DC office market has no clear saviors as record vacancy rate continues to rise

The hemorrhage may be slowing in DC’s struggling office market, but another quarter of record vacancy rates suggests that big structural questions about filling older buildings still remain unanswered.

Ramp Bisnow/Jon

A view of DC’s central business district from the rooftop of 1333 New Hampshire Ave. NW.

The vacancy rate in the district hit a record high of 19.9% ​​last quarter, according to a new market report from CBRE. A report by Colliers pushed DC’s vacancy rate to 17.8% and the market saw negative net absorption of 17K SF in the second quarter.

While those numbers are concerning, absorption appears to be turning positive again as the new office pipeline thins out, said Miles Rodnan, principal research analyst at Colliers.

“The slowdown in new construction, if it continues, will also help the market, but I think we’ll have pretty high vacancy rates for a while,” Rodnan said. “We’ll take what we can get in the market right now.”

Class A space has seen positive demand for three straight quarters in DC, according to Colliers, indicating that the bifurcation of demand for newer and older buildings has become further entrenched.

“Typically there is pent-up demand because there have been so many postponements or suspensions of leasing processes over the past two years,” said Randy Harrell, vice president of CBRE. “I think we’re going to see a continued increase in rental activity. What’s harder to predict is the net result of that net activity.”

The quarter saw some significant leases in trophy space come to fruition, including law firm Williams & Connolly’s 300K SF lease in two new buildings in the second phase of The Wharf, which closed in 2018.

According to CBRE, 71% of tenants who moved during the pandemic upgraded the class of space they occupied and moved into a building that was built or renovated within the past five years.

“That doesn’t necessarily mean a trophy, but these trophy buildings and refurbished Class A buildings are really becoming the winners, even more so now than before,” said Erin Janacek, head of research at CBRE.

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555 Fourth St. NW

Many of these moves are for less space than previous corporate leases, and now the district’s largest class of tenants are beginning to join this trend. The Justice Department reduced its footprint by 30% when it signed a lease for a new dig at 555 Fourth St. NW, one of the first major relocation deals by a federal agency in the past two years.

This downsizing is expected to continue, said Andrew Wellman, analyst at Colliers Research.

“I think there are still tenants, whether it’s becoming more efficient in buildings or in a hybrid work environment, I think there’s still potential for tenants to downsize,” said said Wellman. “I think we haven’t reached the top yet, or hit the bottom.”

Federal government tenants tend to occupy less expensive space than law firms or tech companies, which could mean more bad news for beleaguered owners of Class B and C office buildings. net uptake for both building classes was negative 148K SF in the last quarter, led by a negative net uptake of 208K SF in the CBD alone, according to Colliers.

Office owners said bisnow last month that they were disappointed with the follow-up to the Biden administration’s statement that a “vast majority” of federal workers would be back in office this spring. The lack of office utilization could portend a shift to smaller leases for federal agencies in the future.

“As far as the private sector goes, maybe we’re probably getting to that point, but we’re still going to have federal downsizing for years to come,” Wellman said. “Even though they are downsizing, there’s still a lot to come, I think.”

While large tenant moves haven’t been a boon for landlords, midsize and smaller tenants have been more active, Harrell said. He said many had “kicked the box” for a new lease at the height of the pandemic, but were beginning to better understand their future space needs and were looking to sign on within the next 12 to 24 months.

“In previous times of high market activity, they really hadn’t been active,” Harrell said. “There is inflated activity in this size bracket at the moment, and thankfully they are deliberately moving forward with the process.”

Coworking providers have been the district’s top source of rental demand this year, adding nearly 150,000 square feet to the market. The sector was among the hardest hit at the start of the pandemic – between July 2020 and January 2021, the overall occupancy of flexible office space providers in the DC region fell by 879,000 square feet, or approximately 18% of their previous footprint, according to CBRE data at the time.

“Not only have we seen multiple coworking leases, but the health of existing coworking leases that I’m aware of has improved,” Harrell said.

Yet there are long-term structural trends indicating that the vacancy rate will remain high. In addition to the federal government’s likely downsizing, law firms, one of the district’s largest classes of tenants, have also been downsizing since before the pandemic, Harrell said.

But one of the biggest question marks for the DC office market going forward is the tech sector. The quarter saw notable highs, such as Google’s 130K SF sublet at 655 New York Ave., and lows, like Yelp announcing it would be closing its 52K SF office in Chinatown.

Despite signs that technology is now an important and permanent part of DC’s business community, Wellman said he’s not yet convinced there will be enough space to offset the challenges that have accumulated. in the DC office market over the past decade.

“I think the tech industry is often viewed not as a savior, but as a real growth industry,” Wellman said. “I think a lot of markets could potentially be saved by the growth of the tech sector. That may be the case here, but I don’t think that’s true in DC yet.”

Jose C. Birney