- The Washington Times - Monday, February 16, 2009

The Washington area’s economy has long enjoyed a reputation for resilience during downturns, thanks to the bulwark of the federal government and a steady stream of corporate newcomers attracted by the area’s well-educated work force. But the severity of the current economic crisis has led some D.C. commercial real estate managers to abandon the myth of the “recession-proof” economy.

“2008 is obviously a year to forget,” said Sigrid Zialcita, a research director for Cushman & Wakefield Inc., at the D.C. real estate firm’s annual round table last month.

Not only did demand for office space steadily decline during the year, but the severe financial crisis that broke out last fall is now also threatening the financial underpinnings of many commercial real estate projects that had previously been viable. Financial problems have put several new projects on hold, including the planned retail and entertainment “Ballpark District” around the new Nationals stadium and a potentially massive redevelopment across the Anacostia River in Southeast.

The slowdown is affecting all of the region’s primary submarkets — Washington, suburban Maryland and Northern Virginia.

Vacancy rates inside the Beltway are now comparable to the previous downturn in 2002-2003, Ms. Zialcita said. Outside the Beltway, however, they are closer to the levels reached during the more severe recession of the early 1990s.

“It means that the impact of the financial crisis on the suburbs is more severe,” she said. “Even Montgomery County, which is usually a stronghold, has been affected.”

Demand has begun to soften in both Montgomery and Prince George’s counties, where leasing activity is approaching a five-year low, according to data provided by Cushman & Wakefield. The overall vacancy rate for Montgomery County, a linchpin of the area’s commercial real estate market, rose 1 percentage point last year to 12.1 percent.

Inside the District, new leasing activity declined to 5.2 million square feet last year, the lowest level in a decade, according to Cushman & Wakefield.

The turmoil on Wall Street has prompted a wave of contractions and layoffs among law firms, resulting in a spike in the amount of downtown space available for sublease. For instance, national law firms Thelen Reid & Priest LLP and Heller Ehrman dissolved last year, and each placed more than 80,000 square feet of Washington office space for sublease in the fourth quarter.

“We haven’t been immune to what is going on,” Ms. Zialcita said.

Other industry executives and real estate experts share her view.

“I would like to say that we are resistant to recession, but we are having a bit of a recession here,” said Tom Hulfish from McEnearney Associates Inc., an Alexandria commercial real estate firm. He said he remains “optimistic” about the future of the market, however.

“Vacancy is the highest in Northern Virginia, where many office buildings have delivered in the last two years with few tenants, particularly in the Dulles Corridor,” said Sandy Paul, national research director at Delta Associates Inc.

The pipeline of office space under construction has been declining in the Washington area overall, with 15.4 million square feet of space under construction or renovation in 2008, down from 20.6 million square feet in 2007, according to the Alexandria real estate research firm.

“A majority of the construction under way is located in the District of Columbia,” Mr. Paul said. “Given the slowing job market, we expect the office vacancy rate in the District to rise from 4 to 5 percent over the next two years, which should bring it from 8 percent in the fourth quarter of 2008 up to 12 or 13 percent in 2011.”

The area’s overall office vacancy rate, including sublet space, rose to 10.5 percent in December from 9.1 percent a year ago, according to Delta Associates.

“Washington remains better positioned than most other U.S. office markets,” said Brian Dawson, a senior C&W director for capital markets. “We have to remember that we are in Washington, D.C. — the market which the entire world is envious of.

“Opportunities are here and now,” he said. “If you’re buying today in D.C., you’re almost sure that you’re making a great deal. The market has already corrected and may even have overcorrected.”

Retail on sale

The market for retail space is hurting even more than the office market.

“I expect retailers to suffer a lot in the months to come, even inside the Beltway,” said Ramon Kochavi, regional manager of Marcus & Millichap’s D.C. office. “They are in the forefront of the economy.”

Mr. Kochavi believes retail rents inside the Beltway could decline this year, “even in posh areas like Georgetown,” but he rejected the idea that empty storefronts will multiply inside the Beltway, “an area that doesn’t have any big malls.”

“But it will happen outside the Beltway,” Mr. Kochavi warned, “especially in places that were overbuilt such as Prince William and Loudoun counties.”

The retail market is substantial in the Washington area, which has more than 1,000 shopping centers and an average of 25 square feet of retail space per capita — 20 percent greater than the national average. Almost 60 percent of that retail space is concentrated in Northern Virginia.

Mr. Kochavi said he was confident in the ability of Washington’s “very unique market” to gradually recover from this recession.

“We are not recession-proof, but we’re sturdy in recession,” he said. “We have a very desirable market both nationally and internationally.”

High incomes are a main reason Washington is seen as a highly desirable location for retailers. The region ranks third in the country for average weekly wages, which rose to $1,433 last year, according to the U.S. Bureau of Labor Statistics.

High incomes not only help to foster a healthy retail environment, but they make the region more resilient during recessions, analysts say.

Rich niches

While Washington’s overall commercial real estate market retrenches, niche markets continue to thrive, particularly health care and biotechnology, according to C&W.

“Hospitals, medical office buildings and health care centers are going to need more real estate,” said Richard Taylor, director of C&W’s health care practice group. “Medical staff and physicians have a very specific use of real estate. They tend to pay more than average office users because of the high investment they have in their buildings.”

Anne Roseneau, another C&W director, was optimistic about opportunities in technology.

“One of the bright spots in this difficult context is the increasing demand for technology,” she said. “The market in Northern Virginia is extremely healthy right now with good tenants like Facebook, Microsoft and Yahoo.”

Scheer Partners Inc., a Rockville provider of commercial real estate services, actually opened a new office in Vienna last month to serve a growing client base of entrepreneurs from a variety of industries including information technology, software and life sciences.

Efforts to lure businesses to the Washington area appear to be paying off. In September, Volkswagen Group of America opened a new corporate headquarters in Herndon. Earlier this month, Hilton Hotels Corp. announced plans to relocate its headquarters from Beverly Hills, Calif., to Fairfax County.

Maryland continues to nurture a growing bioscience industry in its Interstate 270 corridor. In December, MedImmune Inc. announced its plans to nearly double the size of its 361,000-square-foot Gaithersburg headquarters in the next three years.

However, the biggest hopes of the commercial real estate industry rest in Washington’s tireless engine of growth: government.

“The silver lining for Washington amidst the turmoil is that the federal government is creating new agencies and hiring new personnel to implement the bailout and stimulus programs,” said Mr. Paul of Delta Associates. “That is likely to generate additional demand for office space over the next several years.

“Despite the weakening fundamentals, Washington will remain one of the best-performing markets in the nation,” he said, “in a year of much lower expectations.”

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