Route 28 North Industrial Submarket

• RBA: 35,287,627 SF
• Vacancy Rate: 3.7%
• 12 Month Net Absorption: 1,800,000 SF
• Average Asking Rent: $12.65
• 12 Month Rent Growth: 4.5%

The Route 28 North Industrial submarket may be the strongest in the DC metro area across every asset class. Even with 2,000,000 SF delivering in the past 12 months the vacancy rate only increased by 0.3% in that time and is well below the market average at 3.7%. The submarket saw 1,800,000 SF in positive net absorption over the same period and a staggering 4.5% growth in rents. Over 1.1M SF is set to deliver in the next year with an additional 694,000 SF proposed. This area is also known as Data Center Alley with one of the largest concentrations of data centers in the nation/world with nearly 70% of the world’s internet traffic flowing through the corridor. The submarket has AOL to thank for the infrastructure that eventually led Amazon, Google, and Microsoft to purchase hundreds of acres for future development. In addition to this, the submarket’s proximity to Dulles International Airport, location in the richest county in the nation (Loudoun), and major north/south and east/west highways (Route 28 and the Dulles Greenway respectively) have all combined to create the region’s largest industrial submarket with seemingly unlimited potential.

Route 28 North Office Submarket 

• RBA: 10,348,741 SF
• Vacancy Rate: 16.3%
• 12 Month Net Absorption: (115,000 SF)
• Average Asking Rent: $26.52
• 12 Month Rent Growth: 0.8%

Route 28 North’s office and industrial markets’ fundamentals are in stark contrast and tell a story that began before the Great Recession. Before 2008, Loudoun County planners had a much more optimistic outlook for area’s office demand, as evidenced by the prevalence of land zoned PD-OP (Planned Development Office Park). Over the years the submarket became known as Data Center Alley and demand was primarily for industrial uses. This quietly created prime conditions for a surge in office demand in the submarket. Amazon, Google, and Microsoft have invested heavily in the submarket and with the completion of the Silver Line in late 2020, developers will have the opportunity to transform the office market into mixed use, transit-oriented office projects that attract both international and regional companies that support and/or collaborate with the tech giants.

Route 28 South Industrial Submarket 

• RBA: 11,780,111 SF
• Vacancy Rate: 8.2%
• 12 Month Net Absorption: 126,000 SF
• Average Asking Rent: $12.96
• 12 Month Rent Growth: 4.2%

The Route 28 South Industrial submarket is a smaller, older version of its northern neighbor; however, its fundamentals comparatively strong. The past 12 months saw a 1% drop in the vacancy rate, 126,000 SF of net absorption, and a 4.2% growth in rents. Despite having a vacancy rate that is above the metro average (8.2% vs. 6.6%), the submarket commands an average rental rate that is $0.31/SF higher than Route 28 North. There are no projects proposed or set to deliver in the next 12 months which should cause vacancy rates to continue to decline. Further evidence of the submarket’s health is the average and median submarket cap rates in the past 12 months: 6.3% and 5.4% respectively.

Route 28 South Submarket Office 

• RBA: 14,330,215 SF
• Vacancy Rate: 15.2%
• 12 Month Net Absorption: 210,000 SF
• Average Asking Rent: $28.25
• 12 Month Rent Growth: 0.7%

Route 28 South’s office vacancy is above the metro average, but this is not necessarily reflective of the overall health of the submarket. It does, however, reveal its vulnerability to large move-outs as UNICOM’s move in 2018 increased the submarket’s vacancy rate by a brutal 3.2%. The submarket’s inventory is nearly evenly split between 4 & 5-Star and 3-Star properties, but the differences in average rents and vacancy is anything but even at $31.70/SF vs. $25.21/SF and 13.9% and 21.5% respectively. Peterson Companies delivered 480,000 SF in September 2018 (for a government tenant) and there is 125,000 SF set to deliver in the next 12 months with another 170,000 SF proposed. The presence of large (3-letter) government tenants should generate consistent demand from government contractor tenants and, barring any large-scale move-outs, should contribute to a continued improvement in submarket fundamentals.

Delaware Statutory Trusts (DSTs), otherwise known as an Unincorporated Business Trust, are legally recognized trusts that allow (1) accredited investors to (2) defer capital gains through a 1031 exchange and (3) invest in a fractional interest in (4) large, institutional quality and (5) professionally managed commercial properties. While DSTs are created by filing a Certificate of Trust with the Delaware Division of Corporations, the business purpose for which they are formed is not restricted to the State of Delaware. Trusts are fiduciary arrangements that allow a third-party, known as a trustee, to hold assets on behalf of a beneficiary or beneficiaries. In this article, I will break down the various components of a DST and explain how, for some investors, they can be an excellent alternative to a traditional 1031 exchange.

(1) Accredited investors

Delaware law does not require DSTs to be registered with the Securities & Exchange Commission (SEC), which is why they are only available to accredited investors. Private trust agreements govern the relationship between the trustee and beneficiaries; including distribution of the trust’s assets, voting rights, etc. There are no regulations or restrictions on the format or phraseology of the governing agreement or limits to the powers of the trustee. As a result, investors must be sophisticated enough to analyze and understand the terms of the trust agreement so that they can accurately calculate their projected return, identify the risks associated with the existing language, and determine whether or not to invest in the particular entity.

(2) Defer capital gains through a 1031 exchange

Delaware Statutory Trusts invest in real property and ownership interests are available for purchase to accredited investors, many with minimum investments as low as $100,000. Because DST real property assets are held for investment purposes they qualify as “like-kind”/replacement properties under Section 1031 of the Internal Revenue Code. Therefore, investors can defer capital gains by reinvesting the money in a DST through a 1031 exchange.

(3) Invest in a fractional interest

The traditional 1031 exchange requires a seller to reinvest capital gains into a “like-kind” property or properties of equal or greater value within certain time limits and, while the timeframes don’t change, DSTs allow investors to take the entirety of their gains and pool them with other investors’ funds. For example, if an investor has $100,000 of capital gains they could invest in a DST investment valued at $10,000,000, effectively purchasing a 1% interest in the asset. Investors are not partners but rather individual owners within the trust and, as a result, receive their percentage share of cash flow income, tax benefits, etc. Liquidity is a potential issue as many investments have long holding periods (5-10 years) and owners’ ability to transfer or sell their interests may be prohibited or limited by the trust agreement.

(4) Large, institutional quality

Because DSTs allow investors to pool funds they are able to invest in properties that were previously only available to the ultra-wealthy and to large institutions such as pension funds, insurance companies, etc., hence the term “institutional quality.” Examples of such investments include hundred plus unit multi-family apartments, high-rise office buildings, industrial projects, shopping centers, etc. The stability and diversification inherent in such properties is reflected in their price tag.

(5) Professionally managed commercial properties

A major reason that property owners may hesitate to sell an investment property despite positive market conditions is that they do not want to pay capital gains taxes but also do not want to have to find a replacement property that they have to manage. They don’t want to be a landlord anymore. One of the greatest features of Delaware Statutory Trusts is that they are held, managed, and administered by the trustee. This is another reason DSTs are reserved for accredited investors. The quality of the “professional management” is paramount to the success of the investment. Trustees should be qualified and vetted by investors to ensure their competency and experience. Ideally, trustees are sufficiently connected and knowledgeable to be able to identify analyze investments regardless of location and structure acquisitions in a way as to maximize the investment’s return. They should also manage the asset efficiently; minimizing operating expenses while adequately maintaining the common areas and building systems so that the property maintains its value and provides the highest return to investors.

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Delaware Statutory Trusts provide accredited investors with the ability to defer capital gains and invest in institutional quality investments without the responsibility of managing the properties, themselves. Depending on the skill, experience, etc. of the trustee, beneficiaries may have the opportunity to invest in markets outside their area of expertise where returns are higher or where there is a greater likelihood of appreciation either through effective management or capital investments. Finally, DSTs provide a “fallback plan” if sellers are unable to identify a suitable or desirable replacement property within 1031 exchange timeframes.

Quiet enjoyment refers to a tenant or landowner’s right to the undisturbed use and enjoyment of real property. It is also defined as a covenant that promises that a grantee or tenant of an estate in real estate shall be able to possess the premises in peace, without disturbance or interference from hostile claimants. This concept is so vital to the leasing and/or ownership of real estate that courts have ruled it to be an implied covenant in leases/contract regardless of whether it is explicitly included.

The concept of quiet enjoyment is most relevant in commercial leasing; however, it can also apply to the exchange or conveyance of land ownership. In this case, quiet enjoyment is synonymous with conveying title, free and clear and absent of encumbrances or claims by other parties. Warranty deeds include covenants of quiet enjoyment while quitclaim deeds do not. As the terms suggest, a warranty deed “warrants”/guarantees the transfer of the owner’s interest in the property, while a quitclaim deed simply “quits”/terminates the owner’s interest in the property; allowing the grantee to take possession. Translation: make sure you’re buying land through a general or special warranty deed, unless you want some long lost relatives popping up one day with real or false claims to ownership of your property.

Purchase and sales contracts are “short-term” agreements that dictate the terms of a transfer of interests in real property. Commercial leases, on the other hand, lay out the terms/ground rules for a “long-term” relationship between landlord and tenant; establishing requirements and restrictions. As a result, the concept of quiet enjoyment is one of, if not, THE most important of all and has implications for both the tenant and landlord.

For tenants, quiet enjoyment means a couple things. The first is “quiet;” meaning that if they abide by the terms of the lease they will not be bothered… peace and QUIET. The second is “enjoyment;” meaning that they have the right to use the premises and ENJOY that use. The practical application of these rights varies by asset class but includes the right to exclude others from the premises, the right to clean premises, basic utilities, i.e. electricity, heat, hot water, etc. Basically, the case is that the absence of such services would interfere with the tenant’s use/enjoyment of the property. Imagine leasing an office space in February without heat… not very enjoyable. Therefore, quiet enjoyment can be viewed as a covenant that inure to the benefit of the tenant while placing certain requirements and restrictions on the landlord.

If a landlord breaches the covenant of quiet enjoyment, common law provides at least two remedies for tenants: rental abatement or lease termination. In practice though, commercial leases contain many, common provisions that specifically addresses elements of quiet enjoyment and seek to limit the landlord’s responsibility. One example are lease provisions that address interruption of services. Landlords, typically, try to exempt themselves from any responsibility from service interruptions, i.e. electricity, heat, elevator service, etc., even in cases of their own gross negligence or willful misconduct. Despite the existence of business interruption insurance and the landlord’s own interest in maintaining the property and timely addressing any issues, tenants should push back on such attempts to limit their rights of quiet enjoyment.

The relationship between tenant and landlord is naturally contentious, at first, as both parties seek to extract the maximum concessions from the other all while limiting their own exposure. Tenants should approach lease negotiations skeptically and cautiously, but must also realize that they are being given use of someone else’s property. Commercial leases are legally binding documents in which both parties are agreeing to do and not do certain things. It is justifiable and reasonable for tenants to do everything they can to limit their own liabilities but, at the end of the day, they’re as responsible for abiding by the terms and conditions of the lease as the landlord. Quiet enjoyment may be to the benefit of the tenant but is also a condition of the tenant’s faithful adherence to the terms of the lease agreement. In closing, pay your rent on time and you’ll be fine.

Examples:

Office

Tenant shall have quiet possession of the Premises for the Lease Term hereof, free from any disturbance or molestation by Landlord, or anyone claiming by, through or under Landlord, but in all events subject to all the provisions of this Lease.

Retail

Landlord covenants and agrees that so long as Tenant has not committed an Event of Default, Tenant’s peaceful and quiet possession of the Premises during the Term shall not be disturbed by Landlord or by anyone claiming by, through or under Landlord, subject to the terms and conditions of this Lease, any Mortgage, and all matters of record, or any other agreements to which this Lease is or may hereafter be subordinated.

 

Route 29/I-66 Corridor Office

• RBA: 3,057,959 SF
• Vacancy Rate: 9.1%
• 12 Month Net Absorption: 3,300 SF
• Average Asking Rent: $25.43
• 12 Month Rent Growth: 0.8%

The Route 29/I-66 Corridor (Gainesville & Haymarket) has seen significant growth from a residential and supportive retail standpoint, but there is little office demand in the area as evidenced by its small inventory of space. Of the 3,057,959 total square feet only 368,251 SF is considered 4 & 5-Star (12%). Over 89,000 SF of space delivered in the past 12 months with another 168,250 SF over three properties that is set to deliver in August 2020. This has the potential to increase vacancy and impact the submarket’s meager rent growth; however, it could also be an indicator of increased demand.

Route 29/I-66 Corridor Industrial

• RBA: 13,303,456 SF
• Vacancy Rate: 6.5%
• 12 Month Net Absorption: 254,000 SF
• Average Asking Rent: $11.83
• 12 Month Rent Growth: 4.5%

Gainesville and Haymarket’s industrial market is thriving and is 2^nd to only the Route 28 North submarket in terms of asset value. In the past 12 months, even with 193,000 SF of new inventory the submarket saw positive net absorption of 254,000 SF, a 0.6% decrease in vacancy, and rent growth of 4.5%. This is clearly an indication of strong demand and even with over 800,000 SF delivering in the next year and another 100,000+ SF proposed, it’s likely that fundamentals will remain strong.

Manassas Office

• RBA: 2,622,226 SF
• Vacancy Rate: 5.0%
• 12 Month Net Absorption: 29,000 SF
• Average Asking Rent: $21.69
• 12 Month Rent Growth: 0.4%

Fundamentals in the Manassas are solid… boring but solid. At 5% vacancy the submarket is well below the metro average and the past 12 months saw a 0.4% rent growth and 29,000 SF of net absorption. Still, at only 2,622,226 SF of total inventory, who cares? The submarket only has 163,000 SF of 4 & 5-Star space, the last of which delivered in 2009, and while Manassas rents may be affordable at an average $21.69/SF, the Route 29/I-66 Corridor seems more likely to absorb any new demand in Prince William County.

Manassas Industrial

• RBA: 6,692,340 SF
• Vacancy Rate: 1.3%
• 12 Month Net Absorption: 45,000 SF
• Average Asking Rent: $11.79
• 12 Month Rent Growth: 4.3%

Manassas’ industrial submarket is similar to its office market in terms of its relationship to the Route 29/I-66 Corridor. The submarket is only half the size of its neighbor with no new deliveries since Q4 2016 and none in the pipeline. The logistics industry makes up the majority of the inventory, which is not surprising when considering Amazon’s impact on brick and mortar retail.   Developers may see Gainesville and Haymarket as the future, but with average rents and rent growth only slightly lower ($0.04/SF and 0.2% respectively) and with vacancy at an astonishing 1.3%, Manassas still boasts strong fundamentals. A fact that is further evidenced by the average and median cap rate for sales in the past 12 months (6.4% and 5.6% respectively).

 

Commercial leases are binding, legal documents that should not be taken lightly. Purchase and sale agreements are “easy.” They dictate the terms of a single transaction at one moment in time. Leases, on the other hand, formalize a long-term relationship between the landlord and tenant. These parties have to “live with one another” and the terms of the lease govern what that life looks like, what is expected of each party, and what happens if either party violates the terms of their agreement.

Every commercial lease is different but, without exception, they are weighted in favor of the landlord. This is to be expected as the landlord is the one leasing their property to a (usually) unknown party. That being said, the level of one-sidedness varies and the goal when negotiating a commercial lease is to even it out so that the terms are reasonable. Reasonableness can vary as well based on the tenant and deal terms, but at the end of the day, a lease should protect the tenant against unnecessary, onerous, and/or malicious fees, disturbances, and requirements so that if they abide by the terms of the lease (particularly payment of rent) there won’t be any issues and they can quietly enjoy the space for the duration of the lease term.

This article deals with the approach to commercial lease negotiations from the tenant’s point of view. The emphasis on “how” relates to the appropriate and productive frame of mind or perspective from which to approach the lease terms based on the stage/round of negotiations. The relationship between landlord and tenant is always combative at first as both parties seek to extract the maximum concessions from the other; however, as the process nears lease signing it becomes increasingly collaborative as it is in the best interest of both parties to have a good relationship. While lease negotiations can involve multiple rounds of comments back and forth, there are generally 3 stages, each requiring a unique perspective from which to approach the process in order to yield the best results.

Stage 1: Tenant’s Initial Review

When the tenant first receives the lease from the landlord, they are receiving the most landlord-sided version of the lease and should approach the review with the assumption that the landlord is a scoundrel and will act in bad faith in any and every way the lease allows. First and foremost, tenants should verify that everything that was in the letter of intent (LOI) is accurately included in the lease, i.e. rent, renewal option(s), etc. I review every sentence and paragraph; imagining the craziest thing that could happen and how it could impact my client (based on their use). I identify the operative language (phrase, word, etc.) and either modify it or delete it to protect my client against probable and improbable situations governed by that particular section of the lease. When landlord’s consent or approval is required it should always be “not unreasonably withheld, conditioned, or delayed.” Exclusions or inclusions should be added where appropriate and/or for clarification to reduce the likelihood of (future) issues resulting from different interpretations. Finally, timeframes should be modified from “days” to “business days” to avoid unintentional defaults due to weekends or holidays. This is the most critical stage of the lease negotiations process in both its importance and the level of scrutiny applied.

Stage 2: Tenant’s Review of Landlord’s Response (to Tenant’s Initial Review)

In this stage, tenants receive a modified version of the lease in which the landlord has accepted some of the tenant’s changes, rejected others, and modified or added language in an attempt at compromise or to address the spirit or intent of the tenant’s requested change. Unbridled skepticism must be replaced by reason. Was the tenant’s original change/request reasonable? Is the landlord’s response? This stage requires a deeper understanding of the implications, likelihood, and purpose of specific lease terms/language. It is no longer productive to view the landlord as the enemy. In most cases, there are good reasons behind a landlord’s “push back,” and it’s important for a tenant to understand those reasons so that they can appeal to the landlord within that context. Some issues simply require push back from the tenant to be accepted by the landlord in the next round (persistence pays off) while others require a deeper, more nuanced explanation. There are times when landlords will simply not agree to a tenant’s demand/change, and, in cases such as this, tenants must conduct an honest risk analysis and realize, as the Rolling Stones said, “you can’t always get what you want.”

Stage 3: Conference Call

This is the collaborative phase of the lease negotiations. The best way to resolve any issues after Stage 2 is to schedule a conference call in which both parties discuss (and hopefully resolve) any remaining issues. The best approach at this stage is to approach the landlord as a friend and partner. It is in the tenant’s interest to express the rationale behind their request and explain to the landlord that they intend to be good tenants that pay on time but simply want to protect against any unforeseen or unintentional issues. In many cases, the landlord will agree to language that addresses the tenant’s concerns; however, when the landlord cannot or will not concede to the tenant’s request based on the impact on other tenants in the building/project and/or the landlord’s management of the property, they will explain why.  At the end of the day, both parties are entering into an agreement for their mutual benefit, and a conversation can go a long way to establish the trust necessary to formalize that relationship.

In response to the abuses that led to the Great Depression and its devastating impact on individual investors, Congress passed the Securities Act of 1933, also known as the “Truth in Securities Act,” which regulated interstate sales of securities, along with the Securities Exchange Act of 1934 which regulated sales of securities in the secondary market and created the Securities & Exchange Commission (SEC). A security is a certificate or other financial instrument that has monetary value and can be traded, i.e. stocks, bonds, derivatives, etc. Basically, the SEC was created to protect people from being scammed. They accomplish this goal by regulating the securities industry and specifically by determining the criteria for being an accredited investor.

As the term implies, “accredited” investors are “officially recognized or authorized” as sophisticated and/or capable of investing in higher-risk, unregistered investment vehicles. The SEC under Regulation D establishes the requirements for such individuals based on income, net worth, asset size, governance status, or professional experience. In order for an individual to be considered an accredited investor they must meet one of the following requirements:

1. Annual income of $200,000 (or $300,000 joint income if married) for the past 2 years with the expectation that one will earn the same or more in the current year.
2. Minimum net worth of $1,000,000 either individually or jointly if married. One’s personal residence is not included in their net worth, but neither is their mortgage counted as a liability. Net worth is defined as assets minus liabilities or what you own minus what you owe.
3. In 2016, Congress included registered brokers and investment advisors as accredited investors along with individuals that can prove sufficient education and/or job experience in unregistered securities.

If membership has its privileges, what’s so great about being an accredited investor? First, as the status denotes, accredited investors are financially stable, experienced, and knowledgeable. They understand the risks involved in an investment and/or have the resources to absorb reasonable losses. Second, whenever dealing with the government there is a cost associated with “red tape.” Regulatory filings and compliance can be costly. As a result, investments that can be offered directly to accredited investors are able to produce a higher return (by lowering costs). The final point is a combination of the previous two. The exclusivity of investments available only to accredited investors makes them valuable. Furthermore, the sophistication of the investors provides validation for the investment vehicle, itself. If such investments weren’t solid, safe, etc. they wouldn’t exist because no accredited investor would risk investing in them.

You can fool all the people sometimes and some of the people all the time, but you’d be hard-pressed to fool a bunch of high net worth individuals with investment experience.

I-395 Corridor

• RBA: 11,121,602 SF
• Vacancy Rate: 24.7%
• 12 Month Net Absorption: (27,200 SF)
• Average Asking Rent: $30.47
• 12 Month Rent Growth: 2.7%

Landlords in the I-395 Corridor are praying that the “Amazon effect” extends to their submarket, which has one of the highest vacancy rates in the metro at 24.7%. Rent growth was the highest in the area behind only the Capitol Riverfront, which may indicate an increase in demand to its proximity to Amazon’s HQ2. Still the submarket suffers from a lack of metro access and competition from neighboring submarkets like Falls Church, Crystal City, and particularly the Eisenhower Ave Corridor, which has only slightly higher rents, metro access, and an abundance of 4 & 5-Star properties. In fact, the I-395 Corridor has only slightly more 4 & 5-Star inventory at 5,362,225 SF vs. Eisenhower Ave’s 4,109,627 SF despite its total inventory over twice that of its neighbor. Time will tell if the submarket can recover from the damage done by BRAC. Apart from renewals from the U.S. Patent and Trademark Office and the GSA, leasing has been dominated by local businesses downsizing.

Eisenhower Ave Corridor

• RBA: 4,891,844 SF
• Vacancy Rate: 9.1%
• 12 Month Net Absorption: 29,500 SF
• Average Asking Rent: $36.24
• 12 Month Rent Growth: 3.9%

At only 4,891,844 SF, the Eisenhower Ave Corridor is a relatively small submarket; however, it is absolutely dominated by 4 & 5-Star properties which comprise 84% of the total office inventory. The submarket’s vacancy rate is comfortably below the metro average of 13.1%. The Department of Defense vacated 600,000 SF in 2017 but the building was demolished, which reduced the office inventory and vacancy levels. This large-scale move out was also offset by the National Science Foundation leasing 700,000 SF when 2415 Eisenhower Ave delivered in the same year. Two indicators that the “Amazon effect” may continue to improve fundamentals are the nearly 4% growth in submarket rents over the past 12 months along with the co-working company, Industrious, recently leasing 25,000 SF at Carlyle Tower. This may signal diversification in tenant mix in a submarket dominated by federal tenants. The submarket’s resiliency and attractiveness will be put to the test in a few years (2023, 2024, and 2025) when over 2.1 million square feet of space come up for renewal from government tenants. The USPTO, alone, occupies 2,000,000 SF.

Old Town Alexandria

• RBA: 10,398,384 SF
• Vacancy Rate: 10.9%
• 12 Month Net Absorption: (3,600 SF)
• Average Asking Rent: $33.45
• 12 Month Rent Growth: 1.3%

Conventional wisdom would suggest that Old Town Alexandria will benefit from Amazon’s HQ2 based on its location, alone; however, I do not believe this will be the case. The major issue with Old Town is that it’s old. Rent growth, while positive, is more likely the result of a strong economy rather than increased demand. The submarket is comprised mostly of 3 and 1 & 2-Star properties (over 77%), and the type of companies that will want to be in close proximity to Amazon will prefer neighboring submarkets with an abundance of 4 & 5-Star properties. Old Town is still Old Town and due to its walkability, retail amenities, and metro access it will still be attractive to certain, most likely smaller, tenants. Evidence of this is ALX Community and Spaces leasing approximately 59,000 SF in the past year. The two co-working companies clearly saw a demand from small businesses and entrepreneurs who want to work, live, and play in Old Town without having to sign “larger,” long-term leases.

Article X of the Constitution of Virginia mandates that all property shall be taxed. Furthermore, it requires such taxation be uniform upon the same class of subjects within the territorial limits of the taxing authority. Because revenue derived from real estate assessments makes up a significant portion of local government budgets, the importance of the process for determining a property’s fair market value cannot be understated. Tax rates vary from municipality to municipality and are subject to change. Therefore, in order to ensure that assessments are fair and equitable the Code of Virginia mandates the process be uniformly applied and in accordance with state statues and local ordinances.

Fairfax County, alone, has 362,089 individual properties to assess every year. As a result, the Department of Tax Administration uses accepted mass appraisal standards and techniques recognized by the International Association of Assessing Officers (IAAO) and other nationally recognized professional appraisal organizations. As the term implies, “mass appraisals” are different from appraisals of individual properties. When estimating the value of a group of properties, appraisers use different techniques based on the statistical analysis of large amounts of data. Properties are classified and stratified based on their characteristics with property type at the top of the hierarchy. Under the Code of Virginia, the Department of Taxation has established the following 7 classes:

1. Single-Family Urban
2. Single-Family Suburban
3. Multi-Family Residential
4. Commercial and Industrial
5. Agricultural or Undeveloped – 20-100 acres
6. Agricultural or Undeveloped – over 100 acres
7. Tax Exempt

Once classified and stratified, Assessing Officers will collect and analyze data that provide market value indicators. This data includes local economic conditions, planning and zoning regulations, neighborhood boundaries, current construction cost data, income and expense data for rental properties, recent qualified real estate sales, etc. and comes from public records, real estate and construction professionals, property owners, and physical inspections. This data provides the groundwork for the appraisal process.

There are 3 traditional approaches to property valuation: Cost Approach, Sales Comparison Approach, and Income Capitalization Approach. Without going into detail for each, it is enough to note that one approach may be more applicable than another based on property class/type. Assessing Officers consider this in addition to their statistical analysis of market value indicators to create Valuation Models.  It is these Valuation Models that provide the basis for uniformity.

The authority to levy taxes is one of, if not, the greatest power accorded to government. When you’re taking people’s money you need to be able to defend and justify the amount you’re taking. In order to do that there must be objective measures to ensure that the process is applied equally to everyone/all properties. Assessing Officers use accepted mass appraisal standards and techniques recognized by national professional appraisal organizations because they provide a third-party standard that in turn creates a uniform framework under which properties can be assessed. Perhaps the most important takeaway is that uniformity refers to the process not the outcome.

Source: Virginia Department of Taxation, Board of Equalization Manual

Successful lease negotiations are based in a comprehensive understanding of the terms and provisions, what’s important about each, and how they impact a particular client (tenant). While every commercial lease is different, there are some provisions that are in every commercial lease. The Hazardous Materials section is a prime example. Language may vary, but there are common points/themes that are important to consider and negotiate:

Definition/Exceptions

Whenever a lease term is capitalized it’s because it has a specific description or definition within the lease. For example, “default” and “Default (or Event of Default)” do not mean the same thing because lower case “default” includes notice and cure periods while capital “Default” defines a violation that is beyond such notice and cure periods. Hazardous Materials is similar in that it is defined by specific federal laws that are the same in nearly every lease. “Hazardous Materials” are defined as a “hazardous substance”, “hazardous material”, hazardous waste”, “regulated substance” or “toxic substance” under:

• Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. §9601, et seq.
• Hazardous Materials Transportation Act, 49 U.S.C. §1801, et seq.
• Resource Conservation and Recovery Act of 1976, 42 U.S.C. §6901 et seq.
• Clean Water Act, 33 U.S.C. §1251, et seq.
• Safe Drinking Water Act, 14 U.S.C. §300f, et seq.
• Toxic Substances Control Act, 15 U.S.C. §2601, et seq.
• Federal Insecticide, Fungicide and Rodenticide Act, 7 U.S.C. §136 et seq.
• Atomic Energy Act of 1954, 42 U.S.C. §2014 et seq.
• and any similar federal, state or local Laws, and all regulations, guidelines, directives and other requirements

Examples of exceptions are for cleaning and/or office products or limitations on quantity, but this is not really necessary as the materials that would trigger a default under this section are clearly defined and legal/proper use and disposal is always a requirement.

 Property Type/Use

The relevance/importance of the Hazardous Materials sections is directly impacted by the property type and use of the space. Tenants leasing industrial space are more likely to be impacted by the section based on their own use, that of neighboring tenants, and/or previous tenants. Office users generally have the least to worry about based on the nature of their use: “general office.” Tenants must understand if their business requires the use of any Hazardous Materials. If so, this should be disclosed to the landlord prior to leasing, but most importantly the tenant must use, store, and dispose of such Hazardous Materials according to applicable laws.

Inspections

Landlords may require the right to inspect the tenant’s space to check for the presence of any Hazardous Materials violations. Such rights should be based on a reasonable standard/just cause and, while landlords would not typically expend the resources to frivolously inspect the premises, the cost should be born by the landlord unless any violations are discovered. Tenants will always be responsible for remediating any contamination (that is the fault of the tenant).

Preexisting Conditions

Depending on the property type, tenants may want to inspect the property for the existence of Hazardous Materials. This is particularly and primarily important with land (office not so much). It’s good to have the landlord indemnify the tenant against the existence of any Hazardous Materials present prior to the tenant’s occupancy, but better to have them covenant that there are no Hazardous Materials prior to the tenant’s occupancy. The first requires the tenant to prove that the Hazardous Materials were there before they occupied and not the result of their occupancy while the latter puts the burden of proof on the landlord.

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Hazardous Materials wouldn’t exist if they weren’t used in one capacity or another. This universal lease provision is mostly a “cover your butt” for the landlord. In most cases they’re never used; making it a relatively irrelevant section in most leases. When it does apply the tenant simply needs to use, store, and dispose of the Hazardous Materials according to applicable law and pay to remediate any violations, spills, etc.

Second best isn’t that bad when considering your competition. Tysons Corner and Reston are two of the largest office submarkets in the country with a combined 50,536,733 SF, 29,519,533 SF of which is comprised of 4 & 5-Star properties (58.4%). That’s only slightly less than Herndon, Fairfax Center, and Merrifield’s entire inventory combined (30,903,488 SF). Whether a matter of perception (Herndon), lack of direct access to Metro stations (Fairfax Center), or delayed development (Merrifield), these submarkets are often an afterthought for tenants when considering where to locate their business; however, with more than 16.5 million square feet of 4 & 5-Star properties between them, these submarkets offer both quality and value with average rents well below the both the metro average (45.19/SF) and Reston ($36.93/SF) and Tysons ($39.97/SF).

Q3 2019 saw an improvement in nearly every metric in each submarket with only Herndon’s 12-month rent growth seeing a slight decline from 2.1% to 1.4% (still positive). Each submarket has its own reason to be optimistic, but the common theme seems to be that the secret is out!

Herndon

• RBA: 12,769,326 SF
• Vacancy Rate: 16.1%
• 12 Month Net Absorption: 95,800 SF
• Average Asking Rent: $31.20
• 12 Month Rent Growth: 1.4%

In 2017, Amazon Web Services moved to Herndon; constituting the largest deal in over 5 years. This was in no small part to Herndon’s proximity to data center alley not to mention Dulles International Airport. With Amazon’s decision to locate its HQ2 in Crystal City coupled with the Silver Line expansion (set to deliver in Q3 2020), the submarket is poised for explosive growth. In fact, we may be seeing the beginning of this renaissance. Herndon’s vacancy rate is above the metro average, mostly due to large scale move outs, but saw a decrease of 0.7% in the past quarter in addition to a 348,800 SF positive swing in net absorption. Rents increased by $0.44/SF on average from last quarter. Currently there is more than 2,000,000 SF available but much of that is within half a mile of the Silver Line stations. Developers may be waiting to break ground due to the existing inventory and vacancy level, but there are more than two dozen projects in the proposed pipeline and sales volume in Herndon is the highest in Northern Virginia.

Merrifield

• RBA: 10,249,212 SF
• Vacancy Rate: 13.4%
• 12 Month Net Absorption: 57,300 SF
• Average Asking Rent: $32.55
• 12 Month Rent Growth: 3.3%

In 2015, Exxon Mobil vacated more than 1,200,000 SF when it moved its headquarters from Merrifield to Houston. As a result, the submarket’s vacancy rate skyrocketed to 25% and while it has since recovered it is still slightly above the metro average (13.1%). Inova filled the void by occupying the former campus, but has since scrapped its plans to develop/occupy 15,000,000 SF; returning the original proposal of 5,000,000 SF. This is still a significant expansion, on par with Amazon (6,000,000 SF by 2024). Time will tell if there is an “Inova effect;” characterized by increased demand from smaller tenants that wish to be close to the healthcare giant, but currently tenants are leaving the submarket for more urban environments along with Tysons Corner and Reston. This is evidenced by the lack of any new development in the past 10 years, none in the pipeline in the next 12 months, and sales of  little more than $10,000,000 since the start of 2018.

Fairfax Center

• RBA: 7,884,950 SF
• Vacancy Rate: 20.9%
• 12 Month Net Absorption: 186,000 SF
• Average Asking Rent: $30.10
• 12 Month Rent Growth: 3.6%

Fairfax Center has cause to be cautiously optimistic due to 6 consecutive quarters of positive net absorption; resulting in a significant decrease in the submarket’s vacancy rate. Still at 20.9% it is well above the metro average. The positive leasing activity can be attributed to the increase in defense spending in the recent budget, but in a submarket heavily occupied by large government contractor tenants it is especially vulnerable to large scale move outs.