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Q4 2016 | Northern Virginia | Office Market Report

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Northern Virginia continued to see increased demand in the fourth quarter, although 2016 numbers do not reflect that. Almost all indicators are positive, but how will rental and vacancy rates fair as the 4.8 million square feet of office space under construction starts delivering?

ECONOMICS

During 2016, the Northern Virginia economy grew by 3.5 percent and generated nearly 30,000 new jobs. Of this growth, 57.4 percent or 16,800 positions were created in office-using sectors of the economy. While this was impressive growth, major industries within
the area were unable to fully engage in the leasing market.

The Government Contracting sector of the economy is the largest and most influential of these industries. While employment has been growing and there is every expectation that procurement spending will increase by about five percent in 2017, political infighting on Capitol Hill continues to create uncertainty as to how the government will be funded and exactly what its spending priorities will be. Until Congress clarifies some of these uncertainties, contractors are expected to be very reluctant to engage the leasing market. There are a few events in the near future which will provide indications as to how productive and collaborative Congress will be. The debt ceiling debate expected this coming spring will be the first litmus test. The second will be the fiscal year 2018 budget debate in the fall. The success of Congress to effectively pass legislation will help communicate where the opportunities exist for contractors, and will allow them to better plan for their businesses.

DEMAND

Northern Virginia saw a drop in demand in 2016, with 328,958 square feet of space given back to the market. There is good news, however. The second half of the year showed promise with two quarters of positive net absorption in a row, taking 505,861 square feet off the market in the fourth quarter alone. These events were not enough to pull 2016 net absorption out of the red as the first half of the year accounted for 1,208,671 square feet of negative absorption. 

The fourth quarter was the only quarter in 2016 that saw positive net absorption in all three building classes. Demand for Class A space increased with 147,405 square feet occupied during the fourth quarter, compared to 626,585 square feet last quarter and 260,207 square feet year ago during the last quarter of 2015. Class B space had the largest demand, totaling 264,544 square feet during the fourth quarter. This was major increase over the third quarter, which registered 11,537 square feet of absorption, but closely mirrored the fourth quarter of 2015, which saw 260,357 taken off the market. Class C space saw 93,913 square feet absorbed during the fourth quarter. This was a positive jump compared to the third quarter when 264,235 square feet was added back to the market. 

While demand in Northern Virginia was positive, a drop in absorption was registered in both Loudoun County and Alexandria City. While it was minimal in Alexandria City, which gave back 5,819 square feet to the market during the fourth quarter, Loudoun saw a much larger drop in demand. The county saw 123,993 square feet given back. This compared to 325,633 square feet occupied in the third quarter of 2016.

SUPPLY

Construction activity remained high, ending the fourth quarter with 4.80 million square feet under construction, the highest since 2013, when the market had 4.83 million square feet being constructed. Tenants flocked towards new space in the market, continuing demand for new Class A space. Two buildings broke ground during the fourth quarter. The larger of the two was the Boro Loft at 1640 Boro Place, which will total 143,606 square feet. Contrary to what has happened in the past, this building broke ground on a speculative basis and is positioning itself as a slightly more economical option to the Boro Tower. Additionally, the National Institute for the Blind’s building broke ground at 3000 Potomac Avenue in the Old Town Alexandria submarket. The Institute owns the building and will occupy 58,000 square feet of the 100,000 square foot building. Crystal Square 3 which is located at 1770 Crystal Drive, formally 1750 Crystal Drive started renovations which will be completed during the second quarter of 2018. Renovations commenced following the U.S. Marshalls move-out. 

Loudoun County was home to the only delivery during the fourth quarter, One Loudoun Marblehead Office Park-Phase II at 20745 Williamsport Place. This, 35,700-square-foot medical office building, entered the market 51.0 percent leased, which is comprised of a mix of both medical and technology tenants.

VACANCY

The continued growth in demand for office space led to a drop in overall vacancy rates, which fell 35 basis points from 18.4 percent to 18.0 percent during the fourth quarter. Vacancy rates were observed falling in all classes of space. Class A Vacancy dropped 15 basis points since the last quarter to 18.5 percent and the combined Class B & C vacancy rate fell 55 basis points to end the quarter at 17.5 percent.

Even with the increase in demand, a continued shift towards efficient space and 4.8 million square feet of space under construction are likely to create a floor for vacancy rates that will be hard to break.

RENTAL RATES

During the fourth quarter, the direct average asking rate increased from $31.44 to $31.51 per square foot. This compares to the same time last year when the direct average asking rate was $31.42 per square foot. The increase was largely impacted due to Class A rates rising by 37 cents, ending at $34.97 per square foot. Class B rates saw a 10 cent drop over the quarter, ending at $28.91 per square foot.

In the Northern Virginia market, landlords are in an arms race to amenitize their buildings to attract tenants. Often these tenants are not considering buildings that do not have amenities that the workforce now views as necessary even if they are not utilized. This race to amenitize did not have a drastic effect on rental rates, but they position buildings to compete with the other product in the market, especially as vacancy rates remain high.

OUTLOOK

After a rough start during the first half of year, fundamentals in Northern Virginia tightened during the second half of the year. Demand increased, rental rates rose in Class A space as tenants continue to move to newer, nicer space and vacancy rates saw a drop in all three classes. Was there anything to have concern about? Looking at the amount of construction underway leads to some pause; 4.8 million square feet hitting the market in the near future. While a lot of this space is pre-committed, at the end of the fourth quarter, two buildings are under construction on a speculative basis. If they don’t have significant leasing upon delivery, this will bring a considerable amount of vacant space on the market. Another concern with so much space coming online is that the pre-leased space in the new construction will pull those tenants out of other buildings within the market causing vacancies in existing product. Even with an increased demand, it will be difficult to offset the impact of new supply on vacancy. 2016 ended on a high note and the future looks better, just maybe not for vacancy rates.


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