Two Massive Deals Highlight Suburban Maryland Third Quarter 

Suburban Maryland captured two of the largest tenants in the DC region in the third quarter of 2017. Marriott, after an exhaustive search that centered around the Bethesda market, finally decided to lease 720,000 square feet at 7750 Wisconsin Avenue in the heart of Bethesda. It was rumored that Marriott expanded their search to outside of Maryland, but likely, Bethesda was the one-and-only choice from the start. It was a huge win for Maryland to retain one of the largest private sector tenants in the region. Perhaps an even larger win for Maryland in the third quarter was the decision for the United States Citizenship & Immigration Services to relocate to One Town Center on One Capital Gateway Drive in Prince George’s County. They signed for 574,767 square feet and will be moving from several locations in the District, the largest being over 250,000 square feet at 111 Massachusetts Avenue, NW. It is not the first Federal tenant to leave the District and likely not to be the last as the Federal Government attempts to both shrink their footprint and reduce rent costs for all future leases.


Economy
During the third quarter of 2017, the Suburban Maryland economy grew by 0.78 percent, an annual adjusted rate of 3.18 percent. This was the fourth quarter in a row where gross regional product was greater than three percent. Despite this economic expansion, quite a few office using jobs were lost. The financial and government sectors lead the decline. During the quarter, about 1,860 jobs were lost by government agencies and about 330 were lost by financial institutions.

These losses were offset by other sectors of the office-using economy. The professional and business services industries added about 550 jobs, while the companies associated with the media and other service sectors added about 180 jobs.

 

Demand
Demand for office space grew during the third quarter, with net absorption registering 148,344 square feet. This is the third quarter of the last four where demand for office space has grown. As in previous quarters, the majority of the positive absorption occurred in Class A space and totaled 115,081 square feet. In contrast, 37,583 square feet of Class B space was returned. Net absorption registered 70,849 square feet in Class C product.

 

Supply
Just one building was completed in the third quarter. Located at 10076 Darnestown Road in the Outlying Montgomery County West submarket. The 16,194-square-foot building delivered completely vacant. While there are several buildings ready to start construction over the next few quarters, there was just 376,724 square feet under construction at the end of the third quarter. While speculative construction is rare in Suburban Maryland, two projects in Bethesda will to start soon. Additionally, the second phase of Pike and Rose along Rockville Pike, located at 909 Rose Avenue, is expected to break ground early next year. All of these projects are in mixed-used neighborhoods with ample amenities and access to mass transit.

Vacancy
With a strong quarter of demand, vacancy for Suburban Maryland dropped by 23 basis points to end the quarter at 15.6 percent. This is below the three-year average of 16.4 percent and the second lowest it has been since the fourth quarter of 2013. Vacancy in the market continues to be stable despite a lack of consistent tenant growth. When the US Citizenship & Immigration Services moves in the next few years, it will be net growth to the market causing vacancy to further decrease. In the meantime, vacancy will likely remain at the current level as new deliveries offset expected demand growth.

Even if these high-quality projects are successful, which they likely will be, the tenants that lease space will most likely relocate out of aging product in the market. Without substantial, sustained employment growth, buildings from which tenants relocate will have difficulty backfilling the space.

 

Rental Rates
During the quarter, there was no movement in rental rates. At $27.15 per square feet, the asking rate ended the quarter where it began. All three classes of buildings were stable with the largest change in rents occurning in Class C space where there was just a five cent increase from $22.23 per square foot in the second quarter to $22.28 in the third quarter.

Averaging $29.48 per square foot, Montgomery County, with its higher-end office buildings, continued to have the highest rents in Suburban Maryland. Prince George’s County has been and will continue to be the lower cost alternative for tenants. It is expected, however, that there will be some high-rent pockets of office product emerging in the county, especially around the new casino in National Harbor.

 

Outlook
Maryland’s market fundamentals are perhaps the most stable in the region with both the District and Northern Virginia expected to experience volatile vacancy swings in the next few quarters. Positive
net absorption coming to Maryland from Federal agencies is a likely outcome over the next few years. One agency has already committed to move out of the District, and it would not be surprising if others followed suit.