D.C. spec office development: Investor confidence or hubris?

Washington, D.C. has long been a favorite among investors.  So much so in fact that developers have recently taken to building on spec—that is, without having tenants signed on—a risky approach typically more common during boom times.  However, according to recent reports in both the Washington Business Journal and The Washington Post, that is exactly what is happening here.   This past October, the Washington Business Journal reported that StonebridgeCarras launched the $150 million phase II of Constitution Square, a 345,000-square-foot office project that it is building on spec—emboldened, no doubt, by its success leasing a good portion of phase 1 of Constitution Square to the United States Department of Justice. (Both projects are part of the master-planned 2.5-million-square-foot, transit oriented, mixed-use development located in the Capitol Hill submarket of D.C.) One month later, the The Washington Post reported that there are “more than half a dozen speculative office projects in the area,” including the Monday Properties 581,000-square-foot spec office project located at 1812 North Moore located in the Rosslyn/Courthouse submarket of Suburban Virginia, which is already underway.  What’s going on?

Well one look at the D.C. office sector’s latest performance stats, and it’s easy to see what’s behind the impetus to build—and buy, for that matter.  For one, the Washington, D.C. commercial office market remains the tightest market in the country, according to a ranking of the top 82 office metros tracked by Reis, Inc., with a third quarter average vacancy rate of just 9.3%.  In addition, office asking rents in D.C. are among the most expensive in the nation, averaging $49.06 psf (in second place behind New York’s average of $56.41 psf). And according to Reis’s latest forecasts, further market tightening and higher rents are anticipated for D.C.’s office sector.

One has only to observe the number of office deals transacted this year to know that investment activity in D.C. is on a tear. According to Reis Transaction Analytics, there were 27 office transactions in the D.C. metro through third quarter 2011 compared to 15 over the same time period in 2010.  Meanwhile, cap rates continue to compress: a twelve-month rolling cap rate of 5.5% is reported for third quarter 2011 versus 6.9% for third quarter 2010. And D.C.’s draw is not limited to U.S. investors. According to a 2011 survey by the Association of Foreign Investors in Real Estate (AFIRE)—a not-for-profit association that represents investors from almost two-dozen countries—the nation’s capital is again rated as a top choice among international investors seeking to invest in the U.S. this year (in second place behind New York).

Still, with all the uncertainty in the market today, does spec development really make sense? There are about a dozen-and-a-half projects totaling more six million square feet currently planned for the D.C. area alone, along with many others slated for neighboring Suburban Virginia, according to Reis. If and when these projects get completed—and leased—will go a long way to determining the future of spec development here.  In the meanwhile, securing new office tenants could very well become the D.C. area’s newest competitive sport.

Additional apartment, retail, and office sector details like commercial property rates, commercial vacancy rates, asking rents, current inventory, lease terms, employment data and more are available for D.C. and hundreds of metros and thousands of submarkets/neighborhoods nationwide—at ReisReports.com.