Pandemic Disruption Weakening Northern Virginia’s Office Market: Report

Devon Munos, Savills’ research manager for Washington, D.C., and Wendy Feldman Block, the firm’s senior managing director for suburban D.C., spoke with Commercial Observer about the effects of COVID-19 on the market and what’s expected for the rest of 2020 and beyond.  

Commercial Observer: What takeaways for Q3 best characterize the current state of the office market in Northern Virginia?

Munos: The Northern Virginia market had been cushioned from the worst of the pandemic’s impact through the first half of the year, but the ongoing pandemic disruption began to shake the market’s stable market fundamentals in the third quarter. Availability has begun to rise as a result of a deterioration in demand, as most tenants are acting cautiously in the current environment and postponing significant lease commitments unless forced to act by an upcoming lease expiration. This supply-and-demand imbalance is weakening the Northern Virginia market.

Where are we compared to the same time last year?

Munos: Availability had been on the decline over the last three years and there was some rent growth, but the pandemic has pushed the pendulum to swing the other way, softening market fundamentals. Any market correction that was in progress before March is being undone by the current crisis. Northern Virginia was already a tenant-favorable market prior to COVID-19, and the pandemic is amplifying these conditions and increasing tenant leverage. 

It’s believed that tenants will shed space in the months ahead. How will this affect the office landscape?

Munos: While tenants are focused on bottom lines, of which a large part is their real estate obligations, they will likely shed additional space in the coming quarters, causing availability to continue to climb. Northern Virginia saw more than 500,000 square feet of sublease space being added to the market over the quarter, almost the same amount that the D.C. market has added since March; but Northern Virginia added it in half the time from Q2 to Q3. The pace of surplus space returning to the market and the longevity of the pandemic will affect how well the market can withstand serious changes to market fundamentals.

What is expected in leasing demand in the upcoming quarter and the early part of 2021?

Munos: Leasing activity was sustained in the first half of the year by deals in progress prior to the pandemic, but as those transactions have been expended, transaction volume has fallen. In Q3, 1.5 million square feet was leased — the lowest quarterly volume seen in almost four years — down from 2.8 million square feet in Q2. Demand will not return to the market until there is more vaccine certainty and less ambiguity surrounding the future of workplace trends.

How will landlords react? What might we see to encourage companies to lease?

Munos: As the pool of tenants who are willing to sign a lease in the near term shrinks, landlords will become more accommodating and offer increased flexibility to tenants who are looking to be more adaptable in the current environment. In addition to favorable deal terms and increased concessions, landlords will likely be amenable to shorter lease terms and more open to providing contraction and termination rights.

Are these favorable deal terms and concessions already happening? What are you seeing?

Block: Yes, landlords recognize that demand is tepid, and they need to be aggressive and creative in securing a new tenant or retaining an existing one. Concessions continue to rise with abatement as the biggest driver, and we are beginning to see some downward movement on asking rents; however, there has not been a full market re-pricing yet. The longer the pandemic continues, the more we expect to see landlords move on the rental rates — something that, historically, even during prior downturns, didn’t change much.

Any examples you can share on average concessions?

Block: Concessions for new, Class A, long-term transactions now average $92 per square foot in tenant improvement allowance and 14 months of free rent, resulting in an incentive package with a total value of $140 per square foot. 

What can you project about the 2021 office market in NoVA based on what we know now?

Block: We expect companies seeking, where possible, to delay decisions as long as they can. If they cannot, many will seek short-term extensions until they have a better sense of the long-term impact of remote work on their offices. We do not anticipate seeing a lot of large deals with growth like we just saw with VW’s commitment to Reston Town Center. As more companies continue to push out the date for a reopening of their offices, what was January 2021 has slid to June 2021, and now, barring a vaccine, is being pushed to fall 2021 and beyond. With most children physically out of school, the burden on working parents is acute.

We also expect to see a lot more sublease space come to market. MicroStrategy is marketing its space in Tysons, where they did a long-term lease extension recently, and the American Diabetes Association just put their entire 80,000-square-foot office in Crystal City up for sublease. As many companies don’t want the market to know how much space they could dispose of, some hold back what I see as “shadow space,” which, if included in the listings, could further push the availability rates higher.

Why do companies want to come to Northern Virginia? What attracts them to the area?

Block: Companies continue to choose Northern Virginia for its pro-business environment, access to an educated workforce, proximity to airports, and diverse stock of housing. One also cannot overlook that this is the preferred location for data centers — over 70 percent, and rising, of the world’s data traffic flows through this area. The technology companies are drawn here because of NoVa’s proximity to the nation’s capital. Furthermore, it is well-established that technology companies like to co-locate near each other. While we haven’t yet seen the full impact of the ‘Amazon effect’ in Arlington, we do expect it in the coming years.

What will help bring tenants back to their buildings and employees to their offices?

Block: Tenants will want to feel safe and I’m not referring to security. They want to know that their buildings are implementing best practices, including things like MERV 15 filters on HVAC units, certifying building air and water, touchless controls where possible, and, where not, self-cleaning covers on elevator buttons and door handles. Furthermore, they should want their landlords to pursue some of the new certifications that have arisen during COVID-19 like Fitwel Viral Response and WELL Health-Safety Rating.