D.C. Set For Healthy, Yet Challenging, Year

The volatile credit market has not spared the nation’s capital its wrath, but “recession-resistant” Washington, D.C. is still poised for a healthy, yet more difficult, 2008. Delta Associates and Transwestern addressed these challenges and opportunities at their 11th annual Trendlines event, held last evening at the Ronald Reagan Building & International Trade Center in Washington, D.C., with over 1,000 in attendance. Larry Heard, Transwestern’s president & CEO, opened the event, and noted that he recently attended a real estate roundtable where 200 leaders were split on whether the U.S. will move into recession. “But most agreed that 2008 was going to be a challenging year,” he said. Last year, the market was talking about how high rents could go and how low cap rates can compress, but now chatter revolves around SIVs, or special investment vehicles, added Thomas Nordlinger, Transwestern’s president of the Mid-Atlantic region. “May you live in interesting times,” said Gregory Leisch, founder & CEO of Delta Associates, calling on the ancient proverb in light of the Chinese New Year. And, indeed, these “interesting times” will create opportunities in the changing market, which still has strong fundamentals and plenty of capital available, albeit more expensive. “There’s a sense of uncertainty, but I see a lot of opportunity in the path forward.” The biggest trends that have affected the nation’s capital include: the credit crunch, with decreased CMBS issuances, tougher underwriting and leveraged buyers leaving the market; the weak U.S. dollar; increased inflation; slowing GDP and job growth, caused by housing stressed, energy costs and the credit turmoil; and a slower D.C. market overall, which saw diminished activity from its leading economic source, the government. However, there are some silver linings to these clouds, Leisch pointed out. For instance, the weak dollar has generated U.S. jobs and fostered foreign investment, while increased inflation caused a hedge for real estate, which has become a favored asset class. And Washington, D.C., is still 200 basis points over the U.S. average for GDP growth. The city’s three-year growth of 41,000 jobs will be enough to support commercial real estate if the market does not suffer and oversupply, and service sector growth is almost double that of the U.S. overall. The 376 million-square-foot office sector has an overall 9.1 percent vacancy rate that is expected to go up 60 basis points this year, but will still fall under the U.S. average of 11.1 percent. Gross leasing is down, due to a decrease in General Services Administration and government procurement activity, shadow space and changes in tenant space. Inside the Beltway will see vacancy rates rise from 7.2 percent to 10 percent, and rental rates will undergo negative pressure. Outside the Beltway will see vacancy jump from 11.5 percent to 13 percent, and rental rates will be under pressure. Washington, D.C.’s CBD and East End submarkets, as well as Northern Virginia’s Crystal City, Rosslyn and Reston submarkets, will be the strongest performers. Looking forward, keys to success in the office sector will be in areas close to transit, tenant-driven, in a submarket with a low pipeline and with a low land-cost basis. The market will especially be looking for build-to-suits, environmentally friendly buildings, medical-related facilities and repositioned Class B assets. The 334 million-square-foot Baltimore-Washington Corridor industrial sector is currently 9.5 percent vacant, down 30 basis points. Baltimore will see a bigger dispersion in demand and supply in the long-term versus Washington, D.C. Rental rates will continue to rise, but not as robustly as the past three years. Future opportunities include distribution warehouses and flex research & development space. Like office, these should be in submarkets with a low development pipeline, a low land basis and tenant-driven. The 201,000-unit residential condominium market has seen the worst, but has begun to stabilize and “better times are ahead,” Leisch said. Building permits are down compared to the long-term annual average of 31,000, and 2007 saw developers cancel 75 projects, with 12,000 units turned into apartments. Prices have also begun to stabilize and interest rates are at historic lows, so the sector is poised to recover ahead of the housing market. Successful projects are located near mixed-use areas, transit and job concentration, and the market has opportunities for boutique builders, units aimed at first-time homebuyers and units that contain high-end features. The 504,000-unit apartment market’s vacancy rate rose from 2.9 percent to 3.6 percent, but still leads the nation in Class A apartments. Three-year demand will call for an additional 14,000 units, but upcoming deliveries will increase the vacancy rates to a higher 5.3 percent in that same period. Rental rates are expected to rise 1 to 2 percent, and submarkets with the strongest growth include eastern Prince William’s County, some of Prince George’s County, Bethesda-Chevy Chase, Md., the Baltimore-Washington Corridor, Germantown, Md. and Crystal City, Va. Opportunities exist in asset reposition, superior design and location and niche building for senior and student housing. One sector that has remained virtually unchanged is the 52 million-square-foot grocery-anchored retail, in which D.C. is “chronically short,’ Leisch said. There are over 19,300 residents per grocery store, way above the U.S. average of 8,100 residents per grocery store. Vacancy rates should remain low and rents continue to climb throughout this year for most retail types. Thos who invest in repositioning older product or develop new lifestyle, mixed-use and grocery-anchored centers will see the most success. “The market is looking forward to deal with problems in an opportunistic manner,” said Kelly Toole, a partner in Greater Washington Area Beers & Cutler P.L.L.C. who concluded the event. “There’s growth anticipation in many areas.” Besides the Trendlines overview and forecast, the event honored Oliver Carr III, president & CEO of Carr Properties, with its annual Trendsetter Award. “When people usually talk about cars, they’re talking about hybrids and prices per gallon,” said Michael Harreld, regional present of the Greater Washington Area PNC Bank, who presented the award. “But in this market, when you talk about a Carr, it’s about quality and a long history.” Carr was quick to dedicate the award to his team, and noted that that taking a risk and starting his own business was one of the best decisions he has ever made.