The dominating presence of the federal government in Washington, D.C. and the surrounding Virginia and Maryland suburbs historically has helped ensure a stable commercial real estate market.

But even by that standard, what's unfolding in the D.C. market is impressive. A combination of increased hiring by professional and business service firms and contractors who serve the federal government, along with the government's expansion in the defense and homeland security arena, have accelerated the market's growth to such an extent that it has become one of the strongest in the nation — and perhaps the world.

The landscape of Washington, D.C. is quickly changing. Multiple large projects are transforming the city from one of sterile buildings housing federal agencies, law firms, lobbying groups and associations to one of glamorous multi-use projects that include offices, upscale retail shops, attractive housing and exciting nightlife.

As a result, this increasingly multicultural and cosmopolitan city enjoys the lowest overall vacancy rates for office space of any metropolitan area in the United States. In the third quarter of 2004, the District's office market posted a 7.5% vacancy rate, compared with 11.2% in New York, according to Cushman & Wakefield.

Further evidence of the District's strength is its growing employment base, anchored by the expanding federal government. Today, the area is one of the most affluent in the United States. With an unemployment rate of 3% — the lowest in the nation — Washington, D.C.'s future looks promising. Nearly 74,500 new jobs were created in the market over the last 12 months — 28,800 of those in the professional and business services sector, and 12,000 in the government.

Office Projects Define Downtown

Quickly disappearing are the blocks of distressed and decayed real estate that once extended east of the White House to Capitol Hill. Projects such as the 1.6 million sq. ft. Station Place office complex are making use of key amenities to develop unique facilities and redefine Washington's downtown. Station Place is being developed in three phases by Louis Dreyfus Property Group. The project connects directly to Union Station, a national landmark that services both Amtrak and the local Metro.

The project also is redefining the city's commercial area north from Massachusetts Avenue to Capitol Hill. On 5.5 acres, Station Place, the largest private project under development in the District today, is pre-leased to the Securities and Exchange Commission (SEC).

“Station Place is enhancing the Capitol Hill-Union Station area while anchoring the East End of D.C.'s office district,” says Jeffrey I. Sussman, president of Louis Dreyfus Properties. “There is not a lot of commercial land in Washington, D.C. Our building is the last piece.”

Space at Station Place costs $35 per sq. ft. triple net, compared with an average asking rent of $38 for the city as a whole. “D.C. is the strongest leasing market in the world,” says Audrey Cramer, executive vice president of Cushman & Wakefield in Washington, D.C. “Station Place is defining where our downtown is.”

Developers also have zeroed in on Washington's East End submarket over the last two consecutive cycles. “The East End is a neighborhood that has established itself in 25 years,” says Sussman. “This is because the area is shared by the convention center.”

Unlike the peaks and valleys experienced by New York City or San Francisco, the Washington market is stable. “Due to the height restrictions, no one can build a taller building and diminish yours,” he explains.

Washington's next major redevelopment will occur in the District's southeast submarket. Here the Government Services Administration (GSA) has earmarked 55 acres of blighted real estate located within a mile of the U.S. Capitol Building near the Anacostia River to be transformed over the next 10 to 20 years into a vibrant community where office workers, residents and visitors can live and work. It has been dubbed the Southeast Federal Center.

“It's a real opportunity for an old section of the city to blossom,” says Whayne S. Quin, a lawyer and head of the mid-Atlantic land-use division at Holland & Knight LLP.

Eleven of the 55 acres have been sold to JBG Cos. to be developed into the headquarters for the U.S. Department of Transportation (USDOT). When completed in 2007, the DOT will occupy 1.35 million sq. ft. in four buildings. Construction is slated to begin in 2005.

A development team led by Forest City Washington Inc. of Bethesda, Md., has proposed a mixed-use project on 42 acres along the Anacostia River that will include 1.8 million sq. ft. of office space, 2,800 residential units, 160,000 to 350,000 sq. ft. of retail, and a 5.5-acre riverfront park — all part of the $8 billion Anacostia Waterfront Initiative released last spring by the District of Columbia Office of Planning.

Big Growth in Suburbs

Mega-projects are under way in Washington's suburbs as well, with the largest projects located in Northern Virginia. In Alexandria, the U.S. Patent and Trademark Office Headquarters Consolidation Project (USPTO) is culminating in a five-building, state-of-the-art development that began from a scrap of land more than a decade ago.

Encompassing 15 acres, the project — under development by LCOR Alexandria LLC — is the largest construction site on the East Coast and represents the largest lease ever signed by the government. The project will include 7 million sq. ft. of mixed-used office, residential and retail.

Farther afield in Leesburg, Va., development is under way on the 281-acre Janelia Farm Research Campus of the Howard Hughes Medical Institute. When completed in early 2006, the $500 million, 760,000 sq. ft. complex will house a permanent research staff of 200 to 300 scientists.

Meanwhile, investors are buying into the Washington, D.C. metropolitan boom. Corporate Office Properties Trust (COPT) is purchasing Chantilly, Va.'s Westfields Corporate Center. The four-story, 114, 000 sq. ft. Corporate Pointe III cost the Columbia-based real estate investment trust $21.7 million. The purchase boosts COPT's real estate holdings in Northern Virginia to 2.2 million sq. ft. COPT also recently completed a $113 million acquisition of Pinnacle Towers in Tyson's Corner.

The Alter Group is developing Stone Bridge Corporate Center, a 47-acre, Class-A office park in Manassas, Va. The Center, designed to accommodate build-to-suit offices ranging from 100,000 to 300,000 sq. ft. on sites of five to 40 acres, will create as much as 550,000 sq. ft. of mid-rise space in the Prince William County market.

“The park site on I-66 some 15 miles outside the Washington Beltway is a unique business and residential climate known for its rolling countryside and small-town charm that co-exists with technologically sophisticated economic development,” says Michael J. Alter, president of the Skokie, Ill.-based development firm. “With a 9% office vacancy rate, Manassas' and western Prince William County's skyrocketing corporate growth have made it the nation's third-fastest growing county for job creation.”

In suburban Maryland, the greatest demand for office space is concentrated along Metrorail lines, including the I-270 Corridor, Prince George's County, and inside-the-beltway submarkets of Silver Spring and Bethesda Chevy Chase.

A Retail Stronghold

Washington continues to be one of the strongest retail markets in the U.S. with 4 million sq. ft. of retail space delivered in 2003, and 2.6 million scheduled to be delivered this year.

The market is expected to remain strong due to its solid employment base. The area ranks second nationally in both personal income and retail vacancy. At 5.9%, the retail vacancy rate is at its lowest point in four years, reports real estate services provider Newmark & Co. Some suburban submarkets have vacancy rates below 4%.

Developers and brokers credit D.C.'s leasing surge to pent-up demand for downtown shopping, the growing number of private-sector employees and an aggressive effort by city leaders to court retailers.

Numerous locations and property types provide investors with a variety of opportunities to enter or expand within the market. The District is undergoing a tremendous revitalization, particularly near the MCI Center sports arena in the District's East End section. Projects include the 956,000 sq. ft. Gallery Place, a mixed-use development of the John Akridge Co. and Western Development that is scheduled to open in November.

Financed by public subsidies, Mass Mutual and the AFL-CIO Building Investment Trust, the 11-story Gallery Place is a combination of 193 condominiums, shops, restaurants and office space located across from the arena, one of the city's largest Metro stations and near the new Washington convention center. With approximately 275,000 sq. ft. of the project designated for retail space, Gallery Place is one of the largest investments in downtown retail in 20 years. The complex features a United Colors of Benetton, Ann Taylor Loft, City Sports and Urban Outfitters and a 14-screen Regal Cinema movie theater, downtown's first major-release theater.

Meanwhile, in developed shopping areas of the city, like Georgetown, well-known chains, high-end clothing boutiques or luxury goods stores are replacing mom-and-pop shops.

“Bars that historically catered to college students are being replaced by more upscale tenants, such as higher-end shops and restaurants, because of tremendous demand by these upscale retailers,” says Peter Mallios, managing director of Newmark's Washington, D.C. office. “Asking rents for space are being pushed to unprecedented levels, from $60 to $100 per sq. ft. This is almost double what Gallery Place is asking.”

In the suburbs, office construction is expected to spur the growth of neighborhood centers and other large retail hubs in Montgomery County, Md., and Fairfax, Va. As residential home prices continue to soar, these areas are attracting new residents interested in more affordable housing. The value of homes in the District have appreciated 95.1% over the last five years, while homes in Maryland and Virginia have appreciated 58.1% and 52%, respectively.

“Retail rents will continue to grow throughout the area, but up-and-coming retail destinations in the suburbs will provide tremendous growth potential for long-term investors,” says Mallios.

Apartment Market Booms

Low interest rates, a $5,000 tax credit for first-time buyers and strong job growth are enticing some apartment developers to convert their projects to condominiums.

For the apartment market, this means tightening vacancy rates, accelerating rent increases and declining concessions. Consequently, Delta Associates has dubbed the Washington metro area the nation's best apartment market. About 7,700 units are scheduled for completion this year, an increase of nearly 950 units from 2003, as builders take advantage of available capital and the area's employment growth.

Hotel Sector Goes Upscale

The opening of the Mandarin Oriental Hotel this spring in Southwest D.C. illustrates how the hospitality sector in Washington is flourishing. Not only is the Mandarin Washington's first 5-star hotel, but it also marks a trend toward hotels that offer amenities. After all, Washington attracts a wide host of visitors for business, pleasure, conventions and lobbying. “It's a fabulous mix,” says Ray Martz, vice president of finance for LaSalle Hotel Properties.

LaSalle is involved in a number of recent hotel transactions, including the Hilton in Old Town Alexandria, Va., and Lansdowne Resort near Dulles Airport where LaSalle is spending more than $40 million to turn the 560-acre resort into a mid-Atlantic destination.

Hotel occupancy rates year-over-year through August have increased from 67.5% to 72.7%, reports Smith Travel Research. The average daily rate improved from $110.12 to $116.82 for the same period.

Today, D.C. is regarded as one of the top lodging markets in the nation. Missing from the market, however, is a convention hotel. JMB Co. is working with Marriott to build such a hotel, although, like all developments in the District, the challenge is finding a large enough parcel. Available land is in extremely short supply in the close-in metro market.

As a result, Washington is experiencing urban sprawl, leading to more traffic congestion for commuters. But as long as companies and federal agencies continue to grow and want to be close to the seat of government in the District, and residents desire to live close to work, Washington will remain a stable real estate market.

Karen E. Thuermer is an Alexandria, Va.-based writer.

WASHINGTON, D.C. - BY THE NUMBERS

POPULATION OF METRO AREA:

4.8 million

UNEMPLOYMENT RATE:

3.0%

LARGEST PRIVATE EMPLOYERS:

  1. Northrup Grumman
  2. Geico Insurance
  3. Verizon


Source: Greater Washington Initiative

METRO AREA STATS

Office:

8.9% vacancy, 3Q 2003

8.3% vacancy, 3Q 2004

Rent per sq. ft.: $39.83, 3Q 2004

Source: CoStar Group Inc.

Multifamily:

2.1% vacancy, 3Q 2003

2.1% vacancy, 3Q 2004

Average effective rent per Class-A unit: $1,369, 3Q 2004

Source: Delta Associates

Retail:

6.2% vacancy, 3Q 2003

5.9% vacancy, 3Q 2004

Rent per sq. ft.: $22.57, 3Q 2004

Source: Newmark & Associates

Flex-Industrial:

13.2% vacancy, 3Q 2003

14.3% vacancy, 3Q 2004

Rent per sq. ft.: $12.25, 3Q 2004

Source: Advantis

Hotel:

67.5% occupancy, August 2003

72.7% occupancy, August 2004

Average Daily Rate: $116.82, August 2004

Source: Smith Travel Research

MAJOR PROJECTS UNDER CONSTRUCTION:

Southeast Federal Center, U.S. Department of Transportation headquarters, part of a 55-acre, multi-phase project that will include four buildings totaling 1.35 million sq. ft.

Developer: JBG Cos.

Completion: 2007

Howard Hughes Medical Institute, a 650,000 sq. ft. biotech office and research building.

Cost: $500 million

Developer: Mark Winkler Co.

Completion: 2006

Station Place, a three-phase, 1.5 million sq. ft. office complex connected to Union Station.

Cost: $478.5 million

Developer: Louis Dreyfus Property Group

Completion: 2007