D.C. office space, real estate sags

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.”

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