year, though, with net absorption totaling about 30,000 SF.

Vacancies jumped dramatically in 2014 due to two moveouts that highlight the potential impact of the flight-to-quality trend in the West End Submarket. Both involved tenants that opted for newly constructed space. The first was the Association of American Medical Colleges, which vacated nearly 200,000 SF at 2501 M St. NW and 2450 N St. NW when it consolidated its headquarters at a new building in the East End. In the second move-out, law firm Pillsbury Winthrop Shaw Pittman vacated nearly 250,000 SF at 2300 N St. NW for space in Akridge’s 1200 17th St. NW in the CBD.

More move-outs are on the horizon, as well. Law firm Buckley Sandler, currently in the World Wildlife Fund Building, recently announced it will be moving its office to Brookfield’s 2001 M St. NW in the CBD when its lease expires this year. Buckley Sandler occupies more than 31,000 SF in the West End but will expand to 65,000 SF when it moves to the CBD.

The largest move-out looming is that of research and technology consulting firm Advisory Board, which is slated to move to Washington’s East End Submarket in 2019. Advisory Board is currently the West End’s third largest tenant, occupying about 318,000 SF at 2445 M St. NW, which will become vacant in Q2 2019 and has not yet been backfilled.

Rent – At over $50/SF, average office rents in the West End Submarket are among the highest in the metro. They remain comparable to those in the CBD, a primary competitor, but are lower than those in the East End. Of the core D.C. submarkets (East End, West End, and the CBD), the West End has the tightest headline vacancy rate, suggesting that the submarket might be primed for rent growth. It also has the highest availability rate, due to large blocks of available, but currently occupied space, like the 189,000 SF in the American Pharmacists Association headquarters, which makes the environment more competitive than the headline vacancy rate suggests. Still, conditions are so tight in the 3 Star slice that it’s hard to imagine rents going anywhere but up, especially since the free rent that was common in the early and middle stages of the cycle is starting to burn off. In fact, average annual rent growth in this segment from 2014–18 was roughly 2%, but growth slowed in each of the past three years.

Types of Commercial Leases/Rent Structures: Modified Net/Gross

Unlike residential real estate where contracts and forms come in templates that are, for the most part, fill-in-the-blank with little room for modification, it seems that no 2 commercial real estate leases (or contracts) are the same. They typically contain many of the same provisions but vary from landlord to landlord (or better said, attorney to attorney). That being said, there are 2 basic types of commercial leases that are organized around the rental structure or calculation method: “net” and “gross.” In this series I will go through the “Who,” “Why,” and “What” of these 2 rental structures/commercial leases; explaining who typically uses which, why they use that particular rent calculation method, and what you can expect from each. I will also touch on the “third” type of commercial lease/rental structure, which is a combination of the two.

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Modified Net/Gross

Now we come to the commercial leases/rental structures that simply refuse to conform to convention. They just have to be different. While this can be frustrating when attempting to quantify the overall costs of leasing space, there are benefits to this a la carte approach.

Who?

You typically see modified rental structures with condominium projects and/or smaller/individual landlords.

Why?

Just to be pains in the butt? No. Rather it’s because condo units (office, industrial, flex, or, in rare cases, retail) are separately metered and it can make sense to include some charges in the rental rate and exclude others. For example, with an office condo the owner may offer a rental rate which is net of utilities and cleaning. Utilities are already billed to the individual unit; making it easier for the tenant to directly pay these costs based on their use. An additional benefit is the resulting lack of “regular business hours” for utilities; allowing tenants to only pay for the hours and amounts they consume. The same idea applies to cleaning.

Another reason is that modified rental structures may allow the landlord to advertise a lower face rate than their full-service counterparts. By having the tenant pay these costs directly they do not have to overstate the amounts as a hedge against excessive usage. In an office market where full-service rates are around $30 per square foot, a landlord may advertise a rate of $27 per square foot net of utilities and cleaning (estimating that such costs are about $3 per square foot), which to the laymen looks like a better deal when in reality it may end up being more expensive for the tenant.

In addition, because condos are owned by individuals or smaller companies these landlords will opt for a rental structure that best suits their needs and preferences rather than what market typically dictates. An owner of an office condo may charge a modified net rent because they don’t want the accounting hassle of reconciling the varying amounts under a full-service lease. They would rather simply invoice the tenant directly for the individual costs (bills they receive).

Finally, cheapskate landlords may quote a modified rental rate to save on brokerage commissions. Because agreements typically stipulate that the commissions are paid on the lease value which is based on the total rent paid over the term; by separating rent from other charges the landlord understates the lease value on which the commission is based.

What?

It’s hard to make a general statement on what tenants can expect from a modified rental structure. Of key importance is understanding what each structure means from a cost perspective and what the tenant is responsible for as a result. A tenant whose business operates outside of regular business hours or who requires special services based on the nature of their business may realize cost savings by excluding the specific costs from operating expenses/CAM and paying only based on their usage and/or specific needs. Industrial, flex, and retail users may have one of the traditional “nets” included in their rent such as CAM, but may still be required to maintain, repair, and even replace the systems servicing their unit.

Types of Commercial Leases/Rent Structures: Net

Unlike residential real estate where contracts and forms come in templates that are, for the most part, fill-in-the-blank with little room for modification, it seems that no 2 commercial real estate leases (or contracts) are the same. They typically contain many of the same provisions but vary from landlord to landlord (or better said, attorney to attorney). That being said, there are 2 basic types of commercial leases that are organized around the rental structure or calculation method: “net” and “gross.” In this series I will go through the “Who,” “Why,” and “What” of these 2 rental structures/commercial leases; explaining who typically uses which, why they use that particular rent calculation method, and what you can expect from each. I will also touch on the “third” type of commercial lease/rental structure, which is a combination of the two.

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Net Leases

For the purposes of this article, the “net” lease/rental structure discussed will be the most common: the triple net lease. In triple net leases, tenants are charged a rental rate and then are charged for each “net:” common area maintenance (CAM)/operating expenses, real estate taxes, and insurance. Tenants are also responsible for paying utilities and janitorial services for their space separately. While there are subtle yet significant differences between net and gross leases, at the end of the day the tenant is paying for the same costs: rent plus costs of ownership. For example, a triple net rental rate of $10 per square foot with costs of $5 per square foot and utilities of $2 per square foot would simply be quoted as $17 per square foot, full-service. Triple net leases are more landlord-friendly than full-service leases. Tenants are responsible for their own space and the landlord essentially just collects their rent check.

Who?

Triple net leases are typical of industrial, flex, and retail space.

Why?

Industrial tenants’ businesses and uses of the space can vary significantly. Granite fabricators require significantly more water than say a logistics company who is essentially using the space for storage. As a result, it makes sense to charge each tenant individually. Flex space is a combination of office and warehouse with proportions of each varying from tenant to tenant. Again, due to this variability, it makes more sense for landlords to submeter usage. Retail space follows the same logic.

What?

Expenses/nets are charged to tenants in the same way as in full-service leases: by proportionate share of the tenant’s space to the overall building/project. Because most property types associated with triple net leases do not typically have internal common areas each tenant is responsible for the systems serving their space, i.e. HVAC units. Tenants oftentimes are responsible not only for maintenance and repair of such systems but in some cases replacement as well. Tenants are responsible for cleaning and maintaining their own space.  Triple net charges can vary from year to year, which can make forecasting expenses difficult. Therefore, when negotiating lease terms tenants should try and cap controllable expenses. One benefit to triple net rental structures is that tenants may benefit from any decreases in costs, unlike their full-service counterparts.

Types of Commercial Leases/Rent Structures: Gross

Unlike residential real estate where contracts and forms come in templates that are, for the most part, fill-in-the-blank with little room for modification, it seems that no 2 commercial real estate leases (or contracts) are the same. They typically contain many of the same provisions but vary from landlord to landlord (or better put, attorney to attorney). That being said, there are 2 basic types of commercial leases that are organized around the rental structure or calculation method: “net” and “gross.” In this series I will go through the “Who,” “Why,” and “What” of these 2 rental structures/commercial leases; explaining who typically uses which, why they use that particular rent calculation method, and what you can expect from each. I will also touch on the “third” type of commercial lease/rental structure, which is a combination of the two.

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Gross Lease (Full-Service)

Other names for gross leases are “full-service” or “full-service gross.” As these names imply the rental structure of this type of lease includes all leasing costs in the rental rate. Leasing costs include common area maintenance (CAM), operating expenses (sometimes synonymous with CAM), real estate taxes, insurance, janitorial services, utilities, etc. The landlord estimates these costs and adds them to the amount they want to net from leasing the space. For example, if the landlord estimates these costs to be $10 per square foot and wants to net $20 per square foot from leasing the space they will quote a rental rate of $30 per square foot, full-service.

Landlords must always consider market conditions when setting their asking rate. This is one reason that landlords have an incentive to keep costs as low as possible. If the market rental rate is $30 per square foot and landlord A has costs of $10 per square foot and landlord B has costs of $12 per square foot, landlord A has a competitive advantage. They can advertise the same asking rate as landlord B and make a $2 per square foot greater profit. Landlord A also has the option of reducing the final negotiated rate by up to $2 per square foot and still remain as profitable as landlord B which also gives them an edge in attracting and securing tenants (all other things being equal).

Landlords are able to maintain their profit margin by charging tenants for any increases in the costs of ownership as pass-throughs (discussed in greater detail in my article What Are Pass-Throughs?) as well as through annual escalations.

Who?

Full-service leases are most commonly used in office leasing.

Why?

Due to the relatively uniform nature of the tenants’ use of the space (not business type), office landlords are able to predict and apportion the costs of occupancy amongst tenants. A law firm will not require substantially more electricity, water, janitorial services, etc. than an IT company. Common areas are shared by tenants and the costs of ownership are thus easily charged to tenants based on their proportionate share of the building (tenant’s square footage divided by the total building square footage).

What?

Full-service rental structures are convenient for tenants because all of their costs are included in one, easy payment. Tenants can expect to be charged for increases in those expenses over their base year and are responsible for costs specific to their business such as taxes and insurance (general liability, personal property, etc.). Furthermore, if a tenant consumes utilities in excess of what is considered to be building standard, i.e. electricity, such utility service will be separately metered. Also if a tenant requires services above and beyond that offered to other building tenants they will be required to contract and pay for that service directly. An example of this is if a government contracting company has a SCIF within their space and/or has higher security requirements they may be required to contract with a cleared janitorial company.

Annandale Multi-Family Submarket Q1 2019

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Overview – The Annandale Submarket is the gateway between Fairfax and Arlington County and is characterized by strip malls, shopping centers, and freestanding retail and office structures. The area is not pedestrian-friendly, and residents generally need a car to get around. The submarket has had very little new apartment construction since the 1980s—the last major property was added in 2009—resulting in vacancies well below the metro average, but it has also struggled with negative absorption and softening rent growth. This submarket is characterized by the large garden-style apartment communities that drive Annandale’s fundamentals. Its inventory is mostly 3 Star garden-style apartments, with a higher share of two and three-bedroom units than is usual for the metro. The inventory makeup is not expected to change anytime soon given the quiet construction pipeline.

Vacancy – A lack of supply has kept vacancy rates below the historical average, but demand in Annandale could continue to suffer as renters leave the submarket for the higher-quality inventory and metro access in Falls Church/Vienna, Arlington, and Alexandria. Absorption has been negative in three of the past five years.

The local job market is powered by retail employment, government, technology, and Northern Virginia Community College. The submarket’s white-collar jobs drive demand for 3 Star and 4 & 5 Star assets with convenient accessibility and a variety of amenities. Only one high-end asset exists in the submarket—Greystar’s Bailey’s Crossing apartments, which delivered in 2009. Metrorail does not serve the Annandale Submarket, but four stations are in the adjacent Falls Church/Vienna Submarket north of Annandale.

Rent – Average asking rents in Annandale are almost $1,700/month, roughly 5% lower than the metro average. Rents improved the past two years, growing about 4% cumulatively, but this pales in comparison to the nearly 4% annual gains from 2010-15.

However, rent growth bears watching, particularly given the frequent negative absorption. Annandale’s affordability and proximity to the region’s important employment nodes allowed it to perform well early in the cycle, but those advantages are not enough to boost the forecast for growth since affordability will likely be an issue for submarkets like this one. Because Annandale is a renter-by-necessity submarket, landlords can only push rent so far before it consumes too much of renters’ incomes and they move. Competing car-centric areas like the Columbia Pike Corridor in Arlington may be soaking up some of the demand Annandale has left on the table.

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Springfield/Burke Submarket Q1 2019

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Overview – Vacancies peaked at about 22% following a supply wave from 2011–13 and, despite a subtle recovery, are still extremely high. Rent growth has been weak as a result, and rents remain below the prerecession peak. On a bright note, the submarket experienced a big win when the GSA announced it was moving the Transportation Security Administration’s (TSA) headquarters to Springfield from Pentagon City, a move that will bring 3,400 employees to the submarket and help stabilize fundamentals. Sales have been relatively tame this cycle, with the exception of last year, when more than $63 million in volume recorded.

Leasing – The majority of office space in Springfield/Burke is clustered on the eastern end of the submarket, which provides the best access to highways and public transportation. While the Metro’s Blue Line terminus is in the submarket—the Franconia-Springfield station—it’s more likely to serve commuters going into D.C. than those who work in Springfield/Burke. Regardless, both the Capital Beltway and I-395 provide easy access to the submarket’s office nodes.

A supply wave from 2011–13 led to a large jump in vacancy, but strong demand in 2015–16 helped it to recover somewhat. High-end 4 & 5 Star properties comprise nearly one-third of Springfield/Burke’s office inventory, and these are the worst-performing products here. The submarket’s overall vacancy is high, but that of 4 & 5 Star product is even worse. As of mid-October, vacancy for 4 & 5 Star assets was more than 35%.

Three major move-ins made 2015 a great year for demand—with more than 170,000 SF of net absorption, it was the strongest year this cycle. The largest was an 80,000-SF lease signed by MGP Retail Consulting, the real estate arm of German grocery chain Lidl. Accenture also signed a 53,000-SF lease, and the GSA took 33,000 SF.

The biggest news for Springfield/Burke was the GSA’s decision to move the TSA headquarters to Springfield. The agency is relocating from Pentagon City and will bring about 3,400 employees to the area. Boston Properties plans to break ground this year on a 625,000- SF property adjacent to the Franconia-Springfield Metro station, where the TSA has a 15-year lease.

Rent – Rent growth has been inconsistent since the recession, and rents have yet to match the prerecession peak. The submarket logged three years of rent gains, however modest, from 2015–17, but rents had dropped slightly this year as of October. Persistently high vacancies could continue to weigh on growth moving forward. Despite extremely high vacancies in 4 & 5 Star properties and lackluster growth, rents in these assets have returned to their prior peak.

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Annandale Submarket Q1 2019

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Overview – Several years of negative absorption led to increasing vacancies in Annandale, and levels are now just marginally below the metro average. The submarket lacks large office users, but this presents one benefit—a limited risk of further increase in vacancies. The subpar fundamentals here have kept rents from fully recovering from the recession, with growth wavering between years of gains and losses. Pricing and volume are typically depressed in this locally driven submarket, but volume in 2017 was the highest in years, at more than $13 million. Sales this year have been relatively strong as well—as of early October, volume was just over $9 million.

Leasing – Tenant move-outs have weighed on fundamentals and caused significant vacancy expansion since 2014. Submarkets farther north like Tysons Corner and Reston, which boast Metro access and newer office stock, have attracted tenants like DynCorp, Noblis, and Computer Sciences Corporation. In Annandale, the only tenants that occupy more than 25,000 SF are the Fairfax County Government and Northern Virginia Community College. Annandale has had trouble attracting new tenants to fill the void, too—only six leases for more than 5,000 SF have been signed since January 2016.

The bulk of office demand since 2016 has come from local Northern Virginia businesses and nonprofits that typically lease small blocks of space (1,000 SF–2,000 SF). But anemic leasing paired with tenant move-outs has resulted in several years of negative net absorption and has kept rents from gaining traction.

Rent – Weak fundamentals have weighed on rents in Annandale, which remain below their prerecession peak. Rents have struggled to find consistent gains, with growth wavering between positive and negative, resulting in losses in six of the 10 years from 2008–17. After posting gains of almost 2% last year, rents essentially stayed flat in the first three quarters of 2018. At just under $25/SF, rents here are among the lowest in the metro. An old inventory and lack of public transit prevent landlords from raising rates, especially when many tenants willingly give up the rock-bottom rents here in search of newer inventory and Metro accessibility. The one bright spot for Annandale is a lack of construction, which could help vacancies—and, in turn, rents—recover slightly.

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Woodbridge/I-95 Submarket Q1 2019

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Multi-Family Report

Overview – Woodbridge/I-95 Corridor is a suburban, commuters market that is popular among young families and renters alike for its affordability. It is not as accessible as other suburban submarkets like Arlington or Fairfax, but commutes to D.C. are reasonable. Oversupply was a mid-cycle concern due to an unprecedented supply wave, pushing vacancy to an all-time high in 2014. Although it quickly recovered in the years following, negligible absorption in 2017 and delivery late last year pushed vacancy back above the metro average briefly. Rents rebounded strongly in 2018, but nothing of note has traded last year. This year is already off to a hot start, with The Enclave at Potomac Club Apartments selling for more than $90 million at a 4.8% cap rate.

Vacancy – Concerns of oversupply were warranted but have been quelled thanks to strong demand and a dearth of deliveries over the past few years (the December delivery of the 402-unit Rivergate notwithstanding). New deliveries have generally leased well. For example, the four buildings that opened in 2014 (comprising 1,145 units) leased an average of about 20 units per month, faster than the metro average of about 16 units per month during that time. One of the stronger performers was the 308-unit Stonebridge Terrace Apartments, which opened in June 2014 and stabilized in 12 months, leasing roughly 23 units per month. The most recent delivery, Rivergate, completed in December 2017 and was more than 60% occupied as of Q4 2018.

Woodbridge/I-95 Corridor residents are young, and the submarket has a median age of 33. That is similar to the median age in Rosslyn and slightly younger than in Adams Morgan/Columbia Heights, submarkets with reputations for attracting young professionals. The appeal of living here is much different from the appeal of Adams Morgan or Rosslyn, which provide more transit-oriented, live/work/play environments. Much of the appeal for young residents in the Woodbridge/I-95 Corridor Submarket comes in the form of starter-home affordability. This is one of the most affordable submarkets in the metro, and the median home price is half that of Adams Morgan/Columbia Heights or Rosslyn. In fact, in recent years, there was a general out-migration of 25–34-year-olds from Northern Virginia neighborhoods into second-ring suburban submarkets like Woodbridge/I-95 Corridor or similar areas like Loudoun and Fauquier Counties.

Furthermore, Marine Corps Base (MCB) Quantico and Northern Virginia Community College’s Woodbridge Campus are here and also contribute to the below-average median age. The Woodbridge Campus has over 11,000 students, and an estimated 12,000 civilian (including families) and military personnel are based at Quantico. Quantico provides an extra boost for apartment demand here—because service members are transient, they are much more likely to rent than own. According to the leasing agent at the Stonebridge Terrace Apartments, most tenants are military or government workers.

Rent – In Q4 2018, rents posted the healthiest year-over-year gain since late 2016. Much of these gains can be credited to the above-average absorption which has brought occupancies back in line with the metro average. With recently built properties reaching stabilization, no new units under construction, and the continued investment from recent acquisitions in adding value to properties, rent gains could continue.

The Woodbridge/I-95 Corridor is one of the more affordable areas in the D.C. metro, with average submarket rents of about $1,500/month, roughly 10% lower than the metro average. One reason for Woodbridge/I-95’s popularity is low rents that allow tenants to splurge on 4 & 5 Star apartments. But this gap continues to close. Average asking rents at the three properties delivered since 2015 were about $1,800/month as of Q4 2018 but only one property has been able to push rents since delivering.

Construction – The big wave of mid-cycle deliveries are leased up, and no properties are under construction, alleviating concerns of oversupply. Recent new supply has significantly expanded 4 & 5 Star stock, which was sparse prior to 2009 when it amounted to only 700 units. Since then, 4 & 5 Star inventory has expanded by 500%. That sounds extraordinary, but considering how scarce that inventory was, there was plenty of pent-up demand to lease it up. Low vacancy in that segment is a testament to this demand, and until December 2017, 4 & 5 Star vacancies were about equal to that of 3 Star assets.

Another factor that may contribute to strong 4 & 5 Star demand is relative affordability. Asking rents in 4 & 5 Star apartments are around $1,650/month, about 30% cheaper than the market average. In fact, the average cost of a 4 & 5 Star apartment in Woodbridge/I-95 Corridor is equal to the 3 Star rate metro-wide. Renters who work in one of the metro’s primary office nodes and are willing to sacrifice time commuting could find affordable high-end apartment living here.

Sales – The $90 million sale of the Enclave at Potomac Club Apartments in January 2019 has already boosted sales volume. Sales volume was descending each of the last two years, with nothing of note trading in 2018.

Fairfield Residential sold the 4 Star, 406-unit Enclave apartments for $90.4 million, or $223,000/unit, at a 4.8% cap rate. The property was one of the first new luxury apartments to deliver in the submarket this cycle. From 2013-18, rents grew about 6% cumulatively and the property was fully leased throughout.

The previous middle years of the cycle marked above average volume and pricing, and as a result, many of the institutional grade assets here have already traded hands. Of the few that remain, a similar buyer profile to who has been active already in recent years could buy into the submarket, as demonstrated by Mesirow Financial’s recent purchase. The vast majority of the buying activity has come from large, private companies scattered across the country. Dweck Properties has invested the most money, acquiring two assets. The first, Rolling Brook Village, was purchased in 2015 for $138.5 million ($189,000/unit), and the second, The Sutton, was bought in 2016 for $104 million ($248,000/unit). Other large buyers include Bell Partners, Penzance, Friedkin Investment Co, and Federal Capital Partners.

The trend in many outer-ring, suburban submarkets has been value-add plays, but this submarket is bucking that trend somewhat. Most of the volume, and the priciest sales since 2015 have come from newly built assets. The aforementioned Sutton was built in June 2015. Bell Stonebridge was built in June 2014 and sold in 2015 for $75.8 million, and Stone Pointe was built in September 2014 and sold in late 2015 for $69.5 million.

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Route 28 North (Dulles/Sterling) Industrial Submarket Q1 2019

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Overview

Vacancy rates expanded in early 2016 due to heavy supply hitting the submarket, but strong absorption has since kicked in, and the current rate is at a cyclical low. Construction slowed slightly last year, helping keep fundamentals on solid footing, but there was 3.4 million SF under construction at the end of Q4 2018, so the supply pipeline is worth monitoring. Strong demand and tightening vacancies have led to the highest rent growth so far this cycle—average annual growth was above 3.5% from 2016–17, and growth last year again surpassed 3%. Sales have also had a banner year, hitting a record high.

The Route 28/Dulles North Submarket is the busiest submarket for construction in the metro (the next busiest submarket has about one-seventh as much inventory underway), due mainly to the corridor known as Data Center Alley, a stretch along the Dulles Greenway (Route 267) containing one of the largest and fastest growing concentrations of data centers in the nation. As companies like Amazon and Google have expanded their needs for server space, they have expanded into the dense node of data centers where roughly 70% of the world’s internet traffic flows through.

Leasing

Vacancy rates have dropped to their lowest levels of the cycle after increasing in early 2016 when new supply reversed years of compression. More than 5.5 million SF delivered from 2016–18, marking the peak of this cycle’s supply wave. And while vacancies have recovered, the robust pipeline could cause rates to increase yet again.

Route 28/Dulles North is home to Data Center Alley, which is along the Dulles Greenway (Route 267). Also known as the Dulles Technology Corridor, the submarket includes one of the largest concentrations of data centers in the nation. In fact, nearly 70% of the world’s internet traffic is routed through Data Center Alley. A recent example of demand from major tech companies comes from Google. In late 2017, the tech giant purchased two sites here for a combined 148 acres where it plans to build data centers. More recently, Microsoft purchased 332 acres in Leesburg, though the firm has yet to disclose how it will use the land.

However, the typical tenant here is relatively small, with  only a handful of users occupying blocks larger than 75,000 SF. More than 70% of tenants occupy less than 5,000 SF, with tenants like Excel Courier, Raytheon, and Broad Run Contracting occupying some of the largest spaces. Tenants of note in the 50,000–100,000 SF range include Allied Van Lines, Pryme Technologies, and DHL Global Forwarding.

Rent

Rent growth was relatively tame this cycle until 2016 when submarket rents took off. Growth has surpassed 3% each year since 2016, including in 2018. Today, average rents are above $12/SF and at an all-time high, more than 16% above the submarket’s low in 2011.

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Leesburg/West Loudoun Submarket Q1 2019

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Overview

Leesburg/West Loudon has experienced continuous positive absorption since 2011, helping compress vacancies from above 20% in 2010 to the single digits. Most demand has stemmed from small-block office space users, such as information technology and software companies and medical office users. Despite some of the lowest vacancies in the D.C. metro, the submarket faces heightened competition from properties in the neighboring towns of Ashburn and Sterling, which has weighed on rent growth. Construction was strong in 2015–16 and picked up again this year after a lull in 2017. Sales in 2016 provided a bright spot for the submarket, with volume hitting a record $54 million. Activity slowed again in 2017, but as of mid-October, volume in 2018 had surpassed 2017’s level.

Leasing

Few large tenants exist in the Leesburg/West Loudoun Submarket, since most of the office space caters to suburban residents and includes businesses like banks, doctors, lawyers, and financial advisors. In fact, only nine tenants occupy more than 20,000 SF, and only two of those occupy more than 50,000 SF. Some of this is a result of availability: Leesburg/West Loudoun has a relatively small inventory, and more than three-quarters of it consists of 1 & 2 Star assets that average less than 7,000 SF. The median new lease signed since 2017—at about 1,100 SF—is indicative of the submarket’s office needs. The completion of phase two of Metro’s Silver Line, slated for 2020, could create additional demand for the submarket. Although the Metro won’t reach Leesburg, a short drive to Ashburn will put dense population centers like Reston and Tysons Corner within reach via public transit.

Rent

At less than $27/SF, rents in Leesburg/West Loudoun are in the bottom half of submarkets in the D.C. metro. Rents here are comparable to those in the neighboring Route 28 Corridor North and South submarkets, but those in Herndon are significantly higher. This can be partly attributed to a different inventory mix—4 & 5 Star assets make up roughly 60% of stock in Herndon, while they comprise only about 15% in Leesburg/West Loudoun.

Despite a steep decline in vacancies, rent growth has struggled. After reaching a cyclical peak of almost 4% in 2013, growth slowed, staying relatively flat in the years since. Rents levels jumped again in 2016, increasing by about 3.5%, but this proved to be an anomaly, as growth dropped to less than 1% last year and has been essentially flat in 2018. Unfortunately, there are few drivers capable of spurring a turnaround outside of the expansion of the Silver Line.