How Bethesda’s Development Boom Could Be Impacted By The Pandemic

Cranes have lined the Downtown Bethesda skyline in recent years as developers build a wave of new office, multifamily, hotel and retail projects. But now, with a pandemic and economic downturn, those developments will deliver into a market that looks starkly different from when they broke ground. 

The region is now starting to allow businesses to reopen in a partial capacity, and Montgomery County Executive Marc Elrich announced Thursday that the first phase of reopening will begin the morning of June 1. The first phase will allow restaurants to begin outdoor seating and other nonessential retailers to begin curbside pickup.

But it could take months, or even years, after the initial reopening for the Bethesda economy to return to its previous levels. 

Bethesda developers say the hospitality and retail markets are feeling significant pain and will take a long time to recover, and the under-construction apartment and office space will be slower to lease up than initially expected, but they remain bullish on the market and say it is one of the best-positioned areas in the region to recover from the crisis. 

Absorbing The New Office Space 

Bethesda had 1.5M SF of office space under construction as of March 31, according to Newmark Knight Frank, in addition to the 300K SF JBG Smith project that delivered 88% leased in Q4.

The new development will add to a Bethesda office market that had had 10.9M SF of inventory as of March 31, with a vacancy rate of 12.9%, according to NKF. For comparison, all of suburban Maryland had a 14.8% vacancy rate in Q1, the District had a 14.5% vacancy rate and Northern Virginia’s rate stood at 18.4%.

Carr Properties is preparing to deliver its 360K SF office building at 7272 Wisconsin Ave., branded as The Wilson, by Oct. 1, CEO Oliver Carr told Bisnow. He said the project is just under 80% leased, and has landed tenants including WTTG Fox 5 and Enviva Partners. 

"Yes this is a big wave, but I think the market is starved for buildings that offer a better experience with better quality amenities and create a healthy environment with improved HVAC systems," Carr said.

"I think coming out of the crisis we're going to see increased funding for NIH, and that could spur more healthcare and research-related demand in Bethesda," he added. 

One developer that hopes to benefit from that demand is Stonebridge. It broke ground speculatively in May 2019 on a 370K SF office building at the corner of Wisconsin and Montgomery avenues, and it has yet to sign a tenant. 

Stonebridge principal Doug Firstenberg said he is in talks with tenants and has been pleasantly surprised about the level of activity during the coronavirus pandemic. 

"It's not moving quite as fast maybe as we thought, but we've been doing virtual presentations and putting in proposals," Firstenberg said. 

He said his plan was always to deliver one to two years after the JBG Smith and Carr buildings to capture the next wave of demand for trophy-level office space in Bethesda. Despite the current economic crisis, he still believes that wave is coming. 

"People are going to reimagine spaces dramatically and figure out how to have more flexibility," Firstenberg said. "I think the new buildings that can be touchless, feel more environmentally attuned and have better layout options are going to do really well. So, as I look at Avocet, I think that is extraordinarily well-positioned to be a receiver of that in Bethesda."

This is not the first time Firstenberg has been under construction on a spec office project when an economic crisis hit. His firm was building NoMa's Constitution Square during the Great Recession.

He said Constitution Square took longer to lease than initially expected, and he was forced to bring down rents to meet the market, ultimately reducing the project's returns. But he eventually managed to land federal government agencies and sell the buildings. He hopes he doesn't have to come down on rents in Bethesda. 

"You have to meet the market and know where the market is, but I think the Bethesda market is stronger," Firstenberg said. "We have no competitive space really for Avocet, and we think there is going to be a group of tenants that are going to look at their needs and say, 'I have to rebuild.'"

Stonebridge also made a Bethesda office acquisition last year that it is positioning as a value play for tenants unable to afford trophy-level rents. In September, Stonebridge and Rockwood Capital jointly acquired the Clark Building at 7500 Old Georgetown Road. The building will have about 65K SF coming available on the upper floors next year, Firstenberg said, and the new owners are renovating the building. 

Another Bethesda project Stonebridge had in the planning stages will likely become a casualty of the crisis, Firstenberg said. It has been partnering with Donohoe Cos. to plan a 175K SF lab building for life sciences companies. The project at 8280 Wisconsin Ave. has yet to sign a tenant, break ground or secure a construction loan. 

"That one does not look as promising," Firstenberg said of the lab project. "It looks like it's gotten caught up in the timing of the pandemic. We had everything teed up for pre-development, but to pull off a construction loan on a spec building right now is pretty daunting. So I'm not as confident that 8280 will ultimately deliver as our first bio project."

Firstenberg said Stonebridge remains bullish on the life sciences market and is keeping an eye out for other sites that could work in the future. Donohoe has control of the site where the firms had planned to partner on the project, and it is likely to hold onto the property as a long-term development play, Senior Vice President Jad Donohoe said. 

"Even if that isn't something that is going to find a lead tenant in the short-term, we've looked at that and said, 'It's also a really good covered land play,' in that there's already an income-generating use on the property," Donohoe said. "That could be a property where it may just want to be a covered land play for some years until we get to the other end of this crisis."

Donohoe said he expects other developers with projects that had yet to break ground will pull back on near-term construction plans. 

"It has kind of encouraged us to hit pause," he said of the crisis. "And I think with many of the stuff in the pipeline, you're going to see delays for things that haven't started."  

The firm owns two existing Bethesda office buildings, and Donohoe said it decided not to reposition them to compete for the top-of-market rents the new developments are achieving, instead choosing to remain a value play. 

"We're choosing not to compete in that rarified Class-A-plus trophy real estate in Bethesda, and we're happy with that," Donohoe said. "We're not trying to compete with the rents that Carr and Stonebridge need to get for their new buildings."

The ability of Bethesda's office developers to fill their buildings will depend on how well the area competes with other parts of the region for companies. Developers and elected officials have said Montgomery County is falling behind Northern Virginia in economic development. Its counterpart across the river has lured tech giants such as Amazon, Google and Microsoft to open large corporate hubs in recent years. 

Montgomery County in December hired a new economic development chief, Ben Wu, who said he is looking to improve the county's competitiveness in the region. He said he sees Bethesda as a key anchor to the county's economic future. 

"Bethesda is still one of the preeminent locations for businesses, not just in Montgomery County but also for companies looking in the Greater Washington area, and we will always be looked at regionally," Wu said. "Since I came on board at the beginning of this year, I've been working with the County Council and County Executive to transform the way economic development is done in Montgomery County to make us much more competitive."

Filling The New Apartment Buildings

In the multifamily sector, Bethesda developers are also building a significant amount of new supply.

The Bethesda-Chevy Chase submarket had 1,446 units under construction as of March 31, with another 1,605 in the pipeline, according to NKF. The submarket's existing apartment inventory as of Q1 was 8,848 units. 

ZOM Living and Mitsui Fudosan broke ground last year on Maizon Bethesda, a 229-unit apartment project in Downtown Bethesda. ZOM Living Senior Vice President Andy Cretal tells Bisnow he expects to deliver the project by the end of next year. 

Cretal said the team's ability to achieve its desired lease-up pace and rents will depend on how smoothly the area's reopening proceeds and whether the economy has bounced back by next year. 

"My sense, in listening to experts, is that the economy will start to recover in 2021, and hopefully that will lead to reasonable demand for apartments in the Bethesda submarket," Cretal said. "I think it's going to take some time."

The project is the first in Bethesda for ZOM. Cretal said the attributes that attracted it to the submarket, including the walkable retail and transit, will still exist after the pandemic. 

"To the extent there's a submarket that can do well, I believe Bethesda will be that submarket," Cretal said. "I think it's positioned as well as any part of the region."

Carr expects to deliver 360 apartments in the multifamily component of its project, The Elm, by the end of the year. He said he expects it may not achieve the leasing velocity it had originally projected because of the crisis. 

"I could see the leasing perhaps being a bit slower than anticipated, I think that's kind of a logical expectation," Carr said. "But we still feel really confident about the project." 

Keeping The Retail And Hospitality Businesses Alive

The retail sector in Bethesda, while it doesn't have as much space under construction as the office and multifamily markets, is more vulnerable to the effects of the coronavirus. 

Restaurants have been limited to takeout and delivery service for more than two months, though the county is moving toward a phased reopening process.

Federal Realty, which owns the Bethesda Row retail complex, has created new curbside pickup spaces to help its restaurant and soft goods retailers reach their customers. Federal Realty Regional General Manager Mickey Papillon said this has helped some of its retail tenants more than others.

"We've seen the gamut from tenants that are only seeing a moderate level of success to tenants that are seeing an incredible amount of success," Papillon said. "If they have been able to shift and adapt to the situation, that has meant some really painful decisions when it comes to laying off staff because they can't support payroll, but ultimately it has allowed them to figure out how to make a balance."

The REIT has not released property-specific rent collection figures, but it had collected 53% of April rents portfolio-wide as of May 1. Papillon declined to provide specifics on rent relief efforts at Bethesda Row, but he said it is working with tenants to help them survive the crisis.

"There is not a broad brush that gets applied, and we try to make sure we understand the full situation to make sure we can help them get through to the other side, because they are the fabric of what makes our community great," he said. 

Papillon is concerned that even when restaurants are allowed to resume partial in-house service that limits on capacity could prevent them from turning a profit. 

"If you have a restaurant designed for 100% occupancy and you can only do 25% or 50%, the business model doesn't make sense, and in the long-run it is going to be very difficult to manage that," he said. 

To help restaurants expand capacity, Federal Realty has been pushing local officials to close down some retail-lined streets to vehicular traffic to allow restaurants to place patio seating in the streets. 

"The ability for expanded restaurant seating outdoors ... it's vital," Papillon said. "We've been in touch with various parties working on this and trying to ensure we're providing support for it and doing what we can to push to make that happen."

Carr Properties is building 12K SF of ground-floor retail at its mixed-use project, and in early March it inked a 4K SF deal with Tatte Bakery & Café. Carr said he thinks the remaining retail leasing may be slower than initially projected, but it does not concern him because of its size compared to the overall project. 

"As you can imagine, tour activity has been way down during the health crisis," Carr said of the retail space. "I think it's logical the vacant street retail will take a little more time to get absorbed."

Firstenberg said he feels "lucky" that his firm decided not to build retail into its Avocet project. 

"The good news is for Bethesda, we don't have to deal with that," Firstenberg said of retail leasing. "As strong as Bethesda retail is, there is going to be a cycle that is going to have to be gone through here." 

But Stonebridge's project does have a component that is in a more vulnerable property sector: a hotel. Stonebridge brought on OTO Development as the partner to build the 220-room AC Hotel by Marriott next to its office tower. Firstenberg said it will likely deliver in 2022. 

"You would think if there was a hotel submarket that was going to recover quickly, this ought to be one of them," Firstenberg said. "You've got the Marriott headquarters here, and you've got to believe Marriott is going to be doing well again by 2022." 

Marriott has continued construction of its new headquarters in Downtown Bethesda despite the pandemic and its own financial challenges, though it did pause temporarily after two workers contracted COVID-19. The Marriott headquarters project, a partnership with Boston Properties and Bernstein Cos., is expected to deliver in 2022 and will also include a 224-room hotel. 

Wu said he thinks a vaccine will be need to be widely administered before consumers fully return to traveling and bring hotel demand back to normal levels. But he said Bethesda is better positioned than other markets because it relies more on business travel and conferences than tourism. 

"The hotels have relied on conferences and right now with a lack of travel and stay-at-home orders in place, that revenue has not been robust," he said. "Once that can be put on track, then Montgomery County hotels will probably be quicker to recover than some of the other hotels around the region and the state."