Overview– Vacancies had gradually declined after peaking in 2012, but demand suffered last year, dealing a blow to the recovery. Still, vacancies in the CBD were slightly below 10% at the end of 2018, far better than those at the metro level. While the overall submarket’s inventory has diminished since 2013, the amount of 4 & 5 Star stock has increased. Renovations, along with new construction, have been a major factor in the increase of 4 & 5 Star supply here.
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 slowed last year, though, with volume at about $770 million.
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.
Leasing – The CBD Submarket’s office fundamentals remain steady, as measured by vacancy, thanks to a limited construction pipeline, with inventory actually decreasing each year from 2014–16 and again in 2018. Metro accessibility and retail amenities are two factors that have attracted one of the best tenant rosters in the metro, making the CBD a premier submarket. This keeps vacancy relatively tight, and although the current rate is well below the metro average, it remains slightly above the submarket’s own long-run average. This is partly due to the sharply negative absorption last year.
Leasing velocity of big-block space has remained steady, despite the challenging leasing environment metro-wide. For example, roughly 14 leases for 50,000 SF or more were signed from 2017-18. Some of the more notable deals included Bank of America’s lease for 62,000 SF at 1800 K St. NW and JLL’s deal for 69,000 SF at 2020 K St. NW. Law firms have been aggressively upgrading offices, often anchoring new construction. But almost without exception, those firms have been downsizing their footprints to offset higher costs per square foot. Morrison & Foerster (81,000 SF), Goodwin Procter (80,000 SF), Paul Hastings (97,000 SF), Wilmer Hale (288,000 SF), and Winston & Strawn (90,000 SF) are all anchoring new, 5 Star construction but have generally downsized footprints, sometimes by more than 40%. One exception is Buckley Sandler. The law firm, currently in the World Wildlife Fund Building in the West End Submarket, recently announced that it will be moving its office to Brookfield’s 2001 M St. NW in the CBD when its lease expires in 2019. 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.
In late November, the Peace Corps announced that it was leaving its 145,000 SF in the submarket, a major blow since the organization is one of the CBD’s largest tenants. Another government organization, the Department of Veterans Affairs, occupies nearly 300,000 SF in two buildings with leases expiring next year. If the agency downsizes or relocates, that would be a significant blow to the submarket.
Rent – Rent growth slowed drastically from 2017–18, posting the worst results since 2013. Although the gains of about 2% recorded from 2014–16 may have been solid for the region, concession packages make effective gains much weaker. Although the CBD’s growth is hardly encouraging, the gains are in line with the submarket’s primary competitors, East End and West End, which have also trended sideways over the past year.
In the race for talent and clients, law firms have proven to be reliable tenants for landlords offering top-quality, expensive space. Sullivan & Cromwell closed on the most expensive deal of this cycle when it leased 57,600 SF at 1700 New York Ave. NW, for $84/SF. However, the 16-year term included 15 months of free rent. Generous concessions packages have been common, especially during the middle years of this cycle. Haynes & Boone (22,600 SF) and the U.S. Department of the Treasury (34,000 SF) each landed 15 free months of rent on lease terms that were 10 and 11 years respectively. Even in 2017, the law firm Bookoff McAndrews (20,000 SF) managed to extract nine months of free rent on a nine-year-and-nine-month deal. Law firms are important tenants for this submarket, but their willingness to trade up to top-quality space has not been enough for landlords to realize meaningful rent growth.