Metropolitan Washington's commercial real estate market slowly continues its march back from the economic exodus of the early 1990s buoyed in particular by strong office, industrial and multifamily markets in Northern Virginia and expanding retail markets regionwide.

But the region is also an ironic mix of lows and highs with no visible trend across the board. Downtown Washington is starting to see pockets of stabilization but continues to be plagued by the city's economic woes, corporate and middle-class migration to the suburbs, fear of crime and a government sidetracked by an election year and downsizing.

But, says Chuck Pilchard, senior vice president of Washington, D.C.-based Larson, Ball & Gould Inc., "Market conditions are expected to improve over the next two to three years. Accordingly, investors who can look beyond the current doom and gloom could view the market and property values as bottoming out and therefore, good investment opportunities exist under a long-term strategy."

And on the positive side, "the debt and equity side of the business is enjoying the positive impact," says David Redmond, vice president of Smithy Braedon *Oncor International, Washington, D.C. "There is plenty of capital from the debt market for all property types in all three markets, and the same is true on the equity side."

Washington submarkets

In general, the downtown markets are suffering from an abundance of Class-B and lower grade building space for which demand is flat, thanks to federal and local government downsizing. "This is quite evident in the negative absorption documented for the first quarter of Pilchard says.

Unfortunately, the trend continues from 1995, which ended with a 10.2% vacancy rate and a net absorption of only 507,000 sq. ft. for the downtown office market, according to Jean Gerrity, director of market research at Faison in Washington, D.C.

"The District of Columbia experienced a difficult 1995, which was significantly more taxing for the economy than for its commercial real estate industry," Gerrity says." though job growth proved adversely affected by the downsizing of federal and District (of Colombia) governments, the absorption of several significant projects has held the city's office vacancy firm. But, in the first quarter of 1995, the District has already lost 421,000 sq. ft. net of tenants. The outlook for 1996 is not hearty, although the year may show positive absorption in certain areas."

Helping with absorption is the fact that there is little new construction in the District markets and if there is construction, "space is essentially preleased by the start of construction," says Drew Genova, principal and director of brokerage services at Trammell Crow Co. in Washington, D. C. "At the same time, there is a significant trend toward early lease renewals for tenants looking to capture the lower rents. It keeps the market stable, but there is a continual lag in absorption."

Some of the more desirable District leasing areas include the Capitol Hill and Pennsylvania Avenue submarkets where office space tends to be newer, has strength in proximity to key government agencies and includes a burgeoning retail entertainment market.

At the same time, some Class-B space is being improved with positive results. An example would be the january reopening of 1200 New Hamshire, a 275,000 sq. ft., eight-story building, which is now 60% leased.

In the central business district, leases were "lagging a bit," Faison's Gerrity says. Older buildings here need renovations to better complete. Georgetown is lagging as well but should at least experience some retail turnaround in the future.

At the same time, the city's east end is celebrating the coming MCI Arena. Scheduled for a September 1997 opening, the arena is where professional hockey's Washington Capitals and basketball's Washington Wizards (the Bullets, new name) will play beginning with their 1997-98 seasons.

"We are already seeing a lot of jockeying for position there," says Alex Peker, a retail specialist with Carey Winston, Chevy Chase, Md. "A lot of developers bought in the last 10 months and are sitting on properties."

The arena and this spring's Washington Opera purchase of the 500,000 sq. ft. Woodward & Lothrop store at Metro Center are two significant downtown revitalization projects, says Steve Goldstein of Julien J. Studley's District of Columbia office.

The opera company paid $18 million for the bankrupt retailer with cost estimates of $102 million to $106 million needed to gut and renovate the building for performances. There are mixed feelings in the city that the opera purchase might not be in the best interest of Washington. It takes a major retail block off the tax rolls for the District, and some feel that opera patrons may not be convinced to take the metro at night to the area.

"But these are two locations that could have been office development and aren't," Goldstein says. "And because there won't be office space, they are keeping the vacancy rates down," making the office already there more valuable.

Goldstein also points to four major law firm commitments this year which, "are a show of strength and positive statements that there are things going on in this market."

Morgan, Lewis & Bockius has signed on for 230,000 sq. ft. in the Presidential Building at 12th and Pennsylvania but won't be moving in until 2002. McDermott Will & Emery is taking 240,000 sq. ft. following a gut renovation of 600 13th St. NW.

In the late stages of negotiation this spring, Goldstein says, Akin Gump Strauss Hauer & Feld was making plans to sign on for 150,000 sq. ft. following a gut renovation of The Investment Building at 15th and K. The renovation is expected to start later this year for an early 1998 occupancy. And the firm of Jones Day Reavis & Pogue was about to sign for 200,000 sq. ft. in the Acacia Life building at 51 Louisiana Ave. NW with a 1998 occupancy following a gut renovation of the building.

There is action in this market despite issues of the District of Columbia government, despite resident fears," Goldstein says. "Right now, there is reason for all the doom and gloom talk, but there are signals of future growth."

What could be the biggest help to downtown markets would be to see the federal government signing new leases. In the late 1980s and early 1990s, the GSA alone accounted for approximately 50% of area leasing."Now people would love to be leasing to the federal government, but, the federal government isn't leasing. It is trying to buy more," Genova says.

Suburban Maryland

"Maryland is a strange market these days in that there are pockets doing very well or very badly, but overall it's not that great," says Neil Narcisenfeld, managing director of Studley's Washington suburban office in McLean, Va. The best exception to the Maryland doldrums is Bethesda, Md., and North Bethesda where Class-A office space sees few vacancies, and companies looking to be in the market are tuning to fill Class-B space. Many new tenants are private sector companies moving from downtown markets. Also helping this office market are the tenants coming to Maryland because Virginia's suburbs, such as Rosslyn and Ballston, have minimal space available, and Montgomery County is a next best choice,

Office rents here at all levels are higher there than they were a year ago with Montgomery Class-A space leasing as high as $27 per sq. ft., says Larry Thau, senior vice president and managing director of Barnes, Morris, Pardoe & Foster in Bethesda. "The suburban Maryland office and industrial markets are exactly where Northern Virginia was in 1992: on the verge of becoming a place to be."

Helping the market is the fact that there has been no new space added, except with tenant commitment ahead of construction. Thau also gives credit to the Montgomery County government, which has taken a pro-active approach to courting new business. "Historically, Maryland has been very laissez faire about making deals, but that has changed, which makes the state easier to sell."

Thau adds that industrial space in Maryland, particularly Montgomery County, istight as a drum. That is a big success story here."

At the same time, Narcisenfeld says, "Silver Spring is dying."

According to Carey Winston, the Silver Spring office vacancy rate is tops in Montgomery County at 26% at the end of 1995.

"Maryland, continues to feel the affects of downsizing by major tenants such as IBM," says Redmond.The loss of occupied space in th first quarter of 1996 was approximately 500,000 sq. ft."

Government contractor Orkand left for Virginia leaving 50,000 sq. ft.; IBM vacated 250,000 sq. ft. and CNA was acquired and left another 250,000 sq. ft. It's a trend that has been happening for at least two years.

Not all is lost on the Silver Spring market, however, with some in the business seeing a future rebirth.

"There is a lot of space to backfill, but we do see some downtown lookers," Narcisenfeld says.

Studley's Paul Schweitzer, senior managing director and co-branch manager of the suburban office, says: "Suburban Maryland was on course with respect to overall absorption, but then several big users pulled out. But, the I-270 corridor should stabilize and see considerable absorption over the next 12 to 18 months. The natural flow from there will help Silver Spring as companies will look to there rather than a build-to-suit option."

While there may not be a direct effect on office absorption, if and when the much talked about American Dream Mall proffered for Silver Spring by Canada's Ghermezians brothers, is built, there will be new energy - enough to pull other segments of the market along, Schweitzer says.

The 27-acre, million sq. ft. enclose mall, the biggest project ever proposed for the region, is entertainment as much as shopping with stores, a hotel, an amusement park, restaurants, a skating rink, a fresh food market, movie theaters and almost anything one needs to exist except sunlight.

Also good for Maryland revitalization is the new Washington Redskins football stadium to be built in Prince George's County. Once built, the stadium is expected to generate $5 million annually in county tax revenues as well as hundreds of jobs.

The Redskins stadium project will hopefully bring continued confidence to that county's market where the office vacancy rate throughout 1995 dropped 21% to 17%. The Greenbelt submarket there is the healthiest with a 9% vacancy rate, but the market has slowed due to uncertainty surrounding NASA, a major area tenant.

Northern Virginia

Tight and expanding Northern Virginia commercial markets bring growth and stability to the region as a whole.

"We are seeing increases in rents every space segment," Schweitzer says. "There is increased competition among tenants for choice spaces. It means th companies need to tighten their decision making curves, because we are seeing landlords not as willing to re-up tenants early when they know they can get a better price on the open market." Some of the submarkets are so tight, Schweitzer says, that they are "functionally obsolete." The Tysons office mark is below a 7% vacancy rate where in the early 1990s it was above 20%.

At Barnes, Morris, Pardoe & Foster senior vice President Patrick Mahady says if a company wants more than 50,000 sq. ft. of Class-A office space in Virginia, it will have to be build-to-suit. The activity comes from high-technology firms, For tune 500 companies, law firms and associations. There is little leasing Activity with the federal government, Mahady says.

"On the positive side, the growth in the technology industry has had a big affect on the Northern Virginia market," says Smithy Braedon's Redmond. "Northern Virginia now ranks third behind the Silicon Valley in California and the 128 Belt in Massachusetts as the largest high tech employer in the country. In the District of Columbia, the market awaits the positive impact of the completion of the new MCI Center and the new 800,000 sq. ft. Convention Center."

The Reston office market, with 12 million sq. ft., closed the first quarter of 1996 a vacancy rate under 5% where a years ago vacancies were 20% to 30%.

"The numbers are literally driving rents up, and tenants are paying the asking rice to be where they want to be," Scheitzer says. Prices for Class-A space in Tysons are leasing in the $23 to $25 per sq. ft. range while Class-b and Class-C space is not too far behind at $16 to $20 per sq. ft.

"We're finding companies cannot be quality specific; they take what they an get," Schweitzer says. "The market is also forcing a number of large users to build-to-suit."

Industrial space in the Virginia suburbs is faring as well as the office market, although there is some good availability around Chantilly and further out. Some of the increased activity is coming from companies putting back office operations in warehouse and flex space and taking smaller Class-A office space in the closer-in spaces where huge blocks are no longer available.

Multifamily

While Valuation International Ltd. of Atlanta dropped Washington, D.C., from its list of the 10 best apartment markets in the country this year, those working the local market say it is still a top performer and forecast more of the same.

"This is one of the most consistent and stable multifamily markets in the country," says Rick Lundregan, senior vice president in the District office Of Barnes, Morris, Pardoe & Foster. "Occupancy rates, even in the worst of times, average 90% or better and when you compare that to office, industrial and retail, none can show that kind of consistency."

In the Washington metro area, rental properties compete favorably with the for-sale housing markets because it is such a transient area. Many come to the nation's capital to work for two to four years and then move on. There is also a high percentage of military families who don't want the hassle and expense of buying and selling a property while only in the area for a couple of years.

"There is a big market of apartment seekers" Lundregan says. "The tenant profile shows that between 60% to 70% probably work for the government or are connected to it. And right now a lot of properties are looking at rent increases that contradict any concerns about downsizing."

The suburban apartment dweller is a mix of singles and families while the downtown market sees more young singles and professionals.

The Washington metro multifamily marketis also considered a top investment in what is very much a seller's market. The purchase market has been active with the majority of buyers representing REITs or pension funds. "Trophy" properties are selling for $1.25 to 1.30 per sq. ft. in the suburbs while downtown buildings are selling for as much as $1.65 at the upper end, Lundregan says.

The suburban apartment markets compete almost equally, although there is more building activity in Northern Virginia, because land is more readily available and permitting is easier than in Maryland.

Retail

Metropolitan Washington is an incredibly hot market with money - not land - luring retailers. Big box retailers continue to blanket the region, but the height of the market may have been' reached.

Growth is evident despite tightening and increasingly expensive retail real estate, a sluggish economy and rising interest rates. Retail and entertainment enterprises continue to move into the region, but the phenomenal ride is slowing with mixed reviews about continued strength and staying power.

A few national retailers have scaled back or delayed expansions. Some have been hit with pockets of falling sales and bankruptcies. At the same time, many are finding huge economic successes. Much of the ambiguity has come at the hands of the wavering federal government downsizing and privatization. And just about every retailer is experiencing the pressures of increased market competition.

"Things are neither great nor doomsday across the board," says Jim Crilley, vice president of leasing for District-based Combined Properties. "The glass is still half full, not half empty. Naively, the region was always thought to be recession-proof, but that is not so anymore with some of the uncertainties surrounding the government. People are a little apprehensive to make purchases of great significance."

Big box retailers lead the way in redrawing shopping areas with available land sites increasingly further from older established shopping meccas. Retailers are also looking more to redevelopment of older properties as well as showing a renewed interest in urban markets.

"There is growth, but it is more cautious now,"says Stephen Oseroff, GFS Realty's vice president of shopping centers. "The idea of having a store on every corner is dissipating as retailers look to get a better handle on existing stores."

What may be the hottest ticket to successful mall or strip center expansion is having a good theme restaurant or other entertainment enterprise. Establishments such as Planet Hollywood, Boston Market, Kenny Rogers Roasters, Applebee's, California Pizza Kitchen and Cheese Cake Factory are flocking to these fertile markets where many in the double-income suburbs find it easier to take home or eat out.

"All retail projects have to have an entertainment and food component these days," says Maury Levin, KLNB partner in the Calverton office.

Some of the safest development includes neighborhood centers anchored with drug or grocery stores. David A. Ross, president and co-founder of Atlantic Realty Cos. of Tysons Corner, says,We are not anxious to go larger with the big boxes. There are a lot of reasons for these retailers to be here but, like any market, there is only so much you can build." Last November, his company completed the community retail phase of Plaza America, a mixed-use project of about 1.1 million sq. ft. in Reston. The 165,000 sq. ft. retail component includes Fresh Fields, Michaels Crafts, Super Crown and Herman's. Two theme restaurants, Fresh Fare and Champs Americana, were opening in May.

Plans for Plaza America also include building I million sq. ft. of Class-A office space in four buildings with construction starting in 1997. Lease negotiations are on-going right now, Ross says, but he will not build until commitments are made for 40% to 50% of the space.

At Federal Realty Investment Trust, COO Hal Vasvari says that while retail rents are generally trending up, location is "absolutely the key" to keeping them that way. And he adds, despite some closings, the region is still fairly healthy because of hot locations like Maryland's Rockville Pike and Virginia's Tysons and Reston markets.

"But there is a lot of competition, some closings and consolidation,"Vasvari says.,And there may not be as many retailers in line. Down the road, I think there is going to be a big impact with consolidations especially at many of these big box power strips. People are going to have to get creative with what to do with these spaces, especially the ones in the fringe shopping areas."

Along the famed Rockville Pike in Montgomery County, White Flint Mall should finish repositioning itself this summer and is following the entertainment trend with Bertucci's and Cheese Cake Factory. The mall also landed the region's only Dave & Busters, a Texas-based restaurant and entertainment combination slated to open later this year.

And looking to join the boom is Rockville City Center, a "user friendly' town center redevelopment. Regal Cinemas, who is already signed on, is to put 15 screens where developers hope to lure several restaurants as well. While the area does not have direct exposure to Rockville Pike, "there is synergy and retail on both sides, and the developer is looking to attract some high-end retail and entertainment," says James T. O'Neill, director of retail leasing for Scheer Partners in Rockville.

The Congressional North project on Rockville Pike is also on tap one block up the street from Federal Realty's newly renovated Congressional Plaza, which now includes a Fresh Fields, Tower Records, The Container Store and Zany Brainy.

"The Rockville Pike market is so tight that even if there is a vacancy, it doesn't stay on the market for long," O'neill says.

While the Rockville Pike real estate picture is tight, developers continue to push further out with their plans.

GFS Realty also owns Montrose Crossing in North Bethesda. The 400,000 sq. ft. center set to open mid-1997 is being reconfigured on an urban grid with a series of internal streets and outdoor cafes, says GFS, Oseroff. Ultimately, the project will be for mixed use with the developer adding four new buildings.

"What you have to do is bring projects into the 1990s and the next century,"Oseroff says. "There needs to be more efforts to go vertical, and this is one of the first introductions to a return to Main Street USA'. It's almost like a regional mall, but without the roof."

The Virginia suburbs are starting to see some center recycling, a little newer concept there as developers and customers are looking for top locations now occupied by 1950's and 1960s vintage centers. Many Northern Virginia malls and strip centers from Dale City, where the massive Potomac Mills is located, to Sterling and Fairfax are also seeing grand renovations and expansions.

One of Northern Virginia's hottest new retail growth areas is in Dulles, an area now considered a bedroom community feeding the Tysons Comer shopping district.

Dulles Town Center, an ambitious 1.2 million sq. ft. Lerner Enterprises project is slated for a spring 1998 completion. Anchors announced by the North Bethesda developer include Hecht's, Sears and JCPenney. The center is located on 554 acres within minutes of Dulles Airport and will include peripheral retail and office development. Lerner is also expanding its nearby Spectrum at Reston Town Center, a 275,000 sq. ft. project.

Downtown Washington is seeing some turnover and hopefully rejuvenation.

"Georgetown is like a ghost town right now - there are a lot of vacancies," O'Neill says. At the same time, Georgetown Park continues to do well and is reaping the benefits of a new food court. Other new additions to Georgetown include a three level Barnes & Noble and Eddie Bauer.

"I think the next three years will see a lot of turnovers as national tenants start coming into the market," Peker says. "There are already a lot of clothing and housewares stores there. These national chains in malls all over the country will have to look to downtown markets for expansion."

The city's central business district around Connecticut Avenue and K Street is doing well with few vacancies, Peker says. Food places and high-end retailers in particular are faring the best.