Downsizing Tenants Hit D.C. Office Market in Q2

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Despite the turbulent economy in the first half of 2022, new office leasing activity in Washington, D.C., was up 16 percent compared to the first half of 2021, according to Cushman & Wakefield’s office report for Q2, which will be released early next week.

The D.C. market registered nearly 1.1 million square feet of new leasing activity during the second quarter. While lower than the first quarter, the activity was still on an upward trajectory for the year compared to 2021.  

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“The flight-to-quality trend for office buildings remained steady in D.C. over the second quarter, as Class A space registered just over 600,000 square feet of positive absorption,” Ryan Miller, Cushman & Wakefield’s managing principal, D.C., told Commercial Observer. “We remain bullish about D.C.’s office market as companies continue to evaluate their workplace needs and return to the office.”

Colliers Q2 report noted there were 38 deals signed for more than 10,000 square feet this quarter, compared to 40 in the first quarter and an average of just over 30 per quarter in 2021.

Miles Rodnan, senior research analyst at Colliers, said leasing activity picking up from the lows of the last two years is a positive sign, but it is not enough to offset the move-outs and space reductions that are occurring. 

“Deal terms have shifted from pre-pandemic levels. Rental abatement and tenant improvement allowances remain elevated, and length of term has decreased,” he told CO. 

Net absorption was flat, with 17,577 square feet returned to the market, but far below the  previous four-quarter average of negative 270,475 square feet, per Colliers. “Unlike other quarters, the second quarter was not as affected by significant downsizes from tenant moves,” the report stated. 

While leasing volume increased, rental rates went in the other direction. Office rents decreased to $55.51 per square foot on a full-service basis, dropping in both Class A and Class B space. Meanwhile, Class C space increased by over a dollar from the first quarter. 

The office vacancy rate didn’t ease up, either. In fact, it increased 150 basis points over last quarter to 19.9 percent, which is up 600 basis points from pre-pandemic levels, according to CBRE’s Q2 report. However, with just 830,000 square feet of office product under construction, those numbers are expected to fall.

The dwindling pipeline should allow for the lease-up of existing space and produce a slowdown in the rate at which vacancy has been climbing, the CBRE research team wrote in its report. 

“While office market fundamentals remain challenged, the uptick in vacancy this quarter was expected given the delivery of four new office properties across the District,” Erin Janacek, CBRE’s mid-Atlantic research manager, told CO. “Overall leasing activity was slightly lower than Q1 levels, but several transactions are in the immediate pipeline and we remain on pace to meet 2021 leasing totals by year-end.”

One of the biggest deals this quarter was in D.C.’s Southwest submarket, which saw 533,770 square feet come on line with both 670 and 680 Maine Avenue SW at the Wharf delivering. Williams & Connolly took 292,000 square feet at the latter building.

Columbia Property Trust delivered three new floors of mass-timber construction atop 80 M Street SE, with the American Trucking Associations taking approximately 60,000 square feet and British Petroleum occupying 16,000 square feet.

2100 Pennsylvania Avenue NW also brought 450,000 square feet to the District this quarter.

In addition to Williams & Connolly, other top leases this quarter included the Department of Justice’s new 331,000-square-foot lease at 555 Fourth Street NW in the East End (though it’s a 30 percent downsizing from its space at 450 Fifth Street NW); Bank of America’s 118,000-square-foot lease, a renewal and expansion at 1800 K Street NW in the Central Business District; and the Psychiatric Institute of Washington’s 68,000-square-foot lease at 4228 Wisconsin Avenue NW Uptown.

Nonprofits have accounted for 16 percent of total leasing activity and 71,000 square feet of occupancy loss in 2022 so far, according to CBRE, with seven leases larger than 10,000 square feet coming in Q2 for a combined 265,000 square feet. The largest was Blue Cross Blue Shield Association inking 63,782 square feet at 750 Ninth Street NW, downsizing by nearly 20 percent from its current footprint at 1310 G Street NW.

The legal sector saw 107,000 square feet of negative absorption during the second quarter, according to CBRE, mostly due to Wilmer Hale’s relocation from 1875 and 1899 Pennsylvania Avenue NW to the 288,000-square-foot space at 2100 Pennsylvania Avenue NW, a reduction of 35 percent.

That said, Class A saw most of the benefit this quarter. “The trend of flight to quality remains as Class A space registered just over 600,000 square feet of positive absorption,” Cushman & Wakefield wrote in its report. 

An increasing trend this quarter was the number of older, empty buildings moving closer to residential conversion, with properties like 1125 15th Street NW, 1425 New York Avenue NW, 1111 20th Street NW, 1125 15th Street NW and 1825/1875 Connecticut Avenue NW all in the process.

Looking ahead, there is still an ample amount of space in the pipeline, with the fully leased, 167,000-square-foot office development at City Ridge expected to be delivered in Q3.

“There are several spec projects in the wings totaling 3.5 million square feet in the Capitol Riverfront, East End and NoMa submarkets, including the SEC’s proposed 1.2 million-square-foot office at 60 New York Avenue NE,” the Cushman & Wakefield report noted.

CBRE noted further headwinds are expected in the office sector, as employees continue to embrace remote and hybrid work.

Keith Loria can be reached at Kloria@commecialobserver.com.