Downtown Bethesda Shines in Sleepy Market
Tenant demand for new construction in Suburban Maryland has never been more evident than in this quarter. Both Booz Allen Hamilton, and Host Hotels and Resorts signed preleases at 4747 Bethesda Avenue for 65,316 and 55,050 square feet, respectively. These leases are on the heels of the Marriott prelease totaling 726,000 square feet at 7750 Wisconsin Avenue. Neither of these is the largest deals of the quarter. Inovalon’s renewal in Bowie holds that designation. Suburban Maryland historically has struggled to compete for tenants requiring high-end space. This is partially due to the higher corporate tax rate and the difficulty competing with incentive packages from Northern Virginia. Most of all, however, is the market’s lack of quality office buildings; there simply is not the quality of inventory available that tenants required. With the delivery of 4500 East-West Highway in 2014, and the upcoming deliveries of 4747 Bethesda Avenue and 7272 Wisconsin Avenue, amenity-rich areas in Suburban Maryland are becoming more attractive to regional tenants.
During the first quarter of 2018, Suburban Maryland’s economy grew by 0.81 percent, an annualized rate of 3.28 percent. This is the most economic growth in over a decade and accounted for 30.3 percent of the total economic growth within the Greater Washington, DC area office market.
Although the total workforce grew by 4,010 participants, the Metro area’s unemployment rate fell seven basis points to 3.56 percent. At full employment, competition for talent remained strong, making office space and the associated amenities both within and surrounding buildings a potential differentiator in attracting and retaining employees.
The robust economic growth has not translated into new office-using jobs. During the first quarter of 2018, 80 new jobs were created in industries that predominately occupy office space. While not as vigorous as the growth in Northern Virginia or the District, it was sufficient to replace the jobs lost in 2017. All sectors of the office-using economy except for the government contributed to the increase. The most significant growth occurred in the professional and business services industries, which added 590 new jobs. The increase was offset by public institutions which shed 730 jobs. These job losses were not just driven by the Federal Government, which reduced payrolls by 310 positions, but there was also downsizing that occurred in state and local institutions.
After back-to-back quarters of positive absorption to end 2017, demand for office space fell by 14,347 square feet during the first quarter of 2018. It was not a significant decrease in demand and is on par the last three quarter average. Tenants continued to prefer newer, high-end space often at the expense of older product. Totaling 112,834 square feet for the quarter, the net absorption was highest in Class A buildings. Net absorption for Class B space was also positive with 52,907 square feet coming off the market. These gains were offset with 180,088 square feet of Class C space being returned to the market.
For the third quarter in a row, no buildings delivered in Suburban Maryland tying the longest drought without any deliveries in over seven years. The building at 1000 Spring Street in Silver Spring is expected to deliver next quarter, bringing just over 120,000 square feet of office/lab space to the market. The property is wholly owned and occupied as the headquarters for United Therapeutics Corporation. Nothing broke ground in the first quarter. However, construction on 7272 Wisconsin Avenue is slated to start early in the second quarter of 2018. While tour volume has been strong, no leases have been executed. The project will commence without a lease in place.
Even with falling demand, the vacancy rate remained roughly the same, falling only four basis point to end at 14.8 percent. If not for the demolition of two Class C buildings in Silver Spring, the vacancy rate would have ended the quarter at 14.9 percent. The vacancy rate decreased in two out of the three classes of space. Class A vacancy fell 26 basis points to end at 15.4 percent, while the Class B rate dropped 13 basis points to end at 14.2 percent. Due to the lack of demand for Class C space during the quarter, the vacancy rate rose from 13.2 to 14.7 percent.
For the third quarter in a row, direct asking rental rates increased in Suburban Maryland. As with vacancy, the Class A and B market outperformed the lesser quality space. The Class A asking rate ended the quarter 14 cents higher at $28.79 per square foot. Class B rate finished 52 cents at $26.17 per square foot up from the end of 2017.
Montgomery County’s rents rose for the second quarter in a row, reaching $29.86 per square foot on a full-service basis - the highest in over ten years. The growth stemmed primarily from demand for high-quality space in amenity-rich environments like Bethesda.
Prince George’s County’s average asking rental rate was more static than that of Montgomery County’s. The county’s asking rate ended the first quarter at $21.71 per square foot, slightly higher than the three-year average of $21.34 per square foot.
With the success of Bethesda’s newest trophy buildings, developers will likely gain confidence in starting more high-end projects in amenity-rich locations. Additionally, another trophy office building in the Pike and Rose development in Rockville could break ground in the near future. Ownership is waiting to ink a lease before they commence construction.
While the consistent declining vacancy will likely not continue, the overall health of the Suburban Maryland market appears on the incline. This coupled with the growing local economy, Maryland is turning into an attractive option for regional tenants.
Maryland’s business environment remains at a competitive disadvantage to Virginia. According to Forbes’ 2017 ‘Best States to Do Business’ report, Maryland ranks 26th while Virginia Ranks fifth. In addition to having higher corporate taxes, politics out of Annapolis have created a very uncertain business environment. In February this year, HB 1052 was introduced. This bill would tighten regulations on craft beer breweries. In addition to just making it more difficult for companies to business in this space, the bill threatens to reverse policies recently pass to loosen regulations. This type of inconsistency in policy does not instill confidence in businesses, and as Amazon makes final decisions on where to house their East Coast headquarters, small non-business friendly practices could make or break a deal.