5 CRE Predictions From D.C.'s Top Developers

With hundreds of properties in every corner of the D.C. region, developers such as JBG Smith, Peterson Cos., Foulger-Pratt, MRP Realty and the Pinkard Group are constantly focused on where the market is heading next. The leaders of these five companies gathered Wednesday at Bisnow's Unifying D.C., Maryland and Virginia event, where they offered five predictions for the area's commercial real estate market. 

1. Pre-sequestration leases expiring soon will increase vacancy  

While some in the D.C. market may feel like the harmful effects of sequestration are in the past, Peterson Cos.' principal Jon Peterson said that is not the case. He warned about "phantom vacancy," or excess space companies are no longer occupying that will come back to the market when they sign their next leases.

"Where tenants signed at least five years ago, those leases are about to come due and they're going to have even more vacancy," Peterson said. "Sequestration is still having an effect on us whether we recognize it or not." 

2. The office consolidation trend could reverse

On the other side of the coin, Peterson sees a trend coming that could help reduce vacancy. He expects many companies that recently shrunk their footprints for efficiency are finding they may have gone too far. 

"They went from 100 feet per person down to 10 feet and said, 'Let's all work together around a table,'" Peterson said. "They were trying to save so much money to get down to so many few square feet per person, I think they're finding out their productivity wasn't worth the bang for the buck on real estate efficiencies. I think there will be a trend back to where it was. Where it ends up I'm not sure, but there was definitely an overcorrection." 

3. D.C.’s restaurant bubble may be getting ready to burst  

New restaurants have been opening at a rapid pace throughout D.C. in recent years, but some landlords think there may be too many for the market to support. From speaking to restaurateurs, JBG Smith CEO Matt Kelly said he sees their margins getting squeezed as competition grows for customers and labor and costs continue to rise. 

"We're at risk of oversupplying the market with restaurants and bars," Kelly said. "I wouldn't be surprised if we see a lot of tenant failures in the next three to five years." 

Having recently opened an office in Southern California, Foulger-Pratt Chairman Bryant Foulger said the difference he noticed in the two restaurant markets was stark. He said D.C. restaurant traffic during the week, especially later in the night, is much slower.

"You combine the fact that we've got a work ethic and people have to get up to go to work the next day with all these restaurants that are being built," Pratt said, adding that he sees retail tenant allowances as a poor investment. "We are very careful. We just don't want to have a project where you have to buy tenants, because that's a very expensive process today, and the likelihood of getting a return on those dollars is remote." 

4. The next downturn should be less severe

The financing environment for new projects continues to get more difficult, Kelly said, as lenders maintain their discipline and demand higher rates of return. The head of D.C.'s newest public REIT said that should make the industry feel comfortable about where the market is heading.

"If and when, I think it is when, there is a dip or downturn or correction in asset prices, it's likely to be less severe if lenders and equity investors maintain their discipline," Kelly said. 

Peterson agreed, giving a hat tip to the bankers in the audience — and the new federal regulations guiding them — who have kept the market from going off the rails. 

"I hate to admit it, I know there are a lot of bankers in the room, but you guys have really kept things under control," Peterson said.

"You're requiring us to put too much equity in," he said to laughs from the crowd. "But in general, I think you guys have done a great job of keeping this group under control." 

5. Expect more investment in last-mile distribution centers

As online retailers increasingly focus on delivery speed and efficiency, Peterson said he sees more growth coming in the industrial sector.

"You're going to see a lot more warehouse distribution and last-mile distribution," Peterson said. "That is really where the retailers are looking." 

The closest large fulfillment centers Amazon has to D.C. sit in Baltimore and Richmond, Pinkard Group founder Bob Pinkard said, creating a need for smaller distribution centers around the District. He said these types of warehouses that serve as the last stop for products before reaching consumers doors are becoming more attractive to investors. 

“If you ask somebody what last-mile is, you get 10 different definitions from 10 people," Pinkard said. “People are expanding that because they like having last-mile investments.”