'There's Just Too Much Vacancy': D.C. Developers Shy Away From Spec Office Projects

The office vacancy rate in Washington, D.C., has risen to record highs as new buildings deliver with large blocks of available space, but some developers today say they are hesitant to start new speculative office projects. 

D.C.'s office vacancy rate reached 13.5% at the end of Q2, according to CBRE, a new record high for the District. That represented an increase from 12.8% in Q1 that was largely attributed to the surge of new supply coming to market. 

New office buildings totaling 1.3M SF delivered in Q2 and 16 additional buildings totaling 3.4M SF are slated to deliver by the end of 2020, according to CBRE, but just 39% of that space was pre-leased as of June 30. The wave of new office development could slow down in the coming years as some developers are becoming more cautious about constructing a building without a tenant already committed, known as building on spec. 

"We've historically built buildings on a spec basis, but we probably wouldn't be starting one in the next couple of years," said Republic Properties Corp. President Steven Grigg, who will speak Sept. 10 at Bisnow's Greater D.C. State of Office Summit. "There's just too much vacancy in the marketplace."

Stonebridge principal Doug Firstenberg is building a spec office project in Bethesda and recently bought a vacant office property he aims to lease up in Alexandria. He said he feels good about those suburban markets because they have limited supply coming online, but he is not as bullish on building new office in D.C.

"The District has some demand dynamics that are more challenging," Firstenberg said. "It's slow. Vacancy has been rising and a lot of the new trophy buildings have gotten great first leases, but they have to fill the balance of the space."

WashREIT, which has a large portfolio of D.C. office properties, tends to not build spec office projects because of its status as a public company, Vice President Anthony Chang said. 

"We have historically steered clear of ground-up development on spec," Chang said, adding that WashREIT prefers multifamily projects where it can add density to existing apartment properties. "That's an ideal situation for us given our sensitivity to making sure we have income for our shareholders."

Chang said many spec office projects have managed to lease up because tenants are seeking new trophy space. He also said the Class-B segment has performed well because much of it has been taken off the market for repositioning projects, but said the Class-A buildings in the middle have faced more challenges. 

"It seems to be the winners are the brand-new trophy product that's coming online, [which] seem to be getting their fair share, and the B market," Chang said. "And then the A's in between are somewhat sandwiched, unless you have something special."

WashREIT has achieved new leasing at some of its older Class-A office properties, including the Watergate 600 building. It acquired the property in 2017 and in March signed EIG Global Energy Partners to a 50K SF lease. 

Skanska has signed three leases in the last three months at 99 M, the Capitol Riverfront office building it recently delivered on spec.

Last week, the developer signed a 12K SF lease with digital fundraising platform GiveCampus, which is moving out of a coworking space. In July, it signed CommonGrounds for 44K SF and the Organization for International Investment for 7K SF. The new deals brought the 234K SF building to 76% leased. 

The developer has least three additional office buildings planned in the District, including two at its Tyber Place development in NoMa and one at 1700 M St. N.W., which it plans to build through a ground-lease deal with JBG Smith. 

Skanska Executive Vice President Mark Carroll said the company is just beginning the design process for 1700 M and hasn't set a timeline for breaking ground. The two Tyber Place buildings are fully designed, but he said Skanska has evaluated the market and has decided not to pursue spec development for the foreseeable future. 

"The way we look at potential starts is really studying what we see coming down the pike in activity in the market, and right now we don't have anything that would be a pre-lease driving us to start that, and we don't have any plans to move forward with spec on those," Carroll said of the Tyber Place buildings.

Carroll said Skanska evaluates projects on a submarket-by-submarket basis and isn't too concerned about the citywide vacancy rate. He said new ground-up office buildings have performed better than the overall market, but many of the tenants moving into those buildings are downsizing from their previous offices, which only further increases the vacancy rate. 

"What happens is tenants are coming out of older, less efficient space and they're reducing their overall footprint," Carroll said. "So if a tenant is coming out of an older building, they can come into a new building and accommodate the same number of people in a smaller square footage. There's a dynamic in the market of that occurring, which is reflected in what you see in overall vacancy."

Grigg, Chang and Carroll will speak Sept. 10 at Bisnow's Greater D.C. State of Office Summit, held at the Marriott Marquis.