Political dramas may dominate the headlines in Washington D.C., but the allure of this market for office investors is far more mundane — stable cash flow. The D.C. story is in the numbers. The metro area is touting an impressive vacancy rate and effective rents that have largely held up under the strain of the economic recession.
At the end of the first quarter, the vacancy rate in Washington D.C. declined 30 basis points to reach 10.4%, well below the national average of 17.3%, according to Reis, a New York-based real estate research firm. At the same time, effective rents have dropped about 5% from their 2009 peak and are currently pegged at $41.43 per sq. ft.
“There is a tremendous amount of domestic capital looking to invest in D.C. for obvious reasons,” says John Kevill, a managing director in the Washington, D.C. office of Jones Lang LaSalle.
Aside from its solid fundamentals, investor demand is being stoked by the area’s dominant industry — the federal government. The office market is benefiting from continued government spending in areas such as healthcare, the war on terror and the economic stimulus package.
“That activity is really differentiating our economy from virtually every other economy in the country, which is why we’re seeing an increase in transactional velocity,” says Kevill.
JLL is currently listing twice the number of for-sale properties compared with a year ago. The giant real estate services firm recently represented America’s Capital Partners in the $43.5 million sale of a suburban office building in Landover, Md.
One of the key selling points for the building at 3300 75th Ave. was a long-term government lease. The building is 100% occupied by the Department of Defense with a new 10-year lease signed by the General Services Administration (GSA).
“That building is a good example of what buyers want in today’s market — stabilized properties with stabilized income streams,” says Kevill.
Income-producing properties are experiencing the strongest buyer demand and the most aggressive pricing. Several interested bidders helped to push the price higher than the recent market norm. Government Properties Income Trust, the buyer, put the property under contract late last year and closed on the sale in March.
The Class-B building sold for a capitalization rate — the initial return to the buyer based on purchase price — of 8.4%. According to first-quarter data from Real Capital Analytics (RCA), cap rates for suburban Maryland office properties have averaged 9.4% over the past 12 months.
Built in 1985, the building at 3300 75th Ave. does have certain limitations for other tenants that include limited utilities and a very specific build-out to suit the current tenant.
“Because the property has strategic importance for the [Department of Defense], the buyer was willing to make a bet that the tenant would be there for the long term,” Kevill says. It also fit with the REIT’s strategy of buying primarily government-leased real estate.
Growing for-sale pipeline
Investors are willing to step up to the plate to acquire stabilized properties. “We are not seeing that same willingness to commit for properties across the board,” Kevill says. Although those stabilized properties remain in short supply, D.C. is beginning to see an increase in deal flow, and a wider variety of deals coming to the market.
The Washington D.C. metro area reported $2.28 billion in office sales in the past 12 months ending in first quarter, according to RCA. That figure may seem paltry compared to the $15.46 billion in transactions that occurred in 2007. However, it also represents a hefty slice of the $16.79 billion in total U.S. office sales that closed in the past 12 months, according to RCA. The research firm tracks deals valued over $5 million.
There is a lot more optimism. Fundamentals appear to be improving. There is more debt financing available to buyers, and job growth is returning. “All of those things are helping our sales market as a whole,” says Jim Meisel, a senior managing director at Holliday Fenoglio Fowler in Washington, D.C.
So far, most of the office sales have involved stabilized, core properties. For example, HFF recently brokered the sale of Washington Harbour. The mixed-use luxury condo and office complex in Georgetown sold for $245 million and a cap rate of 6.2%.
In addition, HFF will soon begin marketing 2121 K Street. Even though the building is 68% occupied, the property is expected to garner a lot of buyer interest because of its core location and potential for the owner to add value.
“We also are starting to see more properties sell where everything isn’t perfect,” adds Meisel of Holliday Fenoglio Fowler. “Those properties tend to be located in the core and inner-ring suburbs, but we take that as a very positive sign.”