OFFICE MARKET ASSESSMENT

The District of Columbia’s office market continues to emerge from the pandemic’s worst effects and has entered the early stages of a recovery with 117k SF of direct net absorption recorded in Q1, marking the first quarter of occupancy gains since the second quarter of 2020.

The District’s direct vacancy rate has risen 140 bps from a year ago to an all-time high of 15.8% largely due tenant downsizings combined with new supply additions but there are signs of stabilization taking place as vacancy only rose 10 bps during the first quarter of 2022.

Driven by the flight to quality, the Class A sector demonstrated signs of turning the corner with 559k SF of direct net absorption in Q1, breaking a streak of six consecutive quarters of occupancy losses and improving the trailing 12-months total to 217k SF of red ink.

Class B properties continued to experience softness with 444k SF of red ink in Q1 and 881k SF of occupancy losses over the trailing 12 months resulting from recent business contractions and a flight to quality trend that has severely impacted this sector over the past 5 years.

Leasing activity modestly slowed during the first quarter of 2022, but pent-up demand has caused leasing volume over the trailing 12-month period to improve by 22.2% Y-O-Y. Leasing volume totaled 1.8 MSF in Q1, up 71.7% compared to its pandemic low a year ago but remains 22% below its 2017-19 pre-pandemic quarterly average.

Sublease availability slightly declined by 36k SF in Q1 and has only contracted by 4.5% since hitting an all-time high of 3.4 MSF at year-end 2020.

Asking rents have slightly contracted by 1.0% over the past year. Although Class A face rates have remained relatively steady, the gap between asking and effective rates have widened as owners remain aggressive in pricing, concessions, and flexibility to attract and retain tenants.

The office development pipeline currently has 2.6 MSF of new product under construction (73% pre-leased), with most of the construction activity taking place in the CBD and Southwest. The District is slated to deliver nearly 2.0 MSF of new product by year-end 2022.

Even though new construction and renovated product continues to outperform lower quality buildings, we expect fewer ground breakings over the next 12 months unless a significant pre-lease is in place. Developers have remained cautious in moving forward on any significant speculative projects largely due to the supply-demand imbalance. Although the decline in development activity could help stabilize vacancy in the long run, the second-generation spaces that will eventually be left behind by those tenants with pre-lease commitments in new projects will place further upward pressure on vacancy rates.

As pent-up demand from the pandemic continues to flow back into the market, office demand is poised to grow in the coming quarters and positively impact the market since those users that postponed decisions are evaluating their future space needs with upcoming expirations.

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