- The Washington Times - Monday, October 1, 2001

Tech bust opens prime space in Dulles corridor

The "irrational exuberance" of various technology-related businesses along the Dulles corridor and a sagging economy have forced millions of square feet of prime office space back onto the market.

But most experts believe that this a short-term problem and is in no way comparable to the local commercial real estate crisis of the late 1980s and early 1990s.

For one, the circumstances are different this time. A decade ago, there was little employment growth and the crisis hit much of the Washington metropolitan area. New buildings were thinly capitalized and landlords were the ones adversely affected.

Today, tenants mostly in the telecommunications, technology and dot-com sectors, as well as service providers for those businesses, are the ones getting hurt. These companies are paying the price for warehousing much more space than needed to support their perceived unlimited growth.

Of real concern to the business community is the potential amount of negative absorption-decreasing demand for real estate space.

Approximately 4.7 million square feet of mostly Class A, or premium, office space has gone back on the market. That is somewhat worrisome to real estate analysts, who say Class A space has a much lower vacancy rate historically than properties in the B or C categories, which tend to be older buildings.

"I view Herndon as the eye of the hurricane," says Kurt Stout, a commercial real estate analyst with Grubb & Ellis. "Yet, I think the worst of the storm is behind us. People are coming up out of the cellar."

A year ago, Herndon had a vacancy rate of around 4.8 percent. Today, the vacancy rate has ballooned to 21.6 percent, according to the research department of Insignia/ESG Inc. Reston's vacancy rate is around 10.6 percent, while the average for Northern Virginia overall is about 8.8 percent.

The excess of prime space has caused a noticeable decline in lease rates in that area, from a peak of $40 per square foot in the late 1990s and early 2000. Today, lessors charge between $24 and $26 per square foot, real estate analysts say.

Still, landlords have insulated themselves from this crisis by requiring hefty security deposits from tenants, and estimating early on that a profit could be made at $25 per square foot, they say.

"In many cases, the landlord pro-forma'd the building at a much lower rent before it spiked up in the mid- to high $30s," says Mary S. Petersen, senior vice president and director of market analysis for Cassidy & Pinkard. "Now, the rates are back in the high $20s."

Deals in the can

The present crisis for tenants may be offset somewhat by the 1.6 million square feet of pending transactions around the Dulles corridor. Fannie Mae, the quasi-government lending institution, will lease 230,000 square feet of office space at the Worldgate complex in Herndon.

The Boeing Co., which has a major contract with the Federal Aviation Administration, has just leased 118,000 square feet of space in the Shenandoah Building in Tysons Corner. Technology company Deltek has leased 80,000 square feet of space in the Columbia Gas Building near Dulles; Perot Systems is leasing 60,000 square feet in the same building.

Microsoft has signed a letter of intent for 50,000 square feet at Terrabrook near the Reston Town Center. And VeriSign Inc., an Internet infrastructure company, has leased the entire 13-story building along the Dulles Toll Road that Winstar Communications Inc. was to lease before it filed for Chapter 11 bankruptcy protection earlier this year. The 405,000-square-foot building will house up to 1,400 Northern Virginia employees of the Mountain View, Calif.-based company.

Interest in still-to-be-completed office buildings may be another indicator that this crisis is nearly over. Reston Town Center's One Discovery Square, which is scheduled for completion in December, is nearly sold out, according to Thomas J. D'Alesandro IV, vice president and eastern regional manager for Terrabrook.

The not-yet-completed Plaza America Tower III already has leased the lion's share of its office space to Cable & Wireless USA. The company, which occupies all of Plaza America Tower I, has leased 275,000 square feet out of 287,000 square feet in the 14-story Tower III. Completion of the third building of the four-building complex is expected during the first quarter of 2002.

"If we were falling through the floor, as some think, why would these companies be taking all this space?" asks Catherine Jones of Insignia/ESG Inc.

Other major corporations are looking to lease or sublease some of the prime space in Northern Virginia. Companies like BAE Systems, IBM Corp., Raytheon Corp. and General Dynamics are scouting along the Dulles corridor, Ms. Jones says.

Cash cow

Further balancing this crisis is the sizable amount of government business given to Northern Virginia firms and the continued hiring at technology companies, despite the reported layoffs.

"Keep in mind that there is $14.7 billion in federal contracts for technology services and products in this region," says Stephen S. Fuller, public policy professor and regional economist at George Mason University.

Thirty-five percent of all of the technology company revenues in the metropolitan area comes from the federal government, compared with 4.7 percent for Silicon Valley in northern California, Mr. Fuller says.

Others concur. "There are plenty of government-contracting-based companies like Booz Allen [Hamilton], Computer Sciences and DynCorp that will continue to improve as the government continues to outsource," says Brian J. McMullan, vice president of the technology practice group for the Staubach Co.

Statistics compiled by the Center for Regional Analysis at George Mason University indicate that the Washington area remains an attractive job market. From June 2000 to June 2001, 420,000 new jobs were created nationwide; 85,000, or 20 percent, were in the Washington metropolitan area. Of those, 35,500 new jobs were in Fairfax County, which includes Reston and Herndon. Nearby Loudoun County added 10,000 new jobs last year, according to the center.

Fairfax County's unemployment and new job rates for June are 1.6 percent and 6.5 percent, respectively, the best in both categories of any U.S. metropolitan area during the past four months, according to the center.

Mr. Fuller describes the present office market crisis along the Dulles corridor as a "pothole" in the road, but one that clearly shows that there was "too much venture capital, too many ideas being developed" without the necessary market analyses. He and other analysts view this real estate crisis as part of an overall rationalization that the market may be self-correcting.

Having an asset like Washington Dulles International Airport is another factor that may ensure the stability of commercial real estate in that area for years to come. Dulles is a primary reason why many technology-related companies settled along the Dulles corridor, Fairfax and Loudoun county officials say.

Dulles, one of the fastest growing airports in the nation, is in the midst of a $3.4 billion capital development project. When it is complete, Dulles will have additional parking, a new runway, two underground rail systems to move passengers from the main terminal to the mid-concourse, a new concourse for United Airlines, a new air traffic control tower and new roads.

The Metropolitan Washington Airports Authority estimates that approximately 19.5 million passengers are expected to pass through Dulles this year.

Mirroring malaise

Not everyone is convinced that the commercial real estate business along the Dulles corridor will come charging back anytime soon. Some experts believe that the slowdown in the office market in that area will mirror to some extent the economic malaise of the country, at least for now. Many of these technology companies along the Dulles corridor provide services rather than goods.

Nevertheless, these companies are linked inexorably to the manufacturing side of their businesses. And that side may not want to expand further until the national economy and the employment picture improve, according to one view.

In an update to investors, Bruce Steinberg, chief economist for Merrill Lynch, predicts that the turnaround in the tech sector "will begin during the first half of next year." The Labor Department's surprising 4.9 percent unemployment rate announcement for August seems to bolster the view that the economy could continue to weaken, and that may, in turn, adversely affect the office market.

"We expect [the commercial real estate market] to remain slow in that area for the balance of the year," says Scott C. Price, research director at Delta Associates. "However, we feel that the majority of sublease space returning to the market already has occurred."

Cassidy & Pinkard's Ms. Petersen says there is scant similarity between this crisis and what occurred a decade ago. Last time, banks and savings and loans were failing, growth in most of Northern Virginia was negligible and the lessors' "asking rents were unrealistically low," says Ms. Peterson, who has been in the real estate business for 25 years. "This is not the 100-year flood."

Ms. Petersen is concerned, however, about the adverse effect this crisis could have on service providers to the technology companies. Palo Alto, Calif.-based law firm Cooley Goodward recently laid off 12 lawyers from its Reston office. The move is part of a nationwide shakeout to cut 20 percent of the non-partner work force.

Despite the layoffs, the Reston office, which provides counsel to several technology companies in the area, has no plans to sublease the excess space left by the departing associates. In fact, the firm is negotiating for additional prime space in Reston, according to Antonio Calabrese, a partner with the firm.

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