Transwestern, along with its research affiliate, Delta Associates, and their sponsors, Baker Tilly and PNC Real Estate, today announced that they held their fifteenth annual Washington, D.C. TrendLines event on February 9, 2012 at the Ronald Reagan Building and International Trade Center. As part of the event, Greg Leisch, CEO of Delta Associates, gave a presentation highlighting opportunities in the Washington, D.C. commercial real estate market. Guests of the event also received a copy of the 15th edition of the TrendLines publication: Trends in Washington, D.C. Commercial Real Estate – Navigating Uncertainty, which distills the trends of 2011 and sheds light on pivotal forces and issues that Delta Associates believes will affect the region’s economy and commercial real estate in 2012 and beyond.
Delta’s presentation on the state of the market addressed seven key trends for investors to consider. The following is a summary of these key trends.
#1: Uncertainty. How did we reach this period of elevated uncertainty in the economy and real estate markets, and how might it play out?
A sense of uncertainty has increased of late, as both households and businesses are under stress. It is impacting consumer spending, business investment, decision-making in general, tenant leasing, and commitments of all types – thus slowing economic growth. An increasing sense of uncertainty has emanated from problems abroad such as the European debt crisis and the direction the Arab Spring seems to be taking. On the domestic front, there is uncertainty due to a dysfunctional Federal government, moving from deadlock to crisis, which resulted in the downgrading of the U.S. debt rating by Standard and Poor’s.
#2: Drive to Efficiency. What is the drive to efficiency doing to our understanding of the Washington area real estate market?
With consumers and businesses uncertain about future economic conditions, many are taking steps to become more efficient – doing more with less. Companies are taking less office space per employee, shedding unneeded office space or right-sizing, and using profits to invest in software and other productivity enhancers. Consumers are reducing demand for housing, downsizing into smaller homes, and increasingly cohabitating. Welcome to the “Era of Less.”
#3: Flight to Quality. Will the flight to quality assets continue, and how does that change an investor’s or developer’s strategy?
Flight to Quality in the Office Market
Class A net absorption of office space in the Washington metro area during 2011 totaled 2.3 million SF, compared to Class B/C net absorption totaling negative 1.3 million SF. This indicates a move to quality, as tenants take advantage of current market conditions to upgrade office space.
Flight to Quality in the Apartment Market
Class A net absorption of apartments in the Washington metro area totaled 3,900 units, compared to Class B net absorption totaling negative 600 units. Both Class A and Class B are experiencing tightened conditions, as demand and limited stock have lowered vacancy rates and increased rents for both classes. However, due to rent compression, the flight to quality means Class A is outperforming.
#4: Increasing flexibility. With people demanding increased flexibility in their housing arrangements, and employers needing increased flexibility in their hiring practices, how does that change the apartment and office markets?
While employees have been seeking increased flexibility for their lifestyles and careers (such as through telecommuting), employers have been doing the same. Given the uncertainty in the broader economy – translated into unclear demand for goods and services – businesses have been looking to the temporary labor market rather than making full-time hires.
#5: Preparing for government right-sizing. Businesses and property owners are preparing for government right-sizing, but is there some upside to this process?
The Washington metro area is currently bracing for right-sizing within the Federal government, as the growth rate of the Federal budget will be scaled back. This could seriously impact the Washington area, as historically 30% or more of the region’s gross regional product (GRP) has been due to Federal spending. This share jumped to around 40% in 2010. Given current austerity measures, we expect this share to decline to around 36.3% in 2015.
#6: Private sector growth. Will private sector growth cushion the blow from projected Federal budget cuts, and by how much?
The Washington area has become proficient in attracting associations and corporate headquarters from other parts of the country. That is likely to be a continuing source of local job creation. But we also see more jobs in the lobbying/legal sectors because with a smaller Federal pie, there is bound to be more fighting over the slices. The greatest sources of local job growth are likely to be in the professional/business services and education/health fields. Technology-focused jobs that straddle the line between professional services and information services also will drive the market.
#7: Thirst for yield. What steps should investors take to optimize investment returns in 2012 and the years ahead?
Much of the 2011 gain realized by investors was driven by cap rate compression, rather than significant leaps in asset performance, although measurable asset performance enhancement occurred for the first time in this cycle. This likely is not repeatable, given the continuing uncertainty in the economy and the fact that prices have already been driven up for core assets. We believe that cap rate compression is largely over for this cycle, and value growth in 2012 will have to be driven largely by improvement in asset performance. Namely, leasing of office, industrial, and retail space will have to pick up for commercial real estate benchmarks to match their 2011 performance. Our thinking is in part a reflection of the slowdown in sales volume during the 2nd half of 2011. Thoughtful investors are seeking out value-add plays, with a goal toward delivering renovated product in 2013-14 when demand for space is likely to be rising.
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Following the market overview presentation, Transwestern, Delta Associates, and their sponsors, Baker Tilly and PNC Real Estate, honored two individuals who have made unique and innovative contributions to the commercial real estate industry as a whole and to the Washington region in particular. This year, they paid tribute to Washington Real Estate Investment Trust’s President and CEO, George F. McKenzie, and Fairfax County Economic Development Authority’s President and CEO, Gerald L. Gordon, Ph.D., as “TrendSetters of the Year” for 2012.
Washington Real Estate Investment Trust, the oldest publicly traded REIT in the country, has long been among the Washington, DC real estate community’s most prominent members. In December 2011, the Trust distributed its 200th consecutive quarterly dividend of equal or increasing rates. This 50-year track record of success is testament to WRIT’s sound investment strategy and powerful operating platform.
Since joining the Trust in 1996, George F. McKenzie has been instrumental in guiding the REIT’s performance. In recent years, WRIT has repositioned its portfolio to focus on acquiring high quality properties inside the Beltway, near major transportation nodes and regional health care centers, and in areas with strong employment drivers. The successful $350 million disposition of WRIT’s industrial portfolio, completed in November 2011, was a major milestone in achieving this objective. For his visionary leadership and distinguished record of accomplishment, Transwestern honored George McKenzie as the 2012 Private Sector TrendSetter of the Year.
Since joining the Fairfax County Economic Development Authority in 1983, Gerald L. Gordon, Ph.D., has seen office space in the county grow from 32 million square feet to more than 115 million square feet, while jobs have increased from 243,000 to more than 600,000. As a result, the real estate tax rate has decreased from $1.47 to $1.07. Fairfax County is now the second-largest suburban office market in the United States and is perennially cited as one of the top jurisdictions in the country to live, work, shop and play.
Over the past few years, companies such as Volkswagen, Hilton Worldwide, Verisign, Northrop Grumman and, most recently, Bechtel, have established headquarters in Fairfax. As the President and CEO of the FCEDA, Dr. Gordon has been the driving force behind this success. His innovative policies have made him a sought-after consultant to city and state governments throughout the U.S. and around the world. For his tireless advocacy and steadfast leadership, Transwestern honored Gerald Gordon as the 2012 Public Sector TrendSetter of the Year.
About Delta Associates
Delta Associates, the research affiliate of Transwestern, is a firm of experienced professionals which has been providing consulting and subscription data services to the commercial real estate industry for over 30 years.
About TRANSWESTERN
Transwestern is a national, privately-held operating company specializing in commercial real estate services, investment and development. The firm’s fully integrated approach delivers value to owners, investors and users of commercial real estate through innovation, penetrating market intelligence and legendary service delivered by teams of local experts. Transwestern has product specialties in office, industrial, retail, multifamily and healthcare and is an industry leader in sustainability solutions and in market research through its affiliate, Delta Associates.