Southwest (Washington, DC) Submarket Q1 2019

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Overview – The federal government is a staple tenant in the Southwest Submarket, limiting redevelopment opportunities close to the National Mall. But building near the waterfront surged as the Navy Yard and Nationals Park construction sparked revitalization of underused land and catalyzed office development. The revitalization has spread to Southwest, too, with the completion of phase one of the Wharf and Audi Field, home to the MLS team D.C. United. Demand has already shown signs of life, as well. Recent demand momentum continued into 2018, with USAID taking down the biggest block of available space in the submarket, but the impact of that move will be muted because it is consolidating between buildings within the submarket.

Consolidation isn’t the only thing weighing on office demand here—the U.S. Department of Agriculture recently announced that it will relocate two of its agencies, both of which are in Southwest, outside of the Washington, D.C., metro. Only four investment-grade properties traded from 2013–16, but sales picked up in 2017, with seven transactions generating $775 million in volume. And last year, two sales had recorded, putting volume at $170 million.

Leasing – Vacancy is still in the double digits, but it is almost half the recession peak. Recent move-outs, including those by the U.S. Department of Energy and the Administration for Children and Families, have put pressure on fundamentals of the highest-quality buildings. As a result, rent growth has stagnated for 4 & 5 Star properties over the past few years. And more bad news is on the horizon: The U.S. Department of Agriculture recently announced that it will relocate the Economic Research Service (ERS) and the National Institute of Food and Agriculture (NIFA) outside of the Washington, D.C., metro area by the end of 2019. This is a huge blow to the Southwest Submarket, since the ERS occupies more than 361,000 SF at Patriots Plaza (355 E St. SW), and NIFA occupies roughly 126,000 SF at Waterfront Centre (800 9th St. SW).

Demand struggled in late 2015 and some of 2016, causing vacancy to increase significantly, but a couple of high-profile deals combined with consistent demand in the 5,000–10,000-SF range helped this submarket recover last year. Demand from big-footprint tenants has been consistent, and since 2014, 10 leases for more than 100,000 SF have closed, although five were renewals.

In one, the Federal Bureau of Prisons moved from Capitol Hill to 115,000 SF at 370 L’Enfant Plaza SW last year. In late 2016, the Urban Institute signed a 120,000- SF lease at JBG Smith’s 500 L’Enfant Plaza SW development, which delivered early this year. The Urban Institute will relocate to its new space from from 2100 M St. NW (in the CBD) in 19Q2. More recently, the Pension Guarantee Benefit Corporation agreed to take 432,000 SF for 15 years in the Portals II. The current tenant, the FCC, will relocate to Sentinel Square III in NoMa in 2020, and the Pension Guarantee Benefit Corporation is expected to take occupancy in 2021. The most recent deal of note was USAID’s 348,000-SF lease at 500 D St. SW, although it is giving back some space at 400 C Street NW.

The downsizing of the GSA’s leased-office footprint in Southwest D.C. could continue to hamper absorption. Government is by far the largest employer in this submarket, its scale clearly evident in the space it uses. Government tenants occupy close to 7 million SF, more than half the submarket’s inventory. The who’s-who of federal agencies that make the Southwest Submarket home include the FCC, NASA, ICE, the SBA, the Department of Agriculture, the Department of Education, HUD, the FHA, FEMA, the FTC, and more.

Rent – Struggling fundamentals weighed on growth in the earlier years of the cycle, but recent performance is stable. Year-over-year growth at the end 2018 was about 1.1%, down about 160 basis points from that time last year. Still, this indicates nearly three years of positive gains, something landlords missed during the declines in 2012-14.

Regardless, at about $50/SF, rents in Southwest are among the highest in the metro. As of 18Q4, Southwest was the fifth most expensive submarket in the metro, behind submarkets like the East End, Capitol Hill, and the CBD.

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