Washington, D.C., just might be the only commercial real estate market in the U.S. with bragging rights. Two of the East Coast's largest developments are under construction there — an $833 million convention center and a $1.3 billion headquarters for the U.S. Patent and Trademark Office. And, when the rest of America's cities are facing office vacancy rates approaching 20% thanks to the miserable economy, the capital boasts a boom-time 6.5% vacancy rate, including sublease space — thanks to the expanding needs of the federal government.

But it gets better. A steady influx of tourists has fueled a renaissance in boutique hotel development, and relative immunity from the nationwide multifamily slowdown has left the nation's capital with the lowest overall vacancy rate. Meanwhile, retail is thriving in areas that retailers formerly ignored, such as the neighborhood surrounding the MCI Center sports arena.

“I'm a big fan of D.C. The District is thriving right now,” says David Houck, senior vice president in the Washington office of The Staubach Co., a Dallas-based broker. “It's the best market in the U.S.” Indeed, “Emerging Trends in Real Estate,” an annual report produced by Lend Lease Real Estate Investments and PricewaterhouseCoopers, ranked D.C. as the top market in the U.S.

Bob Murphy, managing director for Mid-Atlantic development at Dallas-based Trammell Crow Co., says Washington is positioned to retain its edge over many other real estate markets. “This is a permanent thing,” he says. “There are some permanent shifts in demographics into areas that were blighted.” That includes the area called “Old Downtown” northeast of the Capitol where multifamily and retail developments are thriving. “For the most part people want to be downtown,” Houck says. “It's remarkable.”

And the District keeps coming up with more reasons for developing downtown. On March 31, the new Washington Convention Center is scheduled to open. The 2.3 million sq. ft., $833 million project is expected to attract more than 2 million visitors a year and contribute $1.4 billion annually to the local economy. Set on a 17-acre plot in a neighborhood packed with townhouses, the convention center will feature 725,000 sq. ft. of exhibit space, 150,000 sq. ft. of meeting space and a 60,000 sq. ft. ballroom.

Trading Places

Until two years ago, office brokers focused on the fast-growing Northern Virginia market, where AOL and other Internet and telecom companies were gobbling up new office space as quickly as it could be built. Now, the Northern Virginia submarkets have crashed and the action has shifted to downtown Washington. While vacancy rates for the metro area registered 11.6% in the fourth quarter of 2002, up 2 percentage points from 9.6% at the end of 2001, the vacancy rate downtown ticked up to 6.5% from 5.3%, according to Delta Associates, an Alexandria, Va.-based research firm.

There is 1.3 million sq. ft. of office space under construction in the CBD, and 55% of that is pre-leased, according to Delta. “Washington is as hot as a firecracker right now,” says Scott Wimbrow, principal at Lutherville, Md.-based MacKenzie/ONCOR International.

Trammell Crow Co. is developing one of the largest office projects in the CBD for the Union Labor Life Insurance Co. The 400,000 sq. ft., 12-story building, called 1625 Eye St. due to its I Street location, is near the White House, the Capitol and other top government buildings. O'Melveny & Myers LLP, the giant Los Angeles-based law firm, has signed a lease for 118,500 sq. ft. and Union Labor Life Insurance will occupy 56,000 sq. ft.

With demand strong for downtown space, other developers are building offices on a speculative basis. One Metro Center, a 418,000 sq. ft. Class-A building that New York-based Tishman Speyer Properties is building at 13th and L Streets, is expected to open Sept. 1. No leases have been signed, but a Tishman representative says the firm has received many inquiries from prospective tenants.

The John Akridge Co., a Washington-based developer, is building a $100 million, 350,000 sq. ft. Class-A office building at 900 7th St. in partnership with the National Electrical Benefit Fund, a $9.5 billion fund that serves electrical workers. Chicago-based Corus Bank provided roughly $71 million in financing for the building, which is scheduled to open in the summer.

The Northern Virginia and Southern Maryland office markets — which have long fed off of their proximity to Washington — are wrestling with the economic slowdown and technology sector collapse. The Northern Virginia market, which is about twice the size of Maryland's market in the Washington suburbs, has been hit with a glut of sublease space. The market's vacancy rate jumped from 14% in the fourth quarter of 2001 to 20% at the same time in 2002, according to CB Richard Ellis.

Arlington, Va., remains a bright spot for the office sector, with a strong government presence helping to stabilize the vacancy rate at about 11%. The Maryland market is faring better than Northern Virginia, thanks in part to its strong biotechnology presence.

Buoyed By Government Spending

The largest leases in metro Washington inked in 2002 were signed by government agencies. In the first quarter of 2002, the U.S. Department of Transportation signed a lease for 1.35 million sq. ft. at Southeast Federal Center. The building, scheduled to be completed in 2006, is located at the Washington Navy Yard, where JBG/SEFC Ventures LLC has been authorized to develop several office buildings. Meanwhile, the Transportation Security Administration (TSA), created to oversee airline security in the wake of the Sept. 11, 2001 terrorist attacks, signed a 10-year lease in early January to occupy a 491,000 sq. ft. building in Arlington that was vacated by WorldCom in the wake of its financial collapse.

However, all leases pale in comparison to the U.S. Patent and Trademark Office (PTO) deal. After a four-year bidding process, Berwyn Park, Pa.-based LCOR Inc. was chosen by the U.S. General Services Administration (GSA) to develop a new $1.3 billion, 2.4 million sq. ft. headquarters for the PTO in Alexandria. The PTO signed a 20-year lease at the 15-acre, five-building campus, which is slated for completion in first-quarter 2004. The deal represented the largest lease ever signed by the GSA. The facility will consolidate 7,000 employees from several PTO buildings scattered through the area.

The Nation's Strongest Multifamily Market

Despite a national slowdown in the multifamily sector, metro Washington's apartment market remains stellar. In fact, it's the strongest major market in the United States in terms of vacancy rates, according to a fourth-quarter report by Delta Associates — 2.8% for metro D.C. in the fourth quarter of 2002, up slightly from 2.5% a year earlier. The Class-A vacancy rate remained steady at 3.5%, while metro rental rates edged up from $1,552 per unit in the fourth quarter of 2001 to $1,557 per unit in the fourth quarter of 2002.

These strong fundamentals have caught the attention of developers and lenders. “Equity capital pension funds and debt from banks is readily available for apartments. It's the one income property category that everybody feels comfortable about,” says Thomas Bozzuto, president of Bozzuto & Associates, which manages several apartment buildings in Washington. “There are some commercial builders who are trying to get into the business because they can't get financing for their office projects.”

The Bozzuto Group, which is based in Green Belt, Md., is building the 253-unit Whitney Bethesda Theatre Tower for $74 million in Bethesda, which is scheduled for completion in March. Fairfield Residential, which purchased Quince Orchard Cluster Apartments in Gaithersburgh, Md., last year for $74,561 per unit, has changed the name to Grove Park Apartments and plans to spend $16.4 million this year to renovate the 684-unit apartment complex.

There are limits, however. Despite the overall strength of the market, experts expect an increase in vacancy rates due to the 25,480 units scheduled to be delivered by the end of 2005. Delta Associates predicts vacancy rates will reach 5.2% by December 2005, an increase of 2.4 percentage points above current vacancy levels.

Checking into Boutique Hotels

With the massive new convention center expected to open at the end of March, hotel development is picking up in anticipation of an increase in convention business. In October 2002, Bethesda, Md.-based Marriott International, local developer Kingdon Gould III and JBG Cos. won the contract to build a $450 million hotel with up to 1,500 rooms to serve the convention center. With design plans in the early stages and construction expected to span more than two years, the hotel is not likely to open until 2007.

Tourism in the nation's capital remains strong, and development of boutique properties has picked up to serve travelers seeking high-end accommodations. Bethesda-based LaSalle Hotel Properties recently transformed a former Howard Johnson on Rhode Island Avenue in downtown D.C. into the Hotel Helix. The $11 million conversion brought 178 rooms to the market last fall.

LaSalle also renovated the upscale 80-room Clarion Hampshire House Hotel on New Hampshire Avenue, which the firm renamed the Hotel Madeira after spending $5 million on the conversion. Both hotels opened late last year and are operated by San Francisco-based Kimpton Hotel & Restaurant Group.

In contrast to the declining hotel occupancy rates in many markets, occupancy levels have remained steady in metro Washington. Through November 2002, occupancies registered 67.5%, the same percentage a year ago, according to Hendersonville, Tenn-based Smith Travel Research. But hoteliers, like their counterparts in other major markets, are still cutting rates to fill rooms. Average daily room rates were down by 1.9%, from $113.53 in November 2001 to $111.34 in November 2002.

Retail: Heading North

The core business district and prime submarkets such as Georgetown formerly dominated the retail arena in Washington. While those markets remain successful, development in areas once considered marginal is redefining the retail market.

Take, for example, Old Downtown. The area had been struggling until the 1997 opening of the MCI Center, home to the NBA's Washington Wizards and the NHL's Washington Capitals. That spawned a wave of retail development. “There are a lot of restaurants and businesses that feed off of the MCI Center,” says Jim Farrell, principal of the Washington-based Madison Retail Group.

Gallery Place, a 750,000 sq. ft. shopping center adjacent to the MCI Center, has been the beneficiary of many notable deals recently. United Artists has signed a lease to open a 14-screen movie theater, and several smaller tenants have inked leases for space in the mall.

The Golden Triangle, a 38-block area downtown, and Georgetown have remained solid retail markets. “Georgetown is just about as hot as it's been,” Farrell says. “It's very rare that spaces become available there.” Rental rates for prime street-front property range from $50 per sq. ft. to $80 per sq. ft., up slightly from a year ago and considerably higher than the $25 per sq. ft. to $60 per sq. ft. rates in 1999. In the Golden Triangle district, a 7,193 sq. ft. lease recently signed by Ann Taylor Loft spurred a façade renovation at the Charles E. Smith building on Connecticut Avenue.

While Northern Virginia's office market has cratered, the area's sprawling, upscale suburbs continue to attract retailers. Tysons Corner Center has held onto its status as one of the country's most prosperous shopping centers, attracting an estimated 21 million shoppers per year. Rental rates at the mall average $70 per sq. ft., compared with the $21.65 per sq. ft. average in metro Washington. “As far as national retail goes, there is no better area than Tysons Corner,” Farrell says.

Mixing It Up

With the rebirth of downtown neighborhoods such as the Old Downtown section near the MCI Center and steady population growth in the northern suburbs, there is a growing demand for mixed-use developments. Fed up with traffic gridlock, more suburbanites are moving downtown to be closer to work. Other mixed-use developments are taking shape near rapid rail stations outside the city to provide residents an alternative to driving their cars to work.

Dorsky Hodgson & Partners, a national design firm that specializes in designing high-density mixed-use projects, is drawing up plans for five major developments in metro D.C. The proposed Belcrest Center in Hyattsville, Md., would provide 840,000 sq. ft. of mixed-use space, including a 300,000 sq. ft. office building, 170,000 sq. ft. of retail and 130 apartment units on top of retail space. Taylor Development & Land Co. is the developer of the project, which is located near Prince George's Metro Station.

“The district has one of the nation's top urban apartment markets, with a large group of single professionals as well as empty nesters,” says Sandy Silverman, a partner with Dorsky Hodgson's Washington office. “They value being close to the city's cultural offerings, restaurants and clubs.”

The Toll Bros., a Huntington Valley, Pa.-based developer, is building major mixed-use projects in Northern Virginia. In Louden County, on land where Disney dropped plans for a theme park, Toll is building the South Riding Project, which will feature a 174,000 sq. ft. shopping center as well as office space.

In Arlington, Dorsky Hodgson is designing the Hartford condominiums near the Clarendon Metro Station as part of a mixed-use development. The project, which will also include 200,000 sq. ft. of office space, is scheduled for completion in June 2003. Washington, D.C.-based The Holladay Corp. is the project's developer.

The mixed-use boom in metro Washington may have a domino effect in other markets, says Silverman. “These high-density projects offer a preview of redevelopment in the Mid-Atlantic region.”

Ezra Fieser is a Baltimore-based writer.

WASHINGTON, D.C.-BY THE NUMBERS

POPULATION:

City: 572,059
Metro area: 7.6 million
Source: U.S. Census Bureau
UNEMPLOYMENT RATE: 5.3%

LARGEST EMPLOYERS:

  1. World Bank Group 10,000 employees

  2. George Washington School of Medicine 9,527 employees

  3. Washington Metropolitan Area Transit Authority 9,200 employees



Source: InfoUSA

METRO AREA STATS:

Office:
9.6%
vacancy, 4Q 2001
11.6% vacancy, 4Q 2002
Rent per sq. ft.: $28.55 4Q 2002
Source: Delta Associates; CB Richard Ellis

Multifamily:
2.5%
vacancy, 4Q 2001
2.8% vacancy, 4Q 2002
Rent per unit: $1,557 4Q 2002
Source: Delta Associates

Retail:
6.7%
vacancy, 4Q 2001
6.5% vacancy, 4Q 2002
Rent per sq. ft: $21.65 4Q 2002
Source: Delta Associates

Industrial:
9.1%
vacancy, 3Q 2001
11.6% vacancy, 3Q 2002
Rent per sq. ft.: $10.47 3Q 2002
Source: CB Richard Ellis

HOTEL:
67.5% occupancy, through Nov. 2001
67.5% occupancy, through Nov. 2002
Source: Smith Travel Research

MAJOR PROJECTS UNDER CONSTRUCTION:

U.S. Patent & Trademark Office, a five-building, 2.4 million sq. ft. headquarters

Cost: $1.3 billion

Developer: LCOR Inc.

Completion: First-quarter 2004

Washington Convention Center, a 2.3 million sq. ft. facility with 725,000 sq. ft. of exhibit space and 150,000 sq. ft. of meeting space

Cost: $833 million

Owner: The Washington Convention Center Authority

Completion: March 31, 2003

1625 Eye Street, a 400,000 sq. ft., 12-story office tower

Cost: $160 million

Developer: Trammell Crow Co.

Completion: March 2003

Whitney Bethesda Theatre Tower, a 253-unit apartment building

Cost: $74 million

Developer: The Bozzuto Group

Completion: March 2003

Marriott Convention Center Hotel, a tower with up to 1,500 rooms

Cost: $450 million

Developer: JBG Cos.

Completion: 2007