Thanks to some 21 million sq. ft. of new office construction underway, the Washington, D.C. market will see higher vacancies in the months ahead, according to a newly released third-quarter office market report by Marcus & Millichap Real Estate Investment Services.

Office space in the D.C. metro area expanded by 3% last year, or 8.5 million sq. ft., up from 6.4 million sq. ft. in 2006. Office vacancies were expected to end 2007 at 9.7%, an increase of 80 basis points over 2006.

According to the firm’s recent findings, the pace of new development, with 16 million sq. ft. of new office space expected to break ground in the District and Virginia in 2008, will outstrip demand. Total employment was expected to expand by 1.5%, or 45,600 new hires, in 2007.

These new market fundamentals likely will dampen investment activity as well. “In the investment arena, more conservative underwriting will lead transaction velocity to recede from the high levels attained in recent years,” says Ramon Kochavi, regional manager of the Washington, D.C., office of Marcus & Millichap. “In the meantime, prices will rise at a more measured pace.”

Pricing is holding steady, for now. The median price of Class-A assets rose 3% to $300 per sq. ft. from October 2006 to September 2007. The median price of all assets held firm at $266 per sq. ft., the same as the year earlier period.

Kochavi predicts that top assets should still trade at cap rates of 6% or less, but overall, buyers and sellers will have to adjust to a recalibrated market dynamic. For example, by the third quarter, Class-A deal flow had dropped by 40% year-over-year.

Also playing a factor, some 894,000 sq. ft. of new office space came online in the District by the third quarter. Another 1.2 million sq. ft. was completed in Virginia and 467,000 square feet of office space in Maryland.

All of that new building is putting pressure on local vacancy rates. District office vacancies were projected to end 2007 at 8.5%, down 150 basis points from the year earlier, while Maryland vacancies rose 70 basis points to 9.3% and Virginia vacancies were up 60 basis points to 10.9%.

Rents have been a bright spot for the overall market, expected to end 2007 at $35.08, a 6% gain over 2006, while asking rents rose 10% in the third quarter of 2007 in the District. More good news – landlords have trimmed back on concessions, with effective rents increasing 8.3% in the third quarter.

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