OFFICE MARKET ASSESSMENT
The District of Columbia’s office market fundamentals showed modest signs of improvement with 24k SF of direct space absorbed in Q2 – its second straight quarter of positive absorption – bringing the YTD total up to 146k SF of occupancy gains.
The District’s direct vacancy rate rose by 40 bps in Q2 and have climbed 130 bps from a year ago to an all-time high of 16.2% largely due to newly delivered space hitting the market.
The Class A sector registered positive absorption for the second straight quarter with 205k SF of direct net absorption in Q2, driven by pre-leased deliveries in the Wharf, bringing the trailing 12-months total up to 690k SF of occupancy gains.
Class B properties continued to experience softness with 192k SF of red ink in Q2 and 1.3 MSF 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.
Sublease availability rose by 229k SF to an all-time high of 3.4 MSF in Q2. Nearly 80% of the District’s sublease inventory is located in the East End and CBD submarket with 1.5 MSF and 1.2 MSF of space being marketed, respectively.
Leasing activity modestly slowed during the second quarter, but pent-up demand has caused leasing volume over the trailing 12-month period to improve by 17% Y-O-Y. Leasing volume totaled 1.2 MSF in Q2, up 15.6% compared to its pandemic low a year ago but remains 48% below its pre-pandemic quarterly average.
Although Class A face rates have modestly risen over the past year, 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 2.2 MSF of new product under construction currently 63% pre-leased. Developers delivered 994k SF of new product during the first half of 2022, with an additional 1 MSF of new inventory slated to deliver by year-end 2022.
Even though demand remains the strongest for new construction and renovated product, we expect fewer ground breakings over the next 12 months unless a significant pre-lease is secured. Developers have remained cautious in moving forward on any significant speculative projects due to the supply-demand imbalance and uncertainty in the market.
Although the decline in development activity could help stabilize vacancy in the long run, the second-generation spaces that will eventually be left behind as tenants relocate to newer projects will indirectly place further upward pressure on vacancy rates.
The office market will remain tenant-favorable in the near term as space availability options are plentiful, but pent-up activity should help improve leasing fundamentals as return to office momentum continues to build and more companies make long-term real estate decisions. However, we expect office space demand to remain challenged as select tenants consolidate and reduce their footprint to move up in quality and/or adopt a hybrid remote work model.