5 Challenges Facing The D.C. Office Market

D.C.'s office landlords, brokers and general contractors are facing obstacles from stagnant demand to rising construction costs as they operate in a sluggish market despite the nation's broader economic growth. At Bisnow's D.C. State of Office event Thursday, the top players and experts in the region's office market identified five major challenges they are facing today. 

1. Occupancy Has Not Kept Up With New Construction

Developers throughout the District have built offices at an ambitious pace this cycle, but the demand has not increased at the same rate. Occupancy growth has been essentially flat since 2007, with net gains throughout the D.C. area totaling just 6,766 SF, JLL head of office and local markets research John Sikaitis said. To illustrate that, Sikaitis said the region's total occupancy gains equal about one-sixth of the available ninth-floor office space at Franklin Court, where 350 people attended Thursday's event. 

At the same time, developers have built 25M SF of new office product in the D.C. Metro area since 2007, Sikaitis said, equating that to the size of the entire Dulles Toll Road submarket. 

"Because of this supply and demand imbalance, you've seen the tenants get leverage and the rents decline," Sikaitis said. "There have been some winners, but a whole bunch of losers." 

2. Vacancy Is Skyrocketing In Suburban Markets

As companies have gravitated toward urban environments and public transit, suburban non-Metro-accessible locations have been left behind. In 2001, D.C.'s suburban markets had a vacancy of 5.9%, Sikaitis said. But today vacancy is up near 25.2% and continues to rise, he said. 

"That is definitely a losing category," Sikaitis said of suburban office. "When you look at average rents, you can't even measure them because there's not enough demand to meet the space requirement." 

As a major owner of suburban office space, PS Business Parks Vice President Chris Auth said lack of Metro access has been a difficult issue to grapple with. 

"The challenge for us in the suburban markets, or the thing that's always used against us from a selling or leasing perspective, is 'you're too far from Metro and you're just outside the walkability area,'" Auth said. 

To combat this, Auth said PS Business Parks has launched a partnership with Uber. The landlord pays for free rides for its tenants to access public transit and amenities. 

"In Tysons we have over 1M SF, so we provide rides to the Metro and to the malls," Auth said. "While we don't have the same amenity base you might have at The Boro, for example, we do have the ability to get the users to these places with sort of a VIP treatment." 

3. Parking Priorities Are Not Aligned

In order to encourage the use of public transportation and anticipate future trends like driverless cars, local governments have begun to change the way they think about parking. While they used to require a minimum number of spaces be included in a new development, some areas have switched to setting maximum limits on parking. 

But not all tenants are on board with the shift, Brookfield Properties Executive Vice President Greg Meyer said. In Reston, he said Brookfield has buildings with five parking spaces per 1K SF. He said the county is looking to implement a maximum of 2.1 spaces per 1K SF for new construction, but most tenants he talks to want it to stay closer to five. 

"The biggest challenge we have is tenants are still demanding the most parking they can possibly get," Meyer said. "How do we manage that transition? We have to offer the market what it wants right now." 

4. Contractors Can't Keep Up With The Pace Of New Projects

The pace of construction in D.C. has put a strain on the companies building the projects. Developers are increasingly asking for accelerated timelines, but that can not always be easily accomplished, DPR Construction Project Executive Mark McKenna said. 

"Our challenge right now is the market is very busy," McKenna said. "Subcontractors are at a maximum capacity in this area. We need adequate time to develop the subcontract bids to get interest in the project so that we get competitive numbers and value for our clients." 

Labor shortages have also posed a problem as developers have continued to launch construction projects across the city. This has contributed to a spike in construction costs, McKenna said. 

"We just don't have enough tradesmen in this area to meet the demands of the clients," McKenna said. "As a result, we're seeing prices creep up both in terms of labor, which I think is key, and, to some degree, materials." 

5. Demand Is Weak In The Middle Segment Of The Market

New trophy office buildings in the urban core have been able to land high-end tenants, though sometimes just for the top floors. Affordable, Class-B space has been able to land value-conscious tenants. But the office segment in between those two is the one that has landlords worried, Hines Senior Managing Director Chuck Watters said. 

"There is bifurcation in the market," Watters said. "A lot of new trophy are doing fine and Class-B buildings are competing on price. It's really the Class-A properties where there is growth in supply but not demand. It's very competitive." 

Tishman Speyer Senior Managing Director Paul DeMartini echoed this assessment. He said the trophy product with rents above $75/SF are landing tenants who want the best product on the market, and offerings below $60/SF are getting the value tenants, but there is a big gap in between.

"Where people struggle the most is that spot in between 60 and 75," DeMartini said. "It's kind of a 'tweener market. Tenants are either value-oriented or they want high-end space."