TRANSWESTERN OUTLOOK DC AT Q1O8 Even With Soft Office Absorption, Vacancy Remains Low; Rents Continue to Edge Up The District of Columbia s office market experienced steady conditions during the 1st quarter of 2008. Although absorption was sluggish over the past three months, vacancy remains low and rents ticked up by 1.0% (4.0% annualized). Groundbreakings ceased this quarter. However, the pipeline remains high. Regardless, the District remains one of the top performing areas in the nation, with a strong tenant base, low vacancy rate, and high barriers to entry. 1 st Quarter 2008 Office Market Highlights: Net absorption: 37,000 SF, compared to 1.3 million SF in 2007. Overall vacancy rate: : 6.5%, down from 7.6% one year ago. Direct vacancy rate: 5.8%, down from 6.7% one year ago. Sublease space: Decreased by 13,000 SF. Sublease space represents just 0.7% of the inventory. Pipeline (U/C and U/R): 8.7 million SF, up from 6.2 million SF one year ago. Pipeline pre-lease rate: 26%, compared to 34% one year ago. Rents: : Up 4.0% annualized during the 1st quarter, compared to 3.8% in 2007. Investment sales: : $134 million, compared to $1.1 billion in the 1st quarter of 2007. Average sales price: $453/SF.
Net Absorption: Anemic Net Absorption in 000s of SF 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Office Net Absorption District of Columbia 1997 Through 1 st Quarter 2008 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008* Source: Delta Associates; March 2008. Long-Term Absorption Average = 2.2 Million SF *Annualized. The District of Columbia absorbed 37,000 SF during the 1st quarter of 2008, compared to 499,000 SF during the 4th quarter of 2007. In 2007, net absorption totaled 1.3 million SF, compared to the long-term average of 2.2 million SF per annum. The East End surpassed other submarkets in net absorption during the 1st quarter of 2008, as leasing activity boosted net absorption in this submarket over the past three months. The CBD submarket experienced negative absorption this quarter, as the Corporate Executive Board vacated its office space and relocated to the Waterview building in Northern Virginia. We expect more tenants to relocate from the District to Northern Virginia, as the economic climate is changing and Northern Virginia is an affordable alternative. Several tenants have already made the move. For example, Bureau of National Affairs (BNA), DeticaDFI, and Council on Foundations. East End Georgetown Southwest Capitol Hill/NoMa Uptown Net Absorption of Office Space District of Columbia Submarkets 1 st Quarter 2008 Absorption Deliveries Sublease space represents just 0.7% of the District s standing inventory. Sublease space availability decreased by 13,000 SF during the 1st quarter of 2008, compared to increasing by 180,000 SF during the 4th quarter of 2007. In 2007, 18,000 SF of sublease space was returned to the market. Net absorption of Class A space totaled 156,000 SF during the 1st quarter of 2008, compared to 540,000 SF during the 4th quarter of 2007. In 2007, Class A net absorption totaled 990,000 SF. West End CBD -500-400 -300-200 -100 0 100 200 300 400 500 Square Feet (in thousands) Note: Deliveries includes renovations.
Gross Leasing: Below Average Thousands of New Jobs Gross SF Leased (in millions) 20 15 10 5 0 15.0 10.9 10.4 10.9 11.8 12.2 12.5 2000 2001 2002 2003 2004 2005 2006 2007 2008* Source: CoStar, Delta As sociates; March 2008. Gross Leasing Activity District of Columbia 2000 Through 1 st Quarter 2008 15-Year Average = 10.6 Million SF 7.7 6.9 *Annualized estimate. Note: Data updated each quarter. We estimate that gross leasing activity for existing space will total roughly 6.9 million SF in 2008,below the 15-year average of 10.6 million SF. The most notable deal of the 1st quarter was the Federal Aviation Administration s lease of 100,000 SF at 950 L Enfant Plaza, SW in the Southwest submarket. There are 198 buildings with blocks of available contiguous space over 10,000 SF. The East End and CBD combined have the majority of these blocks. The largest block of available space is 1.4 million SF at Constitution Center, the former Department of Transportation headquarters. This space is currently under renovation and is due to deliver April 2009. Buildings with Contiguous Blocks of Available Space District of Columbia March 2008 250 200 198 Number of Office Buildings 150 100 50 119 71 42 0 10,000 SF 20,000 SF 50,000 SF 100,000 SF Minimum Size of Contiguous Blocks of Space Source: Delta Associates analysis of CoStar data; March 2008. Note: Includes buildings under construction or renovation
Submarket Inventory (SF) 1 st Qtr. 2008 NET OFFICE ABSORPTION AND VACANCY BY SUBMARKET: DISTRICT OF COLUMBIA Net Absorption (SF) Vacancy: Class A Rising Over the Year Q1 2008 Vacancy 2005 2006 2007 1 st Qtr. 2008 Direct With Sublet CBD 38,789,025 357,000 730,000 (132,000) (388,000) 4.9% 6.0% East End 43,025,454 446,000 899,000 1,270,000 322,000 5.5% 6.1% Capitol Hill 15,464,021 742,000 1,748,000 212,000 15,000 6.2% 6.3% Southwest 11,590,385 27,000 (764,000) 313,000 46,000 9.4% 9.5% Georgetown 2,964,995 (61,000) 42,000 (89,000) 56,000 5.3% 8.6% West End 3,700,894 11,000 (67,000) (237,000) (22,000) 11.8% 12.7% Uptown 8,210,990 77,000 107,000 (41,000) 8,000 3.2% 4.0% District 123,745,764 1,599,000 2,695,000 1,296,000 37,000 5.8% 6.5% VACANCY RATES AND VACANT SPACE (ALL CLASSES) THE DISTRICT MARCH 2007 vs. MARCH 2008 March 2007 March 2008 Vacancy Rate Direct 6.7% 5.8% Sublet 0.9% 0.7% Vacant Space (Millions of SF) Direct 8.1 7.2 Sublet 1.0 0.9 Source: CoStar, Delta Associates; March 2007. The District s overall vacancy rate edged up to 6.5% at the end of the 1st quarter of 2008, from 6.4% at year-end 2007, but is down from 7.6% one year ago. The direct vacancy rate in the District is 5.8% at March 2008, up from 5.6% three months prior, but is down from 6.7% one year ago. It is important to note that vacancy declined over the past year due to Constitution Center, a vacant 1.4 million SF building, changing status during the 3rd quarter of 2007 from available and vacant to under renovation. Office Vacancy Rate 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Office Vacancy Rate District of Columbia 1997 Through 1 st Quarter 2008 Overall Direct 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1 2008 The District s overall Class A vacancy rate edged up to 8.2% at the end of the 1st quarter of 2008, from 8.1% at year-end 2007, and 7.2% from one year ago. The Class A direct vacancy rate is 7.3% at March 2008, up from 7.2% at December 2007 and 6.4% one year ago.
Construction High; Pre-Leasing Low Square Feet (in thousands) Leasing on Recent Deliveries and Projects U/C or U/R District of Columbia 2005 2009 7000 6000 5000 4000 3000 2000 1000 0 SF Available SF Pre-Leased or Leased 2005 2006 2007 Q1 2008 Q2, Q3, Q4 2008 2009 Recent Deliveries OFFICE SPACE U/C OR U/R THE DISTRICT MARCH 2008 Submarket SF % Pre-leased Southwest 2,946,000 28% Capitol Hill/NoMa 2,509,000 22% East End 1,725,000 28% CBD 1,512,000 26% Total: 8,692,000 26% 27% Projects U/C or U/R Note: Recent deliveries are based on % leased upon delivery. There is 8.7 million SF of office space under construction or renovation in the District at March 2008, compared to 6.2 million SF one year ago. Several pipeline projects are renovations, particularly in the CBD submarket. Renovations represent at 31% of the total District pipeline. Notably, Constitution Center, a 1.4 million SF building, is currently under renovation in the Southwest submarket. 26% of space under construction or renovation at March 2008 is pre-leased, compared to 34% one year ago. Projects set to deliver during the remainder of 2008 and 2009 are currently 22% and 28% pre-leased, respectively. These pre-lease rates are subpar, given the 10-year average pre-lease rate is 53%. The Southwest and Capitol Hill/NoMa submarkets contribute substantially to the total project pipeline. Both submarkets have significant projects underway, as the city and private investors work to revitalize the Southwest Waterfront and the NoMa neighborhood. Although pre-lease rates in the Southwest and Capitol Hill/NoMa submarkets remain low, they should begin to gain traction in the near-term, as the Southwest submarket gains tenants looking to be near the stadium and waterfront development and more tenants become interested in NoMa, now that the Department of Justice and NPR plan to relocate to this submarket.
There were no new projects breaking ground in the District during the 1st quarter of 2008. This compares to 2.5 million SF started during the 4th quarter of 2007. In 2007, 7.4 million SF of office space broke ground. We expect groundbreakings to be light this year, given the state of the market. EFFECTIVE RENT CHANGES BY CLASS OF SPACE DOWNTOWN WASHINGTON DECEMBER 2006 TO DECEMBER 2007 Class of Space Rent Change Class A +3.6% Class B +4.1% Class C +2.2% Office deliveries, including renovations, totaled 442,000 SF during the 1st quarter of 2008, compared to 1.2 million SF during the 4th quarter of 2007. In 2007, 2.3 million SF delivered at 41% leased. Supply v. Demand: Vacancy to Rise We project overall vacancy will increase in the District to 10.7% by March 2010, from 6.5% today. We anticipate new supply will outpace demand by 6.2 million SF over the next two years. Demand has not been able to keep up with development of spec projects in the District. At March 2008, roughly 33% of pipeline projects in the District have no pre-leasing. As developers scale back on new spec projects, demand will be able to catch up to this new supply. Rents: Up 1.0% in Q1 2008 Office rents, for all classes of space, rose 1.0% in downtown Washington during the 1st quarter of 2008, or at an annualized rate of 4.0%. In 2007, rents increased 3.8%. With construction costs on the rise, developing new projects has become an expensive task. In response to higher costs, property owners have increased asking rental rates in order to make deals pencil. At year-end 2007, to construct a high-rise downtown office project, the minimum rent needed was $60.00/SF. Given easing market conditions, we expect inking leases at this rate will become increasingly difficult. As vacancy rises in 2008 and 2009, we anticipate rent growth will ease to 1.0% to 2.0% in 2008 and stabilize in 2009 when vacancy reaches double digits.
Investment Sales: Easing in DC Address/Submarket 1111 19th Street, NW CBD 918 F Street, NW East End 1210 18th Street, NW CBD SELECTED INVESTMENT SALES THE DISTRICT 1 ST QUARTER 2008 Source: CoStar, Real Capital Analytics; March 2008. Price/Buyer $115.0 million ($456/SF) ING Clarion Partners $13.6 million ($439/SF) Douglas Development Corp. $5.2 million ($412/SF) Douglas Development Corp Investment sales volume totaled $134 million on three transactions during the 1st quarter of 2008, compared to $906 million on nine transactions during the 4th quarter of 2007. The sales volume in 2007 totaled $3.2 billion. AAverage sales price for 1st quarter 2008 was $453/SF, down slightly from $460/SF in 2007. Cap rates remain around 6.0% for core assets, as they were for most of 2006. A handful of deals achieved cap rates below 6.0% during the 1 st quarter of 2007. We believe that cap rates may flat and then rise gradually over the next two years, as interest rates rise and alternative investments become more attractive. Land Sales: No Activity There were no notable office land sales during the 1st quarter of 2008. This compares to $31.5 million in land sales during the 4th quarter of 2007. In 2007, land sales totaled $159.2 million on four transactions. The average land price per SF was $830 for 2007 sales. Land prices have increased due to competition for parcels located near the baseball stadium and within the rising NoMa neighborhood. We expect land sales in the District to be sparse during the remainder of 2008, as the economic climate is cooling and few parcels of available developable land remain.
District of Columbia Office Market Outlook We expect the District s office market to experience softening conditions during the remainder of 2008. With numerous projects in the pipeline, we project vacancy to rise over the next 24 months. Although demand should remain steady during the next two years, we anticipate it will not be enough to balance the new supply hitting the market. Rents should react to these conditions and only rise by 1.0% to 2.0% as landlords compete to fill vacant space. Decision-making by the GSA in the near-term could impact District office space, as the Department of Homeland Security intends to relocate to the St. Elizabeth s campus from space in over 60 buildings, primarily located in the District. In addition, the GSA plans to implement a telecommuting program that will shift 50% of government workers into telecommuting roles by 2010. Overall, the outlook for the District remains positive, as the area currently retains one of the lowest vacancy rates and the most premier space options for tenants. Office Market Outlook: Overall Vacancy: Expected to rise from 6.5% today to 10.7% by March 2010. Leasing Activity: Steady in 2008. Construction: Groundbreakings on new projects should ease in 2008. However, renovations should remain steady. Rents: : Expected to rise 1.0% to 2.0% in 2008. Trophy and better buildings in stronger submarkets will outperform these averages. Investment Sales: Light in 2008, as the market sorts out the Credit Crunch.
The District Flex/Industrial Market: Soft Conditions The District s flex/industrial market experienced soft conditions during the 1st quarter of 2008. Net absorption totaled negative 180,000 SF during the past three months, compared to negative 3,000 SF during the 4th quarter of 2007. Net absorption of flex/industrial space totaled negative 195,000 SF during 2007, compared to the 10-year annual average absorption of 91,000 SF. Absorption was soft during the first three months of the year due to several tenants vacating blocks of space. For instance, Verizon vacated 69,000 SF at 1711 Florida Ave NW and CNC vacated 36,000 at 2052 West Virginia Ave NE. The District s overall flex/industrial vacancy rate increased to 11.4% at the end of the 1st quarter of 2008, compared to 9.9% at year-end 2007 and 8.7% one year ago. The direct vacancy rate is also 11.4% at March 2008. There is one flex/industrial project under renovation in the District at March 2008. A 31,000 SF flex/warehouse building is under renovation at 7046-7050 Spring Place, NW. Renovations should be complete by the start of 2009. The warehouse building located at 1111 N. Capitol Street in NoMa will soon go under the chopping block, as NPR plans to convert this building into a 400,000 SF office for its new headquarters. Flex/industrial rents edged down 1.0% in the District during the 1st quarter of 2008, after rising 4.1% during 2007. We expect rent growth to decelerate in 2008, as the economic climate is changing. We expect the District s flex/industrial market to remain steady during the balance of 2008. Although vacancy increased during the first three months of 2008, we anticipate this was only a hiccup due to a handful of tenants vacating space. We expect overall vacancy to edge down during the year, as demand remains steady. Rents should rise modestly over the next 12 months.
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