Brokers Don't Expect D.C.'s Record-High Vacancy Rate To Come Down Any Time Soon

The competition between D.C. office landlords vying for tenants has become more aggressive than ever, with record-high vacancy rates forcing owners to offer increasingly generous deals to those willing to sign leases. 

Given the continued delivery of available space, the lack of new tenants entering the market and the possibility of existing tenants reducing their footprints, market experts don't foresee any improvement in the vacancy rate in the coming years. This means D.C. will remain a tenant-favorable market for the foreseeable future. 

Several top brokers, landlords and tenants, speaking last week on Bisnow's Greater D.C. Office Outlook digital summit, discussed how the vacancy rate is shaping lease negotiations and tenant decisions. 

Especially in Downtown D.C., the high vacancy rate has made the competition for tenants even more aggressive. The one silver lining of this dynamic, brokers said, is that the generous deals available for downtown office appears to be preventing tenants from leaving for the suburbs to this point. 

In Q1, the D.C. Metro area recorded 4.2M SF of negative net absorption, according to JLL, and the region's office vacancy rate rose from 18.7% to 20.3%. 

"I'm not sure we're ever getting out of double-digit vacancy," JLL Vice Chairman Elizabeth Cooper said. "When people say, 'When is it going to get back?' It depends what you mean back to. If we really want it to be a more landlord-favorable market, I don't see it."

The market dynamics differ based on building classes, and brokers agreed that the trophy class is the strongest segment, with Class-A and Class-B buildings experiencing more pain. CBRE Vice Chairman Lou Christopher said that the abundance of obsolete office space on the market makes it difficult to envision D.C. getting back to a landlord-favorable market. 

"Unless old Class-B product is taken out of the market, whether it's demolished or made into residential, I don't think we're getting back," Christopher said. "The one bright spot is trophy. I think trophy could go landlord favorable at some point in the next three to four years, but for the rest of it, I don't see how [vacancy] gets below or even near 10%." 

Jarvis Commercial Real Estate founder Ernie Jarvis said that he doesn't expect the vacancy rate to fall to the single digits any time soon, but he said it will likely come down from where it is today, making now a good time for tenants to do deals. 

"There is going to be a new normal," Jarvis said. "Twenty percent is a lot of vacancy in the marketplace. So we're saying to our clients, 'Take a look now, go into the marketplace and see what the opportunities are, because this moment in time will pass.'"

Cooper said that the concession packages that office tenants can receive in Downtown D.C. have reached the highest level she has seen in her 30-year career. 

"The other problem is not just rents and concessions, but the amount of options that small and midsized tenants have are so abundant that our agency teams are competing against 30 or 40 options," Cooper said. "And what does that competition do? It leads to very aggressive tenant battles, and that's what we're seeing right now."

Cresa Managing Principal Mindy Saffer said concessions have increased because of the coronavirus pandemic's effect on the market, and she predicted it will take at least until late next year before they come down. 

"We think that this massive Covid concession is probably going to start tapering in Q4 2022 or Q1 2023, and then we'll still be in a tenant-driven market like we were pre-Covid, but we may not be getting these enormous concessions," she said.

The size of the concession packages available downtown creates an advantage for the District's office market, Saffer said, in that it prevents tenants from leaving for the suburbs. 

"The fact that landlords are providing such incredible deals right now for D.C. tenants, better than Maryland and Virginia, I do think that is keeping D.C. tenants that are evaluating their options right now in the District," she said. "That is helping keep tenants."

Jarvis also said he is seeing tenants decide to stay in the District because of the attractive deals that are available. 

"Landlords are being so generous," Jarvis said. "We're seeing $150 a foot in tenant improvement packages ... you're seeing a month and a half of rental abatement per year of leases signed. So those are really compelling for downtown occupiers of real estate not to go to the suburbs, but to stay in Washington."

D.C.'s office vacancy rate has reached this level because of forces that existed before the pandemic. Developers have delivered a large amount of trophy office space that has lured anchor tenants from older D.C. buildings, rather than attracting net new demand to the market. And even the new buildings that land anchors often have blocks of vacancy on the less-attractive lower floors. 

The market disruption caused by the pandemic has made developers less likely to break ground on new office buildings, especially projects without significant pre-leasing, The Meridian Group Senior Vice President Katie Yanushonis said. 

"Downtown D.C. has been known as a booming construction market, but we have seen as of late as a result of this pandemic that has been a little more tempered," she said. "Buildings that may otherwise have gone speculative haven't, they've waited for a pre-lease, so it has helped to bring down that number, which will hopefully help to at some point recalibrate the supply-demand dynamic." 

While the pandemic has slowed supply growth, it also introduced a new dynamic that could reduce demand: remote work. While most companies likely won't keep their entire workforce remote full time, a hybrid work model could lead them to cut a fraction of their office footprint, further damaging the market. 

"With the negative absorption plus new buildings coming online, it's going to be a while," Savills Vice Chairman Gary Stein said. "And combine that with tenants trying to take less square footage, even if it's a 10%, 15% or 20% reduction, it's going to continue. There's no metric out there that says it's not." 

Deloitte Managing Director of Human Capital Victor Reyes said the consulting firm has 14,000 employees across its Downtown D.C., Rosslyn and Tysons offices. He said most employees will continue working remotely until after Labor Day, after which they will return to the office.

Reyes didn't say whether some employees would remain remote beyond September, or whether the firm plans to reduce its footprint. But he did cite results of a survey Deloitte conducted that gave a larger view of how tenants are thinking about remote work. 

He said Deloitte surveyed employers and found that 68% expected to have a hybrid model of remote and in-office work going forward, with only 1% planning to stay fully virtual. He said about 40% of respondents didn't plan to make any reductions to their office space usage, but another 40% expected to cut their footprint by around 10% to 20% over time. 

"People do want to come back, and I think they're not quite sure how that's going to work optimally," Reyes said. "They're thinking about the dimension of having some people on-site, some people off-site, and [asking] 'How do I actually stitch together culture? And how much of my culture really is driven by physical proximity?'"

Comstock Partners Executive Vice President Tim Steffan said the CEOs he has spoken with have planned to bring their workforce back and still view the office as a long-term necessity, but they have been uncertain about how to lay out their floor plates for the post-pandemic future. 

"Everything goes along smoothly in the process until we get to that space planning phase," Steffan said. "I’ve seen CEOs pull back and say I’m just going to let people work from home for another three months until I figure out where all of this is going to go. So that is what’s really slowed the process down."