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trendlines 2008
®
February 2008
Foreword
To our friends, clients and colleagues: Our expectations for 2008 include:
We are pleased to provide you this eleventh annual n National Economy: Further deceleration with the
edition of TrendLines: Trends in Metro Washington, DC possibility – though not likelihood – of recession.
Commercial Real Estate. This is a collaborative publication n Regional Economy: Slower but steady growth, driven by
of Transwestern and its research affiliate, Delta Associates. our core industries.
Our purposes are to distill the trends of 2007 and to shed
n Office Market: Continued expansion, but at below-
light on pivotal forces and issues that we believe will affect
average levels of demand, accompanied by rising
the region’s economy and real estate in the period ahead.
vacancies and rents that only edge up.
n Flex/Industrial Market: Steady growth. However, new
In 2007, we experienced a cyclical change, moving from the
robust part of the economic cycle to what some believe may supply may exceed demand by year-end.
be a pre-cursor to a recession. And our real estate market n Housing Market (including condos): Methodical recovery
seems to be shifting from one that favors the landlord to one as excess inventory is reduced. But we do not look for
that favors the tenant. Both shifts are overstated to our way meaningful price traction until 2009.
of thinking, but a shift is in fact underway – from the less- n Rental Apartment Market: Strong conditions, but rising
challenging part of the cycle to one that takes more insight
vacancy due to an expanding pipeline.
to survive and make money. The icon of this shift is the
n Retail Market: Robust market conditions continue as
Credit Crunch that occurred in August. And so this annual
publication, TrendLines, is of even more importance –- as it above-average income and an inadequate development
can shed light on the path forward during a tumultuous time pipeline perpetuate low vacancy and rising rents,
in our industry. although this asset class is vulnerable to a recession.
n Capital Markets: Continued healthy performance, though
More challenges are on the horizon for 2008. Market at reduced volume. Prices should hold steady due to
conditions are expected to deteriorate modestly for most improved operating performance. Cap rates may edge
asset classes yet remain sturdy overall. High operating, up modestly.
financing, and development costs remain hurdles. While n Overall: We will find as many opportunities in our industry
money will be available to invest in commercial real estate in
in 2008 as we did in 2007. But it will take more equity,
2008, it will not be like we got used to in 2007. Also of note,
more insight, more work, and more skill.
the Washington area economy is dealing with the slowing
growth rate of Federal procurement spending, which has and
will dampen job creation and office leasing activity. We hope the information that follows helps provide insight
into these opportunities. We look forward to helping you
interpret everything you see in the market, and to being your
service partner in the successes we know you will achieve in
the period ahead.
Once again, the Washington real estate market is among the strongest in the
country as our area continues to thrive and grow. Visionary companies, many
of whom are our clients, our taking the lead in this growth by reinvesting in the
region and fostering economic development through their commercial and
residential developments. These real estate projects generate jobs and provide the
foundation for our communities.
As business and tax advisors to the real estate industry for over 30 years, we draw
upon our experience serving many of the region’s top real estate companies to
assist owners in creating tax-efficient ownership structures and developing planning
alternatives. We identify opportunities by being experts in the areas of Federal and
state tax laws that affect our clients.
We look forward to continuing to work with the real estate entrepreneurs who
are the foundation of the metropolitan Washington real estate industry as well
as investors – foreign and domestic – who recognize our area as one of the most
desirable investment markets in the United States.
As changes affect the real estate industry, we will be right here with you, advising
you on ways to profit from those changes and use them to give you a competitive
edge. To learn more about how we can help you manage your business in today’s
changing marketplace, please contact us.
Kelly P. Toole
February 2008
PNC is once again proud to sponsor the 2008 TrendLines Report, one of the premier
resources for the area’s commercial real estate professionals.
We understand that in today’s rapidly evolving markets you need lenders and
advisors who can do more for you. Lenders who have experienced varied economic
cycles before and have been consistently available to their customers. PNC is one
of those lenders.
We look forward to continuing to serve the real estate communities of this area,
delivering one of the industry’s broadest platforms of products and services -
including construction, interim, and permanent financing, along with access to the
capital markets, treasury management services and best-in-class loan servicing
provided by Midland Loan Services. And with last year’s acquisition of ARCS
Commercial Mortgage, we can now deliver access to one of Fannie Mae’s top DUS
lenders.
To learn how we can bring ideas, advice and solutions to you, call us or visit
www.pnc.com/realestate.
Sincerely,
Table of Contents
Acknowledgments: The editor, Gregory H. Leisch, CRE, wishes to acknowledge and thank this
project’s research team at Delta Associates: Alexander (Sandy) Paul, President of the Transwestern
Support Group and National Research Director; and Elizabeth Norton, Mid-Atlantic Research
Director. The creative design team at Transwestern and the administrative staff at Delta have our
gratitude. Most of all, our appreciation is hereby expressed to the dozens of industry leaders who
spent their valuable time responding to questions about the future of our industry here in the
Washington area.
Representations: Although the information contained herein is based on sources that Delta
Associates (DA) and Transwestern (TW) believe to be reliable, DA and TW make no representation
or warranty that such information is accurate or complete. All prices, yields, analyses, computations,
and opinions expressed are subject to change without notice. Under no circumstances should
any such information be considered representations or warranties of DA or TW of any kind. Any
such information may be based on assumptions that may or may not be accurate, and any such
assumption may differ from actual results. This report should not be considered investment advice.
TrendLines®: Trends in Metro Washington, DC Commercial Real Estate was designed in-house
for Transwestern and Delta Associates by Ji Chang, Verónica Sandoval and Jessica Newman.
9
CREATING OPPORTUNITIES
IN A CHANGING MARKET
section
CREATING OPPORTUNITIES IN A CHANGING MARKET
CREATING
OPPORTUNITIES
IN A CHANGING
MARKET
The purpose of TrendLines® is to distill the trends of 2007 and shed light on pivotal
issues that shape our commercial real estate opportunities in the Washington
marketplace in 2008 and beyond.
In order to understand the full picture of what challenges and opportunities lay
ahead, let’s first understand the status of the economy – both at the national and
regional level – and its effect on real estate market conditions.
What can we decipher from the muddled economic picture? What clues can we
seize upon that will help us invest wisely in the period ahead?
12
trendlines 2008
®
section 1 | 13
CREATING OPPORTUNITIES IN A CHANGING MARKET
The threat of inflation kept the Federal Reserve from cutting interest rates early in
2007, even though the U.S. economic expansion seemed to be slowing. Through
this decade, inflation had remained under 4% per year, even as gasoline prices
drove the overall barometer higher. However, after the Credit Crunch hit in August,
and consumer sentiment declined dramatically, the Fed took action, cutting the
Federal Funds rate in September, and then again in October and December. This
loosening of monetary policy takes on the added risk of a rising inflation rate, and
indeed, the rate for the 12 months ending in November 2007 rose to 4.3% – the
highest 12-month period in 17 years.
U.S. Inflation
Odds makers are betting on further rate cuts. And the Congress and White
House are discussing an economic stimulus package. These activities will likely
push inflation higher. And with higher inflation would come two problems for the
economy and our industry:
In our view inflation will remain elevated – 4% or so – but not high. In the
meantime, lock in fixed-rate low borrowing rates and take a defensive posture
regarding inflation.
Last year was a strange one for the broadest gauge of American economic
performance: gross domestic product (GDP). After a 2.9% growth rate for all of
2006, the rate dropped to 0.6% (annualized) for the 1st quarter of 2007, then jumped
to 3.8% and 4.9% for quarters 2 and 3. Most observers believe the final numbers
for the 4th quarter will be in the 1.0% to 1.5% range, which will make the annual
average in the 2.2% to 2.6% range.
14
trendlines 2008
®
Decelerating job growth, credit market U.S. Gross Domestic Product Growth
uncertainty, and related housing market
problems should act as a drag on
GDP growth in 2008. With weakening
consumer spending, which constitutes
two-thirds of GDP, Wachovia Bank
economists estimate U.S. GDP growth
will be 2.2% in 2007 when final figures
are tallied, and 2.0% in 2008. We
concur with these estimates. The long-
term average growth rate for real GDP
is approximately 3% per annum.
section 1 | 15
CREATING OPPORTUNITIES IN A CHANGING MARKET
1. Reduced Federal
Procurement Activity
the region.
16
trendlines 2008
®
3. Vulnerability to
U.S. Economic Cycle
section 1 | 17
CREATING OPPORTUNITIES IN A CHANGING MARKET
product types have made their way into Commercial Real Estate Market Position
the contraction phase of the market Washington Metro Area | Year-End 2007
cycle. These product types experienced
rising vacancy, softer absorption than
the long-term average, restrained rent
growth, and an engorged pipeline in
2007.
3. Condominium Market
18
trendlines 2008
®
And still others are buying tired Class B apartments and neighborhood shopping
centers and upgrading them with improved rental results.
section 1 | 19
CREATING OPPORTUNITIES IN A CHANGING MARKET
Cash Is King. After the Credit Crunch, the highly-leveraged buyers found that their
financing was too expensive or simply dried up, and they largely withdrew from the
market. There is still competition bidding for superior assets, but the buyers are
those with cash to spend. And development margins are thin enough that cash will
be rewarded over those with a heavy debt burden.
Be a Niche Player. Success in 2008 will come to those who have the market
knowledge and skill to ferret out deals that will outperform market-wide averages.
Keep in mind that niche players come in three varieties: those who work in
geographic areas, those who focus on specific product types, and those who find
the narrow intersection between those two worlds.
Product Type Plays. Examples of this niche include development and investment in:
20
trendlines 2008
®
For example, the following submarkets are ready for multifamily and office
development due to low vacancy, rising rents, and limited pipeline:
n Bethesda/Chevy Chase
n Rosslyn-Ballston Corridor
n Tysons Corner
Although not established as a submarket yet, the Capitol Riverfront (a.k.a. The
Ballpark District) will be a notable competitor for multifamily and office in the near-
term as entertainment and commercial development transforms this submarket into
a 24/7 destination.
We hope the information in the rest of this report aids you in making the best
possible decisions to meet your particular business objectives. Best wishes for
success in 2008 and beyond.
section 1 | 21
THE
NATIONAL
ECONOMY
section
THE NATIONAL ECONOMY
THE
NATIONAL
ECONOMY
n The employment picture remains healthy, with 1.8 million net new payroll jobs
added in 2007. However, the growth rate slowed dramatically late in the year.
n Inflation remains under control, yet it increased late in 2007.
n Corporate profits remain healthy, although the number of industries under
profit pressure has increased.
n GDP growth was a healthy 4.9% on an annualized basis through the 3rd quarter,
although we know this rate cannot last.
n A weak U.S. dollar, while inconvenient for the American traveler abroad, has
fostered exports and related jobs. And for the commercial real estate industry,
it has encouraged foreign buyers to step into the breach left by leveraged
domestics in the wake of the Credit Crunch.
n Interest rates remain low – both long-term as well as short-term rates. This
bodes well for the economy as a whole as well as our real estate industry in
particular.
n The credit market is tight, with lenders strengthening loan requirements and
some forms of debt simply not available. A near-term rebound in the housing
market is less likely.
n Consumer confidence is at a 26-month low – and the second lowest since the
early 1990s. A spooked stock market is not helping. And with our economy 70%
driven by the consumer, this does not bode well for GDP growth in 2008.
n Oil prices remain high, squeezing consumers on gasoline and home heating
costs.
n The leading economic indicators index is at its two-year nadir. This also
suggests 2008 will see tepid growth.
24
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section 2 | 25
THE NATIONAL ECONOMY
26
trendlines 2008
®
subprime borrowers who face sharp Capital Investment in Equipment and Software
increases in their adjustable interest
rates. We expect improving conditions
for the housing market in 2009.
section 2 | 27
THE NATIONAL ECONOMY
consumer confidence.
28
trendlines 2008®
section 2 | 29
THE NATIONAL ECONOMY
Economic Outlook
We expect the U.S. economy will expand over the next 12 months, although at
a very modest rate. Decelerating job growth and credit market uncertainty should
act as a drag on GDP growth. The policies of the Federal Reserve should keep
inflation under control, though it is likely to accelerate modestly.
Real GDP growth (on an annualized basis) was 4.9% in 3rd quarter 2007, according
to the Bureau of Economic Analysis, after a 3.8% annualized rate in 2nd quarter
2007. The 3rd quarter rate was revised upward from BEA’s preliminary estimate of
3.9%. Despite the improvement, Wachovia Bank economists estimate U.S. GDP
growth will be 2.2% in 2007 when final figures are tallied, and 2.0% in 2008. We
concur with this estimate, given the credit market problems, recent job growth
trends, and the unstable situation in the Middle East. We believe that 2009 will be a
better year for the U.S. economy. The long-term average growth rate for real GDP
is approximately 3% per annum.
The key factors affecting national economic performance in 2008 are likely to be oil
prices, the credit market, and the housing market. As always, the possibility exists
that a terrorist event could jolt economic progress.
30
trendlines 2008 ®
section 2 | 31
THE
WASHINGTON AREA
ECONOMY
section
THE WASHINGTON AREA ECONOMY
THE
WASHINGTON AREA
ECONOMY
Job Growth
With 3.0 million payroll employment jobs, the Washington metro area ranks the
fourth largest job base among metro areas, behind New York, the LA Basin and
Chicago.
Payroll employment increased 40,400 in the Washington metro area over the 12
months ending November 2007 – an average pace of about 3,400 jobs per month.
Compared to other metro areas, the Washington metro area is seventh for job
growth – migrating to the middle of the pack, while other markets caught up.
34
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section 3 | 35
THE WASHINGTON AREA ECONOMY
Coincident and
Source: Bureau of Labor Statistics, Delta Associates; January 2008
Leading Indices
The Washington Coincident Index, Coincident Index
which represents the current state of Washington MSA | October 2006 - October 2007
the metropolitan area economy, was
119.5 in October 2007 – which is 110
basis points below the 10-year average.
The current index is slightly lower than
120.0 one year ago.
cyclical cool-down.
36
trendlines 2008
®
Note: 2005 figures are actuals; 2006 figures are estimates. Procurement figures do not include US Postal Service and FAA purchases
Source: Dr. Stephen Fuller, Delta Associates; January 2008
section 3 | 37
THE WASHINGTON AREA ECONOMY
38
trendlines 2008
®
Although county budgets will feel the pinch of the housing slowdown in the
near-term, we expect conditions to firm faster in the Washington area than in
other metro areas. We expect that consistent demand and a decline in construction
will stabilize pricing and market conditions by 2009.
The Professional and Business Services sector should continue to lead job growth,
as government contractors and law firms spur growth in this sector. If the 2008
election favors Democrats, procurement spending could shift from Northern
Virginia’s defense contractors to Suburban Maryland’s health contractors.
Note: Data restated since 2000 consistent with redefinition of metro area in March 2005
Source: Dr. Stephen Fuller, Delta Associates; January 2008
section 3 | 39
THE
WASHINGTON AREA
OFFICE MARKET
section
THE WASHINGTON AREA OFFICE MARKET
THE
WASHINGTON AREA
OFFICE MARKET
42
trendlines 2008
®
n Net absorption: 5.4 million SF, compared to 6.8 million SF in 2006 and a
long-term average of 8.1 million SF.
n Overall vacancy rate: 9.1%, up from 8.5% one year ago.
n Direct vacancy rate: 8.0%, up from 7.5% one year ago.
n Pipeline (U/C and U/R): 20.6 million SF, up from 16.8 million SF a year ago.
n Pipeline pre-lease rate: 28%, compared to 35% a year ago.
n Rents: Increased 2.2%.
n Investment sales: $13.7 billion, inclusive of two portfolio sales and two com-
pany sales, compared to $13.8 billion in 2006. Average sale price: $369/SF.
section 4 | 43
THE WASHINGTON AREA OFFICE MARKET
44
trendlines 2008
®
Vacancy Rate:
Edged Up Over the Year
The Washington area’s overall
vacancy rate was 9.1% at year-end
2007, up from 8.5% one year ago.
Construction:
Up in 2007
There is 20.6 million SF of office
space under construction or
renovation in the Washington metro
area at December 2007, up from 16.8
million SF one year ago.
Source: CoStar, Delta Associates; January 2008
With high construction and operating
costs, coupled with easing demand and
increased credit difficulty, we expect
Vacancy Rates and Vacant Space (All Classes) construction levels to ease in 2008.
Washington Metro Area | December 2006 vs. December 2007
28% of the space under construction
December 2006 December 2007
is pre-leased at December 2007,
Vacancy Rate
down from 35% a year ago.
Direct 7.5% 8.0%
Sublet 1.0% 1.1% Since 2004 pre-lease rates on recent
Vacant Space (Millions of SF) deliveries in the Washington metro area
Direct 27.0 29.9 have declined. Projects set to deliver
during 2008 and 2009/2010 are 23%
Sublet 3.7 4.2
and 34% pre-leased, respectively. These
Source: CoStar, Delta Associates; January 2008 pre-lease rates are subpar, given the 10-
year average pre-lease rate is 55%.
section 4 | 45
THE WASHINGTON AREA OFFICE MARKET
Construction Starts
Washington Metro Area | 2004 - 2007
Source (All charts on this page): CoStar, Delta Associates; January 2008
Groundbreakings edged up in the metro area during 2007, primarily due to several
renovation projects starting in the District. The most notable renovation project is
1.4 million SF at Constitution Center.
46
trendlines 2008 ®
Projects that delivered during 2007 came online at 36% pre-leased, compared to
2006 projects delivering at 59% leased.
However, we believe that the vacancy rate will be slightly greater outside the
Beltway, as demand is lighter compared to inside the Beltway.
section 4 | 47
THE WASHINGTON AREA OFFICE MARKET
n The overall vacancy rate inside Office Space Demand and Deliveries
the Beltway is projected to rise to Washington Metro Area | 24 Months Ending December 2009
10.0% over the next 24 months,
from 7.2% today.
n We expect overall vacancy to rise
to 13.0% outside the Beltway by
December 2009, from 11.5% today.
Rents: Rising
The average effective office rent
increased 2.2% in the Washington
metro area during 2007, compared to
rising 2.7% in 2006.
Source: Delta Associates; January 2008
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trendlines 2008
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section 4 | 49
THE WASHINGTON AREA OFFICE MARKET
For 2008 we see demand below the long-term average, vacancy edging up, and
rent growth modest.
Although demand should remain steady, we expect it will not be able to keep pace
with the level of available space due to robust construction activity. Construction
levels should ease over the 12 months, as rising construction costs and lackluster
rent growth make new development harder to justify.
Regardless, the Washington area office market remains a top performing market in
the nation even under softer conditions.
Market Outlook:
The key to success in this asset class in 2008 and beyond is to avoid debt, improve
operations at existing assets, and select investment and development opportunities
that have one or more of these characteristics:
n Transportation-favored
n Close-in
n Tenant-driven
n Medical-related
n In a submarket with a low pipeline
n Low land cost basis
50
trendlines 2008
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section 4 | 51
THE
WASHINGTON/BALTIMORE
FLEX/INDUSTRIAL MARKET
section
THE WASHINGTON/BALTIMORE FLEX /INDUSTRIAL MARKET
THE
WASHINGTON/
BALTIMORE
FLEX/INDUSTRIAL
MARKET
n Net absorption: 6.6 million SF, compared to 4.3 million SF in 2006 and 5.4
million SF 10-year average.
n Overall vacancy rate: 9.5%, down from 9.8% one year ago.
n Direct vacancy rate: 8.8%, down from 9.3% a year ago.
n Under construction: 6.4 million SF, down from 10.1 million SF one year ago.
n 24% of the space under construction is pre-leased, compared to 21% a year
ago.
n Rents: Up an average of 2.8%.
n Investment sales: $1.5 billion, compared to $1.9 billion in 2006. Average sales
price: $80/SF.
54
trendlines 2008
®
section 5 | 55
THE WASHINGTON/BALTIMORE FLEX /INDUSTRIAL MARKET
Bulk warehouse space accounted for 43% of the total SF leased in the region during
2007. Flex/warehouse accounted for 41% and flex/R&D accounted for 16%.
There are 751 buildings with contiguous blocks of available space over 10,000 SF
in the Washington/Baltimore region. The largest block of space is 1.2 million SF
located at 2800 Eastern Boulevard in the Baltimore County East submarket.
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trendlines 2008
®
The region’s direct flex/industrial vacancy rate was 8.8% at December 2007, down
9.3% one year ago.
The region’s overall vacancy rate for newer product (built since 1987) ticked down to
10.8% at year-end 2007, from 11.7% one year ago. The region’s direct vacancy rate
for newer product is 10.1%, down from 11.0% a year ago.
section 5 | 57
THE WASHINGTON/BALTIMORE FLEX /INDUSTRIAL MARKET
31% of the space delivered during Flex/Industrial Space Under Construction and Pre-Leased
Year-End 2006 and Year-End 2007 (Millions of SF)
the year was leased upon delivery,
compared to 32% during 2006. At 12/2006 At 12/2007
Metro Area
SF U/C % Pre-leased SF U/C % Pre-leased
Supply vs. Demand: Washington 3.7 40% 2.8 44%
Vacancy to Edge Up Baltimore 6.4 10% 3.5 7%
Regional Total 10.1 21% 6.3 24%
The regional flex/industrial vacancy
rate likely will tick up to 10.2% by
year-end 2008, from 9.5% today. Leasing on Recent Deliveries and Projects U/C or U/R
Washington is likely to see a rate of Washington/Baltimore Region | 2004 - 2008
9.4% and Baltimore a rate of 11.1%.
58
trendlines 2008 ®
Washington Baltimore
Regional Total
Metro Metro
Inventory
Inventory at 12/07 169.3 164.9 334.2
Pipeline Thru 12/081 4.2 4.7 8.9
Inventory at 12/08 173.5 169.6 343.1
Supply2 vs. Demand
Vacant Space at 12/07 15.1 16.6 31.7
New Supply Thru 12/08 4.2 4.7 8.8
Avail. Space at 12/08 19.2 21.3 40.5
Demand Thru 12/08 3.0 2.4 5.4
Vacant Space at 12/08 16.2 18.9 35.1
Vacancy Rate2
Vacancy at 12/07 8.9% 10.1% 9.5%
Vacancy at 12/08 9.4% 11.1% 10.2%
1
Pipeline equals buildings under construction and those planned that may deliver by year-end 2008
2
Includes sublet space
Source: CoStar, Delta Associates; January 2008
% Change
Submarket
December 2006 to December 2007
section 5 | 59
THE WASHINGTON/BALTIMORE FLEX /INDUSTRIAL MARKET
Flex/industrial rents should continue to rise at a moderate pace during 2008, The key to success in this asset class in
as tenants continue to seek space. Given the amount under construction and easing 2008 and beyond is to avoid debt,
demand, we expect rents to rise 1.5% to 2.5% over the next 12 months. improve operations at existing
assets, and select investment and
Investment Sales: Strong development opportunities that
have one or more of the following
Flex/industrial investment sales volume totaled $1.5 billion in the Washington/ characteristics:
Baltimore region during 2007, compared to $1.9 billion in 2006. There were a
n Transportation-favored, like ports,
handful of multiple building deals during the year, which boosted the sales volume.
airports and Interstates – near
Sales prices averaged $80/SF during 2007, down slightly from $88/SF achieved Dulles Airport or the Port of
during 2006. A handful of deals lowered the average sales price. For example, Baltimore
Landover Centre II in Suburban Maryland sold for $11.3 million ($55.15/SF) and 2800 n Submarkets with a low
Eastern Boulevard sold for $37.5 million ($19.56/SF) in Suburban Baltimore. development pipeline – I/95
and I/395 in Northern Virginia or
We expect investment sales activity to remain solid during 2008, as property Montgomery County in Suburban
performance remains healthy. Investors will likely remain interested in the Maryland
Washington/Baltimore flex/industrial market, given its long-term, stable nature. n Low land basis
However, the Credit Crunch is likely to filter leveraged buyers from the market and
n Tenant-driven
reduce the number of bidders for each available asset.
The most notable land sale during 2007 was 47.4 acres at 44901 Russell Branch
Parkway in the Dulles Corridor purchased by Visa USA for $19.8 million. The buyer is
planning a flex/industrial park, called Russell Branch Parkway Industrial Park.
Market Outlook:
Overall, strong population and economic growth will continue to fuel steady
expansion of the flex/industrial market in the Washington/Baltimore region in the
period ahead.
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trendlines 2008
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section 5 | 61
THE
WASHINGTON AREA
APARTMENT MARKET
section
THE WASHINGTON AREA APARTMENT MARKET
THE
WASHINGTON AREA
APARTMENT MARKET
However, this otherwise solid market began to show stress in the 4th quarter of
2006 that continued through 2007 due to:
National Context
The Washington metro area is the 3rd largest apartment market in the U.S., next to
New York and Los Angeles.
At 3.7% stabilized vacancy, Washington enjoys the 3rd lowest vacancy rate in
the U.S. – behind only NY and LA. While this is 80 basis points higher than last year,
most of the increase is due to Class B apartment performance, which is stressed by
the shadow rental market and condo rentals.
Net Absorption during 2007, at 5,042 units, was 1st in the U.S. and the highest
we have seen since 3rd quarter 2006. Absorption at new projects held steady at 17
units per project per month – and this is particularly noteworthy as the number of
projects marketing doubled since 2006.
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trendlines 2008
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Note: Excludes NYC and includes only those units in projects of 20 or more units n Even high-rise within the Beltway
Source: Delta Associates; January 2008
was sensitive to pipeline: the
District, with four projects in lease
Lowest Apartment Vacancy Rates Among Major Metro Areas
Year-End 2007 up, experienced rent growth of
4.3%, while Alexandria, with seven
projects leasing up, registered just
0.5% growth.
Concessions
Concessions doubled for all Class
A projects, from 2.4% to 4.8%
during 2007. The increase was most
pronounced in Northern Virginia, where
Class A rent growth was 0.6% as a
result of the increase in concessions.
Concessions also markedly increased in
Suburban Maryland and in the District.
1/ The largest 71 apartment markets in the U.S. | * Wash = 12 Months Ending 12/07; Others 6/07
Source: REIS and Delta Associates; January 2008
section 6 | 65
THE WASHINGTON AREA APARTMENT MARKET
Concessions for all Class A properties Concessions for All Class A Properties*
(that is, those filling up as well as those Washington Metro Area
replacing turnover) averaged 4.8% Year-End 2004 Year-End 2005 Year-End 2006 Year-End 2007
metro-wide at year-end 2007 – and are
No. VA 3.9% 2.6% 2.7% 5.8%
back up to where they were at the end
Sub. MD 5.8% 2.4% 2.1% 3.4%
of 2004 (see table at right).
District 5.9% 2.4% 2.7% 3.3%
Concessions for projects currently filling Metro-Wide 4.7% 2.5% 2.4% 4.8%
up, and not yet stabilized, are indicated
* Includes those filling up as well as those replacing turnover
in the table at right. Source: Delta Associates; January 2008
under pressure.
Northern Virginia’s 36-month pipeline n Up 0.8% for all investment grade units.
grew to 17,120 units. As a result, we
n Down 0.3% for Class A garden apartments.
expect supply to exceed anticipated
n Up 2.3% for Class A high-rise apartments.
demand through 2008 and into 2009,
and vacancy is likely to edge up.
Positive rent growth in the Vienna garden apartment submarket, amid overall
As the pipeline continued to grow over negative garden rent growth, is a testament to the value of limited pipeline volume
the past 21 months, rents slowed or (no new projects have delivered in the submarket since 2004) combined with Metro
retreated slightly. For example, during access.
2007 rents were:
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trendlines 2008
®
Absorption
The Washington area’s apartment absorption bounced back from a soft
performance earlier in 2007.
Absorption has been consistently strong at 4,300 to 6,500 units per annum over
the past 12 years. However, absorption during the first three quarters of 2007 had
been curtailed because of a soft housing market in which frustrated sellers put
their listings up for rent, thereby siphoning off apartment demand. This created a
“shadow market” of rental units.
Net absorption declined precipitously during the final quarter of 2006, slipping
further and remaining low through the 3rd quarter of 2007. Given continued sturdy
job growth and overall demand, we believe this decline can be largely attributed to
two factors:
1. The cooling of the overall housing market and subsequent rental of housing
units of all types that are slow to sell.
2. The large number of “shadow” market condominium rentals investors placed
on the market in the latter half of 2006 and first half of 2007.
section 6 | 67
THE WASHINGTON AREA APARTMENT MARKET
These conditions seem to have eased in the 4th quarter, as 12-month absorption
rebounded to over 3,200 units. We think these conditions will continue to ease in A Word About Our Definition
2008, thereby positively impacting apartment absorption during the first half of of Vacancy Rate
2008.
We sometimes hear from apartment
developers and managers that their
A testament to the strength of the apartment market: Absorption pace per portfolio vacancy rate is 200 to 400
project remained steady during 2007 at 17 units monthly, even as the number basis points higher than the numbers
of projects in active lease-up increased markedly from 20 to 41. we report, which places them
under unfair investor scrutiny. As a
Absorption Pace Per Project Per Month result, we thought it appropriate to
Washington Metro Area (Projects in Initial Lease-Up) describe here our term “vacancy.”
Delta’s Definition:
Available units to lease
Source: Delta Associates; January 2008
Operating Statement Vacancy:
Economic vacancy
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Washington Investment
Sales: Another Record-
Setting Year
2007 has surpassed prior record-
Source: Delta Associates; January 2008
setting years. In 2006 , as Delta’s Year-
End Apartment Report went to press
in late December, we had identified 15
Class A Apartment Rent Growth Per Year Class A building sales (most of them
Washington Metro Area | 1998 - 2010 gardens), consisting of $1.19 billion
of multifamily Class A building sales
volume.
section 6 | 69
THE WASHINGTON AREA APARTMENT MARKET
Having officially closed in October, the largest transaction of the year is the sale of
Archstone-Smith’s entire portfolio to Tishman-Speyer. This REIT buyout, which includes
numerous Washington metro properties, is valued at approximately $22 billion.
1. What is a better alternative investment vehicle, either within the real estate
sector or even across other asset classes?
2. Strong prospects of improved operating performance as rents continue to
edge up, yielding even better net income.
3. The prospect of increasing long-term interest rates suggests a “closing window
of opportunity” to purchase the higher-performing assets with capital as
reasonably priced as it is currently.
So now, evidently, is the time to buy. And the Washington Metro is, evidently,
the place to buy:
But the recent Credit Crunch appears to be re-pricing all forms of risk – real estate
included. It is too soon to know the implications for apartment pricing, but most
observers believe cap rates have reached their cyclical low and price increases will
now be earned the old fashioned way – by performance enhancement. We believe
the apartment segment is a winner in the turmoil that follows this Credit Crunch –
with home ownership rates edging down from their cyclical high of 70%. If that is the
case, demand for this product type should remain strong. So also should demand
for this asset class.
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During the 3rd quarter of 2007, 16 condominium projects were cancelled, totaling Market Outlook:
3,681 units. In the 4th quarter of 2007, 18 projects were cancelled, totaling 4,367
units. Of those changing course, 13 projects with 3,840 units, were added to the
The Path Forward
Class A development pipeline. Over the last two years nearly 21,000 condominium
In this phase of the real estate cycle,
units have been reprogrammed and added to the Class A apartment pipeline.
the successful investor/developer will
use cash to:
Condo Development Pipeline Removals
Washington Metro Area | Through Year-End 2007
Invest in repositioning existing
under-performing assets and
developing new projects with superior
design features at premier sites within
submarkets that maintain a supply/
demand balance where better than
market average rent increases can be
expected.
section 6 | 71
THE
WASHINGTON AREA
CONDOMINIUM MARKET
section
THE WASHINGTON AREA CONDOMINIUM MARKET
THE
WASHINGTON AREA
CONDOMINIUM MARKET
It is hard to believe if you read the popular press, but new condo unit prices are
steady.
However, sales velocity is way down in the second half of 2007 compared to the
first half. Little wonder:
n The August Credit Crunch removed at least one-third of the buyers due to the
end of exotic mortgages and loans to investors. Jumbo loans became much
more expensive – so many high end buyers are on the sidelines too.
n Demand is off its peak, as job growth, while still near the region’s long-term
average, is lower than it has been since 2002.
n Consumer confidence is at its lowest level since Hurricane Katrina. Consumers
simply are not in the mood to buy.
n And then there is the buyer conundrum: Interest rates and prices are not
rising, so what is the hurry in making a decision?
Even though the inventory of condominiums continues to decline, the main driver
behind the reduction has more to do with project cancellations and less to do with
contract sales.
n Volume. Way down in the second half of the year: (defined as net binding
contracts written with security deposits up) 3,905 units were sold in 2007 –
about the same as in 2003.
n Concessions. Surprisingly, concessions are down in 2007 by 90 basis points
from 2006 – to 3.7% of the purchase price.
n Pipeline. Down 6,601 units during 2007 – 27% – to 17,607 unsold condominium
units that are actively marketing in the metro area at year end 2007. More
importantly, there now is 4.5 years’ worth of inventory of product on the market
at current rates of sales velocity. History tells us that at 2.5 to 3.0 years and
below, prices move up smartly. Some submarkets are there, but as a whole, the
metro has some “cure time” ahead of it.
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n Prices. Condo prices held steady New (and Conversion) Unit Sales by Jurisdiction
in 2007, as viewed by two different 2007
sources of data. Resale prices
Jurisdiction Group # of Units Sold*
during the past 12 months were
Prince William/Loudoun 1,092
down by only one percent. Same-
store new condo prices (after District of Columbia 996
concessions) were up by about Prince George’s 719
one-half a percent metro-wide. Montgomery 505
n Sales pace. Contract cancellations Fairfax/Falls Church 250
continue to have an impact on net Anne Arundel/Howard 173
sales pace. As projects get closer Arlington/Alexandria 170
to delivering, buyers get second
Metro Total 3,905
thoughts about going through with
closing on their units. In today’s *Binding contracts executed
Source: Delta Associates; January 2008
environment, a good sales pace
per project is 3 to 5 units per
month.
New Condominium Sales Trend
Washington Metro Area | 2002 - 2007
section 7 | 75
THE WASHINGTON AREA CONDOMINIUM MARKET
Concessions as a Percentage of Average Sales Price by Sub-State Area Even though there were about 3,900
Year-End 2006 And Year-End 2007 new condo sales in 2007, condo
availability declined by almost 6,600
% of Sales Price units during the same time period.
Sub-State Area YE 2006 YE 2007 At least 2,700 unsold units were removed
Suburban MD 3.6% 3.8% from the actively marketing condo
Northern VA 5.4% 4.1% pipeline in 2007 due to cancellations or
The District 3.5% 2.5%
reversions back to the apartment market.
On the following page is a graph showing
Metro Average 4.6% 3.7%
the trend of condo units removed from
Source: Delta Associates; January 2008 the development pipeline.
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n The move-up market is tough right now – there is a home to sell before the
We believe price traction will start to
occur by late 2008 or early 2009 as the buyer can settle.
inventory-to-sales ratio gets closer n The first-time buyer market could be lucrative – no home to sell, and generally
to the 2.5- to 3.0-year range in select priced not needing a jumbo mortgage.
jurisdictions. n Boutique buildings for the empty-nester market may also be an alternative.
But location is critical here.
We believe sales will track in the 4,000 –
n Developing in close-in submarkets to take advantage of better pipeline
4,500 units range in 2008.
conditions and transit options/existing infrastructure could also prove to be
successful.
During this time in the cycle, we find
the more successful developers are
section 7 | 77
THE
WASHINGTON AREA
RETAIL MARKET
section
THE WASHINGTON AREA RETAIL MARKET
THE
WASHINGTON AREA
RETAIL MARKET
The Washington metro area retail market remained a strong performer in 2007. In
fact, it continues its long run since the early 1990s due to solid employment growth,
high disposable incomes, and an under-developed pipeline of activity. While all
categories of retail are benefiting from these conditions, the focus here is on the
52.1 million SF, 299 grocery-anchored neighborhood centers:
Incomes in the Washington metro area grew by 21.5% from 2000 to 2007, compared
to 17.8% nationally. Compensation in the metro area has risen at a faster pace
compared to other areas, as high-level positions are difficult to fill with qualified
candidates due to a low unemployment rate; this has prompted companies to use
high salaries as a lure.
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Retail Employment
Washington Metro Area
Retail Inventory:
Not Enough
Year Retail Employment Change
2001 255,200 (1,700) The Washington metro area has over
2002 255,900 700 116.0 million SF of retail space, inclusive
2003 256,600 700
of all types of retail, in just over 1,000
shopping centers. Northern Virginia is
2004 263,500 6,900
home to 52% of the total metro retail
2005 268,500 5,000 inventory.
2006 269,900 1,400
2007* 283,800 5,400 With such high income and rapid
growth the metro area should have
*Employment total at November 2007; change reflects growth during the 12 months ending November 2007
Note: 2005 and 2006 have been re-benchmarked by the Bureau of Labor Statistics more retail space per capita than it
Source: Bureau of Labor Statistics; January 2008 does – just 21.3 SF per capita. This
compares to the national average of
Average Household Income 20.0 SF per capita.
section 8 | 81
THE WASHINGTON AREA RETAIL MARKET
data.
Note: Estimate
Source: CoStar, U.S. Census, Delta Associates; January 2008
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trendlines 2008 ®
section 8 | 83
THE WASHINGTON AREA RETAIL MARKET
Jurisdiction Vacancy
Arlington County, VA 0.35%
Washington, DC 0.47%
Montgomery County, MD 1.55%
Fairfax County, VA 1.97%
Loudoun County, VA 2.15%
City of Alexandria, VA 2.80%
Prince George’s County, MD 2.93%
Prince William County, VA 3.82%
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trendlines 2008®
With super center/club stores and Average per Store Sales Volume – By Type
traditional markets capturing customers Washington Metro Area | 2006 vs. 2007
wanting organic food at affordable
Type 2007 Growth 2006 Growth
prices, the organic/specialty niche is
feeling the pressure. In June 2007, Super Center/Club 1.6% 4.7%
the Federal Trade Commission (FTC) Organic/Specialty 0.6% 5.4%
attempted to block Whole Foods Traditional 1.9% 0.8%
from purchasing Wild Oats, another
Note: Includes only grocery stores with $2 million or more in sales
natural and organic grocery chain. Source: Food World, Delta Associates; January 2008
The FTC felt the merger would reduce
options and raise prices for consumers.
Although Whole Foods’ total sales have
increased each year, the rate of growth Whole Foods Sales Growth
has slowed since 2004. According United States | 2002- 2007
to financial press releases, in the 12
months ending September 2007, Whole
Foods states that sales increased
13.2%, compared to 22.8% in 2004.
section 8 | 85
THE WASHINGTON AREA RETAIL MARKET
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trendlines 2008 ®
Grocery-Anchored
Shopping Center
Investment Sales
Investment purchases of shopping
centers in the Washington metro area
suburbs totaled $429 million on 16
notable transactions in 2007.
section 8 | 87
THE WASHINGTON AREA RETAIL MARKET
Given the health of the metro area’s retail market, vacancy rates should remain
low and rents continue to climb through 2008 and beyond for most retail
types.
Although the economy continues to transition off the robust peak of the economic
cycle, we expect retail vacancy to remain low and rents to continue to rise at
grocery-anchored shopping centers in particular. Investment sales volume is
expected to remain robust even if off its peak of 2005 - 2007, as the Washington
metro area is a premier retail market with strong property performance.
In this phase of the real estate cycle, we believe our more successful clients will use
cash to:
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trendlines 2008
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section 8 | 89
CAPITAL MARKETS AND
INVESTMENT TRENDS
section
CAPITAL MARKETS AND INVESTMENT TRENDS
Real estate remained in favor despite a Credit Crunch that drove most leveraged
buyers from the market. Elevated prices and some upward movement in cap rates
did not seem to dissuade buyers, as a volatile stock market and soft bond market
did not offer much competition. Both domestic and foreign investors who sought
to capitalize on U.S. economic growth found real estate to be the best bet from a
risk-reward perspective. When the pace of that growth slowed, the weak dollar
helped foreign investors take even greater advantage, especially after the August
Credit Crunch caused highly-leveraged buyers to withdraw from the market.
Of note, in 2007, investors sought office assets, pushing the national total to $218.4
billion, an increase of 48.9% from 2006. Other product types also experienced gains.
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trendlines 2008
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Source: Real Capital Analytics, CoStar COMPS, Delta Associates; January 2008
section 9 | 93
CAPITAL MARKETS AND INVESTMENT TRENDS
Cap Rates
Washington area office cap rates declined in 2007, at least until the late
Summer or early Fall. The impact of the Credit Crunch appears to be that there
has been a slight increase in cap rates used by buyers to shop for assets. We
anticipate cap rates will edge up in 2008 as the rate of capital flows slows.
The Credit Crunch has pulled highly-leveraged buyers from the market, reducing
competition for available assets. As a result, rapid price escalation is likely off the
table for 2008. Price appreciation in 2008 and beyond will be earned the old
fashioned way – by asset performance enhancement.
Source: Annual survey by Delta Associates, conducted October 2007, of the region’s leading commercial real estate players
Value Increases
Strong demand, declining cap rates and improving fundamentals pushed sale
prices to new heights in 2007, although conditions moderated late in the year.
Average office sale prices rose 15.7% in the Washington metro area in 2007, after
rising 3.9% in 2006. Sales of Washington area office assets averaged $369/SF in
2007.
Similar price increases were realized in 2007 for other asset classes.
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trendlines 2008
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Developers of This
Product Type All Respondents
Property Type
Apts.: High-Rise – Class A 5.62% 5.64%
Apts.: Suburban Garden – Class A 5.85% 5.85%
Apts.: Suburban Garden – Class B 6.29% 6.29%
Shop. Ctr.: Groc. Anchor – Class A 6.48% 6.43%
Office: CBD – Class B 6.55% 6.55%
Office: Suburban – Class A 6.64% 6.65%
Office: CBD – Class A 6.90% 5.90%
Industrial/Distribution: Class A 6.90% 6.80%
Office: Suburban – Class B 7.19% 7.21%
Hotels: Suburban – Class A 7.62% 7.64%
Note: Buyer’s cap rate, based on prior 12 months NOI, before reserves
Source: Annual survey by Delta Associates, conducted October 2007, of the region’s leading commercial real estate players
section 9 | 95
TRENDSETTER
AWARD RECIPIENT
section
TRENDSETTER AWARD RECIPIENT
TRENDSETTER
AWARD RECIPIENT
Each year, Transwestern and its research affiliate, Delta Associates, honor an
individual, or individuals, who have made a noteworthy contribution to the
commercial real estate industry as a whole, and to the Washington metropolitan
area in particular. This year our honoree is Oliver T. Carr, III, President and Chief
Executive Officer of Carr Properties.
For over 100 years, the Carr name has been associated with Washington, DC real
estate. Since founding Carr Capital in 1994 and serving as Chairman, CEO and
President of the successor publicly traded firm, Columbia Equity Trust, Oliver Carr,
III has established his own reputation for investment acumen and creating value for
his partners and investors. In engineering a merger with an institutional investment
fund to take Columbia Equity REIT private, he capitalized on two of the most
significant trends impacting our industry: the expanding flow of capital into real
estate and the growing influence of private equity.
Now, as the head of privately held Carr Properties, with a $1 billion commercial
real estate portfolio and significant resources available for new investment and
development, Oliver Carr, III has once again elevated the Carr brand to the
forefront of Washington’s commercial real estate industry. For his distinguished
record of accomplishment and continuing market leadership, we are very pleased to
honor Oliver T. Carr, III as our 2008 TrendSetter of the Year.
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trendlines 2008 ®
Benjamin Jacobs Michael Glosserman Andrew Florance Milton Peterson F. Joseph Moravec
2007 Private Company 2007 Private Company 2007 Public Company 2006 TrendSetter of the Year 2005 Public Sector
TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year Chairman TrendSetter of the Year
Managing Partner Managing Partner Founder, Director, The Peterson Companies Commissioner
The JBG Companies The JBG Companies President & CEO GSA Public Buildings Service
CoStar Group, Inc.
John E. (Chip) Akridge Congressman Tom Davis Bryant F. Foulger Clayton F. Foulger Douglas M. Duncan
2005 Private Sector 2004 Public Sector 2004 Private Sector 2004 Private Sector 2003 Public Sector
TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year
Chairman 11th District of Virginia Principal and Vice President Principal and Vice President County Executive
Akridge Real Estate Services U.S. House of Representatives Foulger-Pratt Companies Foulger-Pratt Companies Montgomery County
R. William Hard Anthony A. Williams Robert Gladstone Thomas M. Garbutt Michael J. Darby
2003 Private Sector 2002 Public Sector 2002 Private Sector 2001 Institutional 2001 Entrepreneurial
TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year TrendSetter of the Year
Executive Vice President and Mayor Chairman Managing Director Principal
Principal-In-Charge, LCOR District of Columbia Quadrangle Development TIAA-CREF Monument Realty, LLC
Jeffrey T. Neal Ray D’Ardenne Daniel T. McCaffery Robert E. Burke Raymond A. Ritchey
2001 Entrepreneurial 2000 TrendSetter of the Year 1999 TrendSetter of the Year 1998 TrendSetter of the Year 1998 TrendSetter of the Year
TrendSetter of the Year Chief Operating Officer President Executive Vice President, Executive Vice President,
Principal Lend Lease Real CCR McCaffery Operations Head of the Washington, D.C.
Monument Realty, LLC Estate Investments Developments Boston Properties Office & National Director of
Acquisitions and Development
Boston Properties
section 10 | 99
A STATE OF THE MARKET OVERVIEW AND FORECAST REPORT
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trendlines 2008
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101
A STATE OF THE MARKET OVERVIEW AND FORECAST REPORT
Notes
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®
103
A STATE OF THE MARKET OVERVIEW AND FORECAST REPORT
Notes
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105
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301.571.0900
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Transwestern is the Mid-Atlantic Region’s preeminent full-service commercial real estate firm. Northern VA
Partners in Excellence
Delta Associates, an affiliate, is a national provider of industry information, market analysis,
and feasibility consulting for commercial real estate. Washington, DC
106