Capitol Hill Area Multi-Family Market Q1 2019

H St/NoMa Submarket Overview

For a submarket that delivered more than 6,700 units and quadrupled its inventory this cycle, fundamentals are extremely resilient. Demand continues to keep up with new deliveries, thanks to the flood of renters moving to H Street and NoMa. This has kept vacancies in check, and even when vacancies do spike, strong demand results in only a handful of quarters of elevated vacancies. Another 800-plus units are expected in 2019, but based on recent trends, current performance is likely to continue.

Year-over-year rent growth last year surpassed the recent peak in 2015 and was closer to the peaks last seen in the first year of the cycle. Rents should continue to grow as the initial shock of brand new luxury apartments continues to wane. Because almost all of the inventory is new, most rent gains and investor interest comes from the first wave of supply back in the midyears of the cycle. Sales volume cleared $200 million in those years, as early investors took a chance on this emerging submarket, but was quiet the past two years.

Capitol Hill Submarket Overview

The identity of this iconic Washington, D.C. neighborhood is slowly changing. Developers added a significant number of high-end, luxury units to the streets of Capitol Hill this cycle, expanding the apartment inventory by 25%. Developers like Foulger-Pratt and Donatelli Development are transforming entire blocks with the additional supply underway.

Demand for apartments is untested because this type of inventory has never historically been available. Most renters opt for an English basement, which helps explain why developers never built here. With the popularity of H Street to the north and Navy Yard to the south, Capitol Hill is becoming a viable option for development. But it is taking time for these recently delivered projects to stabilize. The vacancy expansion in 2017 was notable, and the two properties that delivered that year averaged just seven to eight units leased per month.

Strong fundamentals led to significant rent gains in the early years of the cycle, but recent weakness slowed that growth. The high-end market was particularly soft, as 4 & 5 Star properties underperformed relative to 3 Star properties. But that could likely be explained by the significant gap between 3 Star rents and 4 & 5 Star rents. Owners in older properties have more room to push rents, while the influx of competition in 4 & 5 Star rents hamstrings owners.

Sales volume is typically low because of the limited inventory. When properties do trade, like the handful of deals last year, pricing is reflective of the smaller apartment complexes. Institutional players being priced out of H Street, Downtown, and Southwest/Navy Yard were able to find a few opportunities earlier this cycle. And with even more projects delivering in the coming years, Capitol Hill might remain in their focus.

Southwest/Navy Yard Submarket Overview

Vacancies were down considerably last year, as strong absorption and a lull in supply allowed new deliveries to fill. Over the cycle, vacancies haven’t completely unraveled, remarkable for a submarket that added more than 6,000 high-end units in nine years. Occupancies were even above the three-year average at the end of 2018 thanks to record net absorption. Landlords continue to benefit from a growing base of young, wealthy renters willing to pay higher rents for better access to neighborhood amenities.

Another substantial wave of projects should deliver in the coming years, again raising questions of over-supply. But based on this submarket’s recent past, new supply has done little to slow rent gains and the sale of the Onyx early last year is the first trade in more than three years, signifying optimism not just for developers, but also for other investors.

Capitol Hill Submarket Q1 2019

Overview – The Capitol Hill Submarket has consistently maintained vacancies lower than the metro’s, due in no small part to its proximity to the seat of American power. Much of the employment (about 55%, according to the census) is categorized as “public administration”— or government work. Office space here rents at a premium to nearby submarkets like NoMa and Capitol Riverfront, due largely to supply limits in the Judiciary Square area, where asking rents regularly exceed $55/SF. In fact, rents in Capitol Hill are the second-highest in the metro, behind only those in the East End. Sales have been strong for the past few years, though volume has decreased each year since 2015. This year ended up being the weakest since then, as just over $50 million was recorded for the year.

Leasing – For most of the cycle, this submarket has been spared the wave of supply that has hit other urban submarkets. That, paired with strong demand drivers, has allowed Capitol Hill to maintain steadier fundamentals than most submarkets in the urban core.

Several recent deliveries have caused vacancies to increase, but they are still below the metro average. Even though the construction pipeline is the busiest it has been in years, strong demand is expected from government agencies that make up more than half of office-using employment, along with the law firms and lobbyists that maintain office space near the Capitol building. Those private users, along with tenants such as the Citizenship and Immigration Office, Department of Education, and Department of Justice—all with significant footprints in this submarket—are not likely to shut down in the near term. However, the submarket is not without risk. The GSA is not afraid to go looking for a better deal, as demonstrated by the Bureau of Prisons’ move to 115,000 SF in L’Enfant Plaza, which left 500 First St. NW completely vacant in its wake.

In a supply-constrained area of the Capitol Hill Submarket, Property Group Partners chose to build a platform over I-395 to support Capitol Crossing, a three-phase, five-building development projected to add 2 million SF of office space to the submarket. The first phase, two spec office buildings, will create the submarket’s second- and fourth-largest office properties, at 560,000 SF and 425,000 SF, respectively. The American Petroleum Institute announced a 74,000-SF lease at 200 Massachusetts Ave., the smaller of the two buildings, which delivered in summer 2018. This was the first lease signed at Capitol Crossing and will bring the trade association to the Capitol Hill Submarket from its current office in the East End. The next most important project is 700 Penn, a 235,000 SF office building that is part of the Hine Junior High School redevelopment, a630,000 SF mixed-use development. Co-working company the Yard was the first tenant to sign on for the project, taking 32,000-SF. As of 18Q4, the property was roughly 70% leased.

Rent – The Capitol Hill Submarket has the second-highest rents in the metro, behind the East End. This is partially due to the limited supply near Judiciary Square and Union Station, where rents average roughly $55/SF, compared with a submarket average closer to $53/SF. Despite the lack of recent supply, rent growth has struggled. Growth the past two years was about 2.5%, significantly stronger than the average annual gains from 2014–16, which were roughly 0.5%.

Southwest (Washington, DC) Submarket Q1 2019


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.

NoMa Submarket Q1 2019


Overview – New development has increased NoMa’s office stock by one-third over the course of this cycle, and that development, along with an influx of apartment supply, makes this one of the most rapidly changing submarkets in the metro. Demand has generally kept up, and while vacancy increased in the middle years of this cycle, strong absorption helped it compress in 2017 and 2018. GSA tenants have been the major driver of office demand here, and the Peace Corps’ announcement that it is relocating its headquarters to NoMa was just the latest example.

The plethora of green 4 & 5 Star buildings here with rents cheaper than those in core office submarkets helps NoMa attract and retain federal tenants. The Department of Justice moved into 345,000 SF at Three Constitution Square early last year and will occupy nearly 500,000 SF in Four Constitution Square when it delivers later this year. Other GSA tenants in NoMa include the Federal Energy Regulatory Commission, the Department of Education, the Securities and Exchange Commission, the Internal Revenue Service, and Customs and Border Protection. The D.C. government also uses space in NoMa for the D.C. Housing Authority headquarters.

Leasing – After a 15-year period of explosive development, heavy tenant migration, and poor absorption from 2015–16, NoMa joined the expansive group of Downtown D.C. office submarkets with vacancies above 10% in the middle years of the cycle. However, leasing has trended in the right direction recently—about 430,000 SF was absorbed in 2017 and another 400,000 SF in 2018, allowing vacancies to recover slightly. The U.S. Department of Justice moved into 345,000 SF at Three Constitution Square last summer, and the FCC and Peace Corps both announced moves to NoMa, accounting for an additional 473,000 SF and 176,000 SF, respectively.

The most recent buildings to open—Three Constitution Square, Republic Square II, Sentinel Square II, and Uline Arena—added more than 1 million SF to the submarket’s inventory, and several sat empty for years before recently finding tenants. For example, Three Constitution Square delivered in January 2014 and was vacant until last year, when the Justice Department took the entire building. Republic Square II was roughly 37% vacant at the end of last year after delivering in early 2016, and the GSA signed a lease in 2017 to occupy more than half of Sentinel Square II, which had been 100% empty since delivering in November 2013.

Construction of the submarket’s newest delivery, Uline Arena, finished in 17Q1, and about 70% of its space is still available for lease. Antunovich Associates, the architecture firm that redesigned Uline Arena, recently announced that it would relocate to the building from Clarendon, expanding its footprint to 9,000 SF. Furthermore, Goodwill of Greater Washington will also be taking space at Uline Arena. The non-profit is relocating its headquarters from 2200 South Dakota Ave. NE and will occupy roughly 24,000 SF.

Government agencies and nongovernment organizations seeking more affordable space than that offered in Downtown have been driving office demand in NoMa. From the beginning of 2014 to the end of 2018, government tenants alone have accounted for more than 50% of space occupied. At about $49.50/SF, average rents are cheaper than in the CBD, East End, and Capitol Hill Submarkets.

NoMa’s plethora of green buildings with cheaper rents should help it to retain federal tenants. The risk of GSA space givebacks looms because the agency has announced plans to reduce its footprint of leased office space, which could undercut demand gains from the private sector in the near term. Since some federal agencies are mandated to occupy green space, buildings that lack LEED certification or Energy Star ratings are most at risk of losing GSA tenants. The submarket contains more than a dozen Energy Star or LEEDcertified office buildings, totaling 9 million SF. These rent for an average of about $50.50/SF, which is right around the GSA rent ceiling of about $50/SF for new leases in the District.

Rent – Rent growth has been subdued this cycle, in stark comparison to the strong gains posted from 2005–08. Relatively low rents and below-average vacancy are apparently not enough to give landlords the leverage needed to achieve meaningful growth. Gains in 2017, which were just below 3%, provided a sign of hope, but rent growth in 2018 slowing to 1.2% means a return to more normal levels.

NoMa contains a plethora of green 4 & 5 Star buildings with rents lower than those of green office space in other core D.C. submarkets. That helps NoMa attract and retain federal tenants such as the U.S. Department of Justice and the FCC, which are major boons for the submarket. However, other submarkets in the District, such as Southwest and Capitol Riverfront, have been more competitive recently, with mixed-use developments like the Wharf attracting large tenants such as the Washington Gas Light Company.

Capitol Riverfront Submarket Q1 2019


Overview – GSA consolidation and Base Realignment and Consolidation (BRAC) fallout pushed vacancies above 20% in the middle years of the cycle. In fact, with over 40% of its office space occupied by GSA and contractor tenants, Capitol Riverfront ranks in the top-five submarkets in the metro for federal office exposure. Besides the U.S. Department of Transportation and Naval Sea Systems Command, other major office tenants include the District Department of Transportation, Lockheed Martin, Computer Science Corporation and Parsons Corporation.

In the largest lease signed in the past five years, the National Labor Relations Board moved into 151,000 SF at 1015 Half St. SE, relocating from D.C.’s East End in 2015. More recently, the National Association of Broadcasters (NAB) signed a 130,000 SF lease at Monument Realty’s 1 M St. SE. NAB plans to relocate its 150-person headquarters here from DuPont Circle when the project delivers later this year. These leases have absorption on the mend, and vacancy is beginning to recover, even if it remains elevated. Hines made news early this year with their sale of Half Street, which they originally purchased in 2013 for $142 million, and then just resold for $135.5 million.

Leasing – A number of D.C.-area submarkets, such as Crystal City and Merrifield, had their office fundamentals shaken up by GSA tenants and government contractors downsizing because of sequestration and Base Realignment and Closure (BRAC). The Capitol Riverfront Submarket was no exception. Vacancies have been elevated since 2013, despite minimal supply pressure. In fact, with over 40% of the Capitol Riverfront’s office space occupied by GSA and contractor tenants, the submarket ranks in the top five in the metro for federal office exposure. However, fundamentals are showing signs of improvement, with vacancies declining since peaking well above 25% in mid-2015.

The large amount of federally leased office space is due to the presence of the U.S. Department of Transportation and the Naval Sea Systems Command (NAVSEA).  NAVSEA, in particular, has been a boon for office demand since this submarket began redeveloping. Government contractors working for the Navy, as well as those looking to win new contracts awarded by NAVSEA—such as Lockheed Martin and shipbuilder Huntington Ingalls, have a vested interest, and in most cases, a mandate, to be close to the Navy Yard.

The Capitol Riverfront Submarket has several positive attributes that could serve as demand drivers for sources besides government contractors. Not only are rents here lower than those in the District’s core submarkets, but this submarket also offers a wide range of retail amenities and is near Capitol Hill. In 2001, the Capitol Riverfront Submarket was comprised of vacant parking lots and public-housing projects. Fast forward to 2018, and the submarket is home to Nationals Park, numerous high-end and fast-casual restaurants, the popular Bluejacket Brewery, and a number of high-end apartment and condo developments, highlighted by WC Smith’s Agora Apartments, which features a 35,000-SF Whole Foods on the ground level.

Tenants that have traditionally favored prime downtown locations are slowly moving to emerging areas such as Capitol Riverfront or NoMa, and the East End Submarket is feeling the effect. For example, Muriel Bowser chose to relocate the office of the Deputy Mayor for Planning and Economic Development here from the East End Submarket in 15Q4. Several other municipal tenants have followed, with the D.C. Office of Campaign Finance and D.C. Board of Elections signing leases here in 2017. The National Labor Relations Board also left the East End when it moved to 1015 Half St. SE, in 15Q3. More recently, the Credit Union National Association announced that it will be leaving 601 Pennsylvania Ave. NW, to move into Skanska’s 99 M St. SE in 2018. WeWork has noticed the Capitol Riverfront’s growing popularity as well—in 16Q4, the tech tenant magnet signed on for 69,000 SF at Columbia Property Trust’s Navy Yard Metro Center.

Rent – Rent growth in Capitol Riverfront has been inconsistent since the recession but has stayed positive each of the past four years, a reversal from the declines from 2012–14. Rents increased by about 3% last year and 3.7% in 2017, the highest rate since 2010.

Still, this is a much-needed reversal and is in large part due to recovering vacancies. At almost $45/SF, asking rents have long since matched their prerecession peak, despite vacancies that are more than one-and-a-half times the metro average. The Capitol Riverfront’s convenient location, Metro access, and burgeoning retail scene have helped the submarket emerge as a live/work/play environment and could boost demand in the long term. Still, consistent rent gains across the submarket are still elusive. However, prospects for rent growth are bolstered by the fact that office space in Capitol Riverfront is more affordable than in other submarkets in the District, with rents well below those in submarkets like the West End, CBD, East End, and Capitol Hill.

David vs. Goliath: Why the Big Firms May Not be the Best Choice

david vs

I started my career as a commercial real estate broker in March of 2008 with a small brokerage firm in Reston, VA. It was just me and the principal broker. On top of that, I was starting out in the greatest economic crisis since the Great Depression. To say I was thrown into the deep end of the pool and told to swim would be an understatement. It was more akin to being thrown into the middle of the ocean during a hurricane.

Looking back, I was fortunate in many ways. While I had no administrative support or name recognition, I did have an experienced, well-respected, and ethical broker who took me under his wing and taught me the business. I didn’t just learn how to broker a real estate transaction. I learned how to do so the right way; putting my clients’ interests before my own, building a reputation for honesty and fair dealing, and going the extra mile to help others and get the deal done.

If I’d begun my career at one of the big firms, things may have turned out very differently… and not necessarily for the better.

Here are reasons why choosing the big firms may not be the best choice for you:

How many brokers do you think are working your deal?

CB Richard Ellis is the largest real estate firm in the world. Do you believe that all the firm’s considerable resources are being devoted to your requirement? At the big shops, agents and brokers form teams to work a listing or represent a client.  I’ve observed that these teams are generally two to four people; consisting of one or two senior brokers who are supported by one or two junior agents (who do most of the work). They may sell you “the team” but that doesn’t mean that they’re all working on your deal. Depending on the size of the deal and/or importance they place on it, you could be passed off to a less experienced, junior broker. If you’re under 20,000 SF, this most likely applies to you.

Market knowledge/expertise

Working at a big shop does not make one a more intelligent, competent, or creative broker. Many times, the difference between helping a client accomplish their goals or not is in how the deal is structured. Working at a big firm does not make one a better negotiator. Negotiations are based on leverage with both macroeconomic and microeconomic factors at play. Successful negotiations are about understanding those factors along with each party’s goals, needs, etc. within that context so that the deal can be structured in accordance with both. This comes from regular market research and analysis. The big firms do not have access to exclusive market data not readily available to anyone with an internet connection and Costar account (CCIMs, on the other hand, do along with the technical and analytical expertise to make sense of said data). The difference is at the big firms, in many cases, market research and analysis are performed by junior brokers and analysts, not the brokers. You should judge a broker based on their experience, not by the company name on their business card. You want to work with a broker that continues to educate themselves on changing market trends and conditions.

Which name is important?

Many brokers at the big shops are knowledgeable, good brokers, and this is not meant to disparage them; however, there are also many that rely on the company name on their card to get them business rather than their own. This point hits close to home for me because I never had the luxury of my company’s name opening doors for me. I built my own brand and reputation by being the best at what I do and providing first-class service to my clients through good, old-fashioned hard work. When you’re choosing which broker to work with make sure you focus on the name they’ve built for themselves, not one that’s been built for them.

In-house vs. a la carte

The big guys like to boast about all the resources they have in-house; using it in their pitch to win business. They’ve got analysts, marketing people, space planners, etc.  I’d say that I hate to rain on their parade, but that wouldn’t make much sense in the spirit of this article. So, let’s look at these in-house resources and see if they live up to the value they’re purported to provide. The analyst position at the big shops is really just a stepping-stone to become an agent and the research they’re doing is more of a tool to win new clients for the brokers than it is to help you.  As I mentioned, your broker should already be knowledgeable and up to date on market conditions. As far as marketing goes, they seem to be more focused on promoting themselves and less focused on promoting their clients’ listings. They are very good at getting their company name and brand out there but I can’t tell you how many times I’ve been doing market research and have come across property listings without floors plans, flyers, or even asking rates (this is intentional in some cases). If I do come across a flyer, it’s oftentimes only one or two pages and still may not include floor plans. I believe in providing buyers and/or tenants with all the information they need to make a decision, which is why every listing of mine has a comprehensive property package with floor plans, professional photographs, zoning information, etc. (if an owner does not have a floor plan I take measurements and create one for them). Finally, space planning and architectural services are generally provided by the landlord at no cost to the tenant (they’re part of the deal). You can either choose to go with the landlord’s architect (and/or contractor) or opt for an improvement allowance and select your own. It’s the difference of being locked into the in-house option or having a choice.

Free your mind

The big shops rely on a few psychological principles to win them business. One is the familiarity principle (also called the “mere-exposure effect”) which refers to the phenomenon that causes people to feel positively about things to which they are frequently and consistently exposed. Recall my point about their marketing materials? This type of thinking has no basis in rationality and is likely to lead to suboptimal decisions and results Another is the principle of authority which causes people to follow or choose “knowledgeable experts.” Basically, it goes like this: “CB Richard Ellis is the biggest real estate firm in the world. They must be the best.” As I said before, CBRE has many fine brokers, but be aware of my previous point about who will actually be representing you and working your deal. Finally, they rely on the principle of consensus in which people will look to the actions and behaviors of others to determine their own. “Northrop Grumman works with CB Richard Ellis… so should we.” You’re an individual with unique goals, needs, etc. What makes sense for one company may not make sense for you. These psychological principles serve as shortcuts to decision-making and surrender our individuality to groupthink. You owe it to yourself to make a conscious decision when determining which broker to represent you and your company.

The points I’ve made above are not meant to criticize firms such as CB Richard Ellis, Jones Lang Lasalle, Cushman & Wakefield, etc., nor is it meant to extol the virtues of the boutique brokerage firm. Rather, its purpose is to dispel the myth that going with the big guys is always the best choice and will yield the best results (they’ll certainly tell you that it is). When making a decision as important as who will represent you, it’s my belief that you should be fully informed as to who and what you’re getting and not be misled by the devices of Madison Avenue.

Applying Real Estate Investment Concepts: Calculating Cost Recovery Deductions


Cost recovery, otherwise known as depreciation, has many definitions:

  1. The periodic allocation of the cost of the portion of an asset that wears out
  2. An allocation of the cost of an asset, taken as an expense against any income that asset produces
  3. The return of investment in business and income-producing property, prorated over its class/useful life
  4. An annual deduction that reduces basis when calculating gain or loss at the time of disposition, or
  5. Non-cash, tax-deductible expense that reduces taxable income but does not reduce cash flows.

Source: Financial Analysis for Commercial Investment Real Estate, CCIM Institute

My favorite definition, and the one I believe to be most relevant and easily understood, is the last one. Cost recovery reduces taxable income without reducing cash flows. It’s truly a thing of beauty and is one of the reasons that tax savvy investors love real estate.

I will now show you how cost recovery works in the real world by showing you how to calculate cost recovery deductions over the holding period of an investment for an actual listing that we currently have for sale: 4221 Walney Rd in Chantilly, VA.

4221 Walney Rd

  • Price: $4,250,000
  • Holding Period: 5 years
  • Date of purchase: April 15, 2019
  • Date of sale: April 14, 2024

Step 1: Calculate Original/Acquisition Basis

Assuming a purchase price of $4,250,000 and acquisition costs equal to 3.5% of the purchase price ($148,750), our original basis is $4,398,750.

4221 Walney Rd Basis.png

Step 2: Allocate Basis

You must allocate the basis between the improvements and the land. Cost recovery only applies to the improvements. There are multiple ways to allocate basis but the most common and easily justifiable is by using the ratio used for taxation purposes by the municipality in which the property is located.

The 2019 tax assessed value for 4221 Walney Rd is $4,270,770 with the land valued at $549,400 and the improvements valued at $3,721,370. To find the allocation percentage for the improvements you must divide the value of the land by the total assessed value of the property.

$3,721,370/$4,270,770 = 87%

You then multiply the original basis by this amount.

4221 Walney Rd Basis allocated.png

The allocated basis for the improvements is $3,832,886.41.

Step 3: Determine Property Type and Class Life of Improvements

The IRS determines the class life for residential and non-residential (commercial) properties, which are 27.5 years and 39 years respectively. Because 4221 Walney Rd is an office building we will use the cost recovery percentages for non-residential properties (below).

IRS Cost Recovery Schedule commercial

Step 4: Apply the Straight-Line Cost Recovery Method

Because the property will be purchased on April 15, 2019 we must use 1.819% to indicate the partial year of ownership. We multiply the allocated basis of the improvements ($3,832,886.41) by this percent, which gives us our cost recovery deductions for year-1 of ownership.

4221 Walney Rd Tables year 1.png

This means that your taxable income for the property will be reduced by $69,720.20 in the first year of ownership!

Next calculate the cost recovery for the full years of ownership by following the same process.

4221 Walney Rd Tables full years.png

This means that for each full year of ownership you will be able to reduce your taxable income by $98,275.21!

Finally, calculate the cost recovery deduction for the year of disposition. Because the date of sale if April 14, 2024 you must use 0.749%.

4221 Walney Rd Tables final year


Therefore, in the final year of ownership your cost recovery deduction will reduce your taxable income by $28,708.32!


That’s how much money you will be able to reduce your taxable income by through cost recovery deductions over a 5-year holding period. Because cash flows are unaffected by depreciation, this will result in an increased after-tax return on investment.

For more information and to review the due diligence materials for this property, please contact Ryan Rauner at or visit our website at

Downtown Washington DC Multi-Family Submarket Q1 2019


Overview – Apartment fundamentals in Downtown D.C. continue to strengthen after inventory increased by about 25% since 2010. Vacancies, which reached the double digits in 2013 and 2014, regained their footing in 2018 and were again below the historical average. Recently delivered projects have been leasing well. In fact, almost all of the absorption came from 4 & 5 Star buildings over the past three years. As developers provide new living alternatives in Shaw, Mount Vernon Triangle, and Chinatown, it appears many residents are trading up for these apartments.

Rents suffered from a slowdown in demand from 2016- 17 but made considerable gains last year. Concessions are still relevant in apartments built in 2018 but are hard to find in older properties. It appears Downtown D.C.’s supply-side concerns are in the rear-view mirror as only a handful of small apartments were under construction at year-end. This could further improve occupancies and rent growth, with the potential to lead to further sales.

Sales activity has been muted after the record level of volume from 2010-15. Only a few properties traded last year and after the flurry of activity earlier this cycle, the disparity between what’s available and at what price point has left many companies targeting other submarkets. Looking forward, Downtown D.C.’s reputation as one of the most sought-after residential submarkets in the metro should keep developers and investors coming back over the long term.

Vacancy – Downtown is frequently considered one of the trendiest places for young professionals to live. Its central location provides proximity to many Metro stops and puts it within walking distance of major job nodes in the CBD, East End and West End. Retail amenities are abundant, too, with Whole Foods Markets near Logan Circle and Foggy Bottom and a Trader Joe’s on 14th Street. The more than 30 fitness centers or gyms here cater to the fitness-focused residents, and the submarket also offers culture and nightlife, with a wide range of fine dining and fast-casual restaurants.

Demographics in the Downtown Submarket are an apartment owner’s dream. Foggy Bottom, Dupont Circle, and Logan Circle were among the first areas of popularity in D.C., but it appears there has been a demographic shift in recent years. Many of the young renters that made this area popular have continued moving east to neighborhoods like H Street, NoMa and the Capitol Riverfront. Filling that backspace is an older, educated renter base. These professionals typically work Downtown, as the average household income is almost $130,000/year, making the $2,500/month average rents affordable.

These favorable demographics led to a significant supply wave, which hit earlier than in most submarkets. More than 3,000 units delivered from 2014–18, and it took almost two full years for vacancies to return to pre-supply levels.

New construction is generally met with strong demand because of residents’ high incomes and propensity to rent. These tailwinds boosted leasing at the submarket’s newest properties. The 5 Star, 197-unit Legacy West End delivered in March 2018 and was about 87% occupied as of Q4 2018. More recent deliveries, like the Lydian and the Lurgan have also leased quickly.

Rents – Rent growth rebounded late last year, after going sharply negative in 2017. Rents fell in response to vacancy increases because of negative absorption and new supply. Year-over-year rent growth of about 2% as of Q4 2018 was still below the historical average, but significantly outperformed the three-year average of about 0.5%. Leasing is likely to pick up over the next few months, and with a pipeline that has largely emptied, that positive momentum could give way to further rent gains.

The submarket remains one of the most expensive in the metro. Average asking rents for newly constructed apartments were roughly $4/SF as of 18Q4, a 20% premium over the overall submarket average. But Downtown is facing more competition from neighborhoods like H Street and Navy Yard, both of which have experienced abundant construction and can provide renters with similar amenities and Metro access in desirable neighborhoods. As a result, both of these submarkets are priced similarly.

Downtown D.C. has one of the largest disparities between 3 Star and 4 & 5 Star rents. On average, the premium is about 40%. This has led to significant rent increases in 3 Star properties. From 2010-18, 3 Star rent growth totaled about 200 basis points more than 4 & 5 Star rent growth.

Properties built in 2018 are still offering concessions. The Lydian and the Lurgan, both built this year, were offering one month of free rent on a 12-month lease at year-end. The Legacy West End and Apartments at Westlight were offering concessions on two-bedroom floor plans.

Downtown DC Multi-Family Report Q1 2019


Washington, DC Central Business District Q1 2019


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.


Washington, DC East End Submarket Q1 2019

Overview – Vacancies in the East End ticked above the metro average at the end of last year, and several projects that are anticipated to deliver early this year could cause rates to continue to increase. Demand rebounded last year after tenant downsizings weighed on growth for several years, with net absorption negative in 2015 and negligible from 2016–17. Construction activity is ramping up, regardless, with 1.2 million SF delivered in 2018 and another 1.2 million SF set to deliver in 2019.

D.C. tenants willing to pay higher rents, such as corporate law firms, prefer newer, more efficient space in the East End. Healthy pre-leasing of new deliveries highlights the flight to quality. Of the 11 properties delivered from 2015–18, six are at least 90% occupied and the remaining properties are between at least 50%.

The flight-to quality trend explains why some of East End’s older, 3 Star inventory—which totals 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 last year posted the strongest year since 2014 and matched the total volume in 2016 and 2017 combined.

Leasing – As longstanding tenants such as the GSA and corporate law firms downsize and relocate into new, top-quality product, demand growth in Washington’s East End continues to lag. Examples of tenant downsizing include Covington & Burling, which reduced its footprint by 7% (nearly 30,000 SF) when it moved from 1201 Pennsylvania Ave. NW to CityCenter. The National Labor Relations Board also left its home at 1099 14th St. NW for new space in the Capitol Riverfront, shrinking its occupancy by almost 50%.

WMATA recently announced plans to consolidate its office space—spread throughout D.C., Maryland, and Virginia—which will result in the agency vacating the 270,000-SF Jackson Graham building at 600 Fifth St. NW and moving to Southwest D.C. Most recently, Baker Botts announced it has pre-leased 103,300 SF at Meridian Group’s 700 K St. NW, anticipated to deliver in early 2019. The law firm will reduce its footprint by about 27% when it leaves JBG’s Warner Building at 1299 Pennsylvania Ave. NW.

Growing tech companies—promising enterprises that can’t yet afford premium space but nonetheless want prime locations—could pick up the slack for office demand in the East End. Washington, D.C. has the highest level of educational attainment in the country (more than 50% of residents hold a bachelor’s degree or higher), which has resulted in tech employers targeting the metro to tap the talented labor pool. Furthermore, a study by the American Institute for Economic Research recently ranked D.C. as the top destination for recent college graduates among major metro areas. The metro has gained millennials at one of the fastest rates of any metro in the U.S., particularly early in the cycle.

The D.C. government also sees the potential and recently passed legislation that gives capital gains tax breaks to “long-term, quality high-tech companies.” The new legislation aims to encourage the creation, expansion, and retention of District-based technology companies and to incentivize District investors to diversify by placing capital in technology startups. Recognizing the potential demand upside, co-working giant WeWork opened one of its first D.C. locations in Chinatown in 2014, leasing around 21,000 SF of creative office space at 718 Seventh St. NW. The company recently opened its 11th location in the D.C. metro just one block away on 6th Street NW. Spaces, an Amsterdam-based co-working company that has also quickly expanded in the U.S., recently leased roughly 50,000 SF at 1441 L St. NW, a space that was formerly occupied by the Bureau of Economic Analysis.

Rapidly growing tech giant Uber Technologies has demonstrated its interest in proximity to the federal government. The company recently chose Downtown D.C. as the new location for its East Coast operations headquarters, where it occupies roughly 73,000 SF. Other well-known tech companies are making their way to the East End, as well. Yelp moved into 52,000 SF at Terrell Place earlier this year—the same building where Facebook recently leased 75,000 SF, more than doubling its previous footprint. More recently, Apple signed a lease for 29,000 SF of office space at 700 K St. NW. The building is across the street from the Carnegie Library, where the tech giant plans to open a retail store by the end of the year.

Rent – At more than $56/SF, Washington’s East End is the priciest submarket in the D.C. metro, with rents that were roughly $3/SF more than the next nearest submarket at year-end. Other submarkets in the District, such as Capitol Riverfront and NoMa, are emerging as alternatives for tenants in the market for 4 & 5 Star space; this competition from other submarkets may explain why rent growth has become increasingly slow in the East End over the past few years.

Landlords’ willingness to provide ample tenant improvement allowances to large office users is indicative of tenants’ negotiating power. Since 2013, seven major law firms have inked long-term deals to be anchor tenants in newly constructed office buildings (Kirkland & Ellis, LLP; Baker Botts; Simpson Thatcher; Venable; Arnold & Porter; Covington & Burling; and Cleary Gottlieb). The average contract rent for these deals is about $57/SF, but the concession packages show just how much leverage such tenants have. The average lease term is 16 years, but these tenants received an average of 13 months of free rent and a staggering $120/SF in tenant improvement allowances.