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Q3 2016 | Suburban Maryland | Office Market Report

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The second half of 2016 began with a substantial decrease in deal velocity and market activity in the Suburban Maryland Market. There was one exception, however, the National Institutes of Health (NIH) signed a 15-year lease at 1 and 2 Rockledge Centre for roughly 500,000 square feet. The NIH took the remainder of 1 Rockledge and renewed at 2 Rockledge in middle September. Not only was it the largest lease of the quarter, it was also one of the few recent major Federal leases without direct Metro access. The lack of immediate Metro accessibility is rare on new Federal leases, but the Centre’s access to the I-270 spur alleviates some of the need for Metro. The NIH will be consolidating from several buildings in Suburban Maryland with the largest move-out coming from 100,000 square feet at 6011 Executive Boulevard in Rockville. In a related deal, the NIH renewed for two years at 6100 Executive Boulevard for just over 62,000 square feet. This building will eventually be vacated for Rockledge Park but the extension was needed in the short-term to prepare for the move. 

After several quarters of surprisingly strong private sector leasing activity, it was not a tremendous shock that the third quarter lacked the same vitality. The largest new tenant to the market, 2U, which initially took just over 200,000 square feet in the Lanham submarket, has expanded into another 50,000 square feet. They have been one of the most impactful tenants to the market and will not only cause a significant decrease in vacancy to the submarket but also to Prince George’s County as a whole. 2U is a combination of two of the fastest growing industry segments in the region, education and technology.

ECONOMIC

The regional economy associated with the Suburban Maryland office market has grown significantly since the beginning of 2016. During the third quarter, the economy grew at an annualized rate of 3.23 percent. This compares to 1.37 percent annualized growth at the beginning of 2016.

As the economy has been expanding, companies have being increasing their payrolls. Since the beginning of the year, the economy has produced 23,710 jobs. However, the bulk of the job creation occurred in industries not associated with the office market. In fact, only 7,000 new jobs were created in office-using sectors of the economy. Only two of the five primary office-using sectors of the economy were responsible for this growth. During the year, there were 6,430 jobs created in the professional and business services industries, and 520 jobs were created in the media/telecommunications industries. This growth was offset by job losses from financial and other services companies. Combined they eliminated 680 positions.

DEMAND

The dramatic swings in net absorption over the last four quarters continued as negative 141,983 square feet was registered in the third quarter. This follows the second quarter when net absorption totaled positive 152,886 square feet. For the year, demand has contracted by 215,163 square feet. During the third quarter, demand for space in Montgomery County fell by 166,016 square feet. Demand grew by 24,003 square feet in Prince George’s County offsetting some of this loss. Overall, year-to-date, demand has been negative in both Prince George’s and Montgomery Counties.

SUPPLY

For the second quarter in a row, there were no deliveries in Suburban Maryland. There was over 400,000 square feet of office space removed due to conversions and federally-owned-and-occupied properties being removed from inventory, effectively decreasing the total square footage for the market. Year-to-date, just 201,494 square feet has delivered to the market, while 607,588 square feet has been removed from inventory for various reasons. 

At the end of the third quarter, only four buildings, totaling, 170,639 square feet were under construction in Suburban Maryland. The largest was the Greencourt Innovation Center at 12358 Parklawn Drive in Rockville. The 103,550-square-foot, Class A office building is expected to deliver completely vacant next quarter.

VACANCY RATES

Despite the negative absorption that occurred in the third quarter, vacancy still decreased due to the removal from so much inventory. During the quarter, the vacancy rate dropped from 16.9 percent to 16.7 percent. With the lack of deliveries over the last four quarters, the vacancy rate has steadily decreased, falling from 17.0 to 16.7 percent. Without a lead tenant for the Greencourt Innovation Center, however, vacancy is likely to increase next quarter. 

Unlike in the District, sublet vacancy has trended downward over the last year and ended at the lowest level recorded by Colliers International. Overall, vacancy rates in Class A space decreased 20 basis points to end the quarter at 17.9 percent. The combined Class B & C vacancy rate, also, fell 20 basis points to end the quarter at 15.7 percent.

RENTAL RATES

The direct average asking rental rate decreased during the third quarter in Suburban Maryland, falling from $26.67 to $26.46 per square foot. This, however, is still up from the beginning of the year, when the average asking rate was $26.22 per square foot. During the quarter, rates across all classes of space fell. The largest decrease occurred in Class A space, with the asking rate falling $0.34 to end at $28.31 per square foot. In addition to lowering their rent expectations, landlords continued to offer aggressive concession packages to attract and retain tenants.

OUTLOOK

Suburban Maryland continues to struggle despite some positive signs - as in the case of the 2U expansion. The systemic problem continues to be the shedding of space by the Federal Government. The NIH lease of more than 500,000 square feet will result in a net loss over 100,000 square feet in demand. There is no sign this trend will let up in the near future. It is expected that nearly every federal lease requirement will result in downsizing of space.

It is likely that landlords will continue to demolish or convert out-of-date office product that the Federal Government vacates. Going forward, the hardest hit locations will be suburban office parks with poor Metro access. Unfortunately for Suburban Maryland, there is an abundance of these parks with few prospects to backfill the space. Transit-oriented developments have been performing well throughout the nation, and there are no exceptions in Suburban Maryland. While traditional office parks struggle to attract tenants, it is expected that projects around Metro stations will continue to be more attractive to tenants and more likely to be redeveloped.

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