Delta Associates

Market Information: Washington DC

Economy: Mid-Year 2009

Federal Funding Keeps Washington Area Economy Running During Recessionary Times

Prepared with the invaluable assistance of Dr. Stephen Fuller

The Washington metro area economy slowed during the 2nd quarter of 2009. The area cut over 30,000 jobs during the 12 months ending April, 2009, mostly in the retail and construction sectors. Despite moderating local economic conditions, it does not compare to the deterioration seen in other metro areas nor at the national level. Despite ailing conditions, Washington maintains one of the strongest economic bases, as the metro area remains one of the top economic centers in the nation, even during recessionary periods.

Payroll employment declined 30,300 in the Washington metro area over the 12 months ending April 2009. This represents a decline of 1.0%, compared to the national decline of 3.8% during this period. The Washington area unemployment rate was 5.6% at April 2009, up from 3.0% one year ago. This compares to the national rate of 8.9% in April 2009. The national rate increased to 9.4% in May 2009.

The Washington area’s gross regional product (GRP) was $401.3 billion in 2008 based on revised numbers, an increase of 3.1% from revised 2007 figures. We expect GRP growth in the metro area to be 1.2% during 2009 in constant dollars, down from 4.8% at the peak of the cycle in 2004. This compares favorably to our projection of the national gross domestic product change of negative 3.0% in 2009.

We expect the Washington metro area economy to moderate in 2009, with few employment gains and a rising unemployment rate. Consumer confidence will remain challenged, as uncertainty of the Federal bailout/stimulus effectiveness remains.

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Office: Mid-Year 2009

Renewals Dominate the Market as Rents Edge Lower; Federal Activity Drives Rent Recovery by 2013

The Washington metro area office market is in the correction phase of the cycle. Vacancy increased 210 basis points during the past year, but remains lower than most large metro areas due to the stabilizing influence of the Federal government. Demand is light and leasing is dominated by renewals, as tenants wait out the storm. Given these conditions, rents declined by 1.5% during the past six months. Despite softening conditions, the metro area remains one of the top performing markets in the nation.

Mid-Year 2009 Market Highlights:

Net absorption: 307,000 SF, compared to the quarterly average of 900,000 SF in 2008.
Sublease space: Increased by 363,000 SF. Sublease space represents 1.5% of the standing inventory compared to 3.4% at the peak of 2002.
Overall vacancy rate:12.1%, up from 10.0% one year ago. Fourth lowest rate in the nation.
Direct vacancy rate: 10.6%, up from 8.8% one year ago.
Space under construction:10.5 million SF, down from 18.9 million SF one year ago.
Pre-lease rate:32%, compared to 27% a year ago.
Rents: Down 1.5% in the 1st half, compared to an increase of 0.1% in 2008.
Investment sales: $245 million, compared to the quarterly average of $919 million in 2008. 1st half 2009 average sale price: $298/SF.

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Flex/Industrial: Year-End 2008

Market Shows Stress, More So in Washington; Sturdy Absorption and Decline in Pipeline Offset by Rise in Vacancy and Modest Rent Growth

The Washington/Baltimore flex/industrial market experienced moderating conditions during 2008. Although net absorption totaled just below the long-term average, it was boosted by healthy leasing activity in the Baltimore area, which was opposite to the sluggish leasing activity in the Washington area. Rents were hesitant to rise in the region given changing market conditions and the national economic climate. The amount of space in the construction pipeline is easing, which allowed demand to catch up with the new supply – as reflected in the rise in the pre-lease rate. Overall, flex/industrial conditions are easing in the Washington/Baltimore region, though market fundamentals remain fairly healthy.

Year-End 2008 Market Highlights:

Net absorption: 4.4 million SF, compared to 6.6 million SF in 2007.
Sublease space: Increased by 753,000 SF. Available sublease space represents just 0.8% of standing inventory.
Overall vacancy rate: 10.1%, up from 9.5% one year ago.
Direct vacancy rate: 9.3%, up from 8.8% one year ago.
Under construction: 3.5 million SF, down from 6.4 million SF one year ago. 30% pre-leased, compared to 24% one year ago.
Space delivered: 7.3 million SF in 2008, compared to 6.4 million SF in 2007. 24% of space delivered in 2008 was leased upon delivery, compared to 27% in 2007.
Rents: Up 0.3%, compared to rising 2.8% in 2007.
Investment sales: $564 million, compared to $1.5 billion in 2007. Average sales price: $102/SF.
Land Sales: $18.3 million, compared to $149.7 million in 2007. Average price per land SF: $5.11.

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Retail: Year-End 2008

Washington Retail Market

Retail job growth has slowed in the metro area as consumer spending has declined due to the economic slowdown. However, the Washington area is one of six major metros still growing jobs in this economic slow down.

Incomes in the Washington metro area grew by 27.5% from 2000 to 2008, compared to 19.9% nationally. By 2013, the Washington metro area's average household income is projected to rise 15.2%, compared to a rise of 11.6% nationally.

The Washington metro area has over 117.0 million SF of retail space, inclusive of all types of retail, in just over 1,000 shopping centers. Northern Virginia is home to 57% of the total metro retail inventory.

The metro area has 25.0 SF of retail space per capita, compared to the national average of 20.0. The area remains underserved as the growing population continues to demand retail services, particularly in the District of Columbia where there is just 8.7 SF of retail space per capita.

Just over half of the Washington area shopping centers are over 25 years old, while only 17% are aged ten years or less. Although new retail projects have entered the market, older centers remain the bulk of retail space -- providing opportunity for renovation and upgrade.

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Class A Apartments: Mid-Year 2009

Washington Absorption Continues to Set Records as Pipeline Shrinks Due to a Halt in Production. Product Shortage May Appear by Late 2012. Market Buys Higher Occupancy with Concessions Whcih Lowers Effective Rents.

Highlights of market performance as of Mid-Year 2009:

The region’s stabilized vacancy ratefor investment grade apartments (Class A and B) increased to 4.3% from 3.6% a year ago. With the national rate at 6.6%, this is one of the lowest vacancy rates of any metro area in the nation.
Rents decreased over the past 12 months for all investment grade product – down 1.4% since June 2008. Class A rents declined by 1.8% during this period, compared to growth of 1.8% at mid-year 2008.
Annual net absorption, at 5,210 Class A and B apartments, remains strong; however, dis-absorption of Class B apartments accelerated over the quarter. Annual Class A absorption continued its upward climb to 8,294 units – a nation-leading pace. Average monthly absorption at new projects was 15 units per month, buoyed by large concessions at newly delivered projects. Even so, this rate is remarkable, as the number of projects in lease-up now totals 47.
Concessionsat Class A projects continued to edge higher, to 6.2% of face rent, compared to mid-year 2008, which were 4.1% of face rent. This upward trend began in the first quarter of 2007 as the market became more competitive.
Pipeline: After rising from a historically low 18,000 units in 2005, pipeline ballooned to 36,951 units in December 2007, largely driven by the reversion of condominium projects. In the first quarter of 2008, the pipeline began its cyclical decline, and has continued downward to 20,771 as of mid-year 2009. We believe this downward trend will continue over the next year due to the difficulty of obtaining credit.
Investment Sales: 2008 was significantly off the pace of prior record setting years, and the first half of 2009 is down further. In 2008, Delta identified 12 Class A building sales (most of them garden properties), consisting of $884.71 million in multifamily Class A building sales volume. So far in 2009, we note $109.5 million of multifamily Class A building sales (one high-rise) and $6 million of land sales to construct new apartments. This dearth of land sales is a potential indicator of a slow-down in the pipeline of oncoming supply in future years.

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Condominium: Mid-Year 2009

Sales Volume Rebounds in Washington as Price Declines Stimulate Sales. Pipeline Continues to Decline, Setting Stage for Product Shortage by 2011.

Highlights of market performance as of Mid-Year 2009:

Volume: New unit sales volume (defined as net binding contracts written with security deposits up) in the Washington metro area during the 2nd Quarter reached 618 units, the highest quarterly total in two years. In the past 12 months, there were 1,667 sales.
Prices: While continuing to hold up better than the single-family market, condo sales prices have edged down. Effective new condo sales prices were down in the Washington metro area by 3.9% from 12 months ago with bigger declines in Suburban Maryland.
Concessions: In the Washington metro area, concessions are down in the District, but up in the suburbs. Metro-wide, concessions are up slightly, averaging 3.7% of the purchase price at Mid-Year 2009 (up 20 basis points from one year ago).
Pipeline: There are currently 8,480 unsold new condominium units that are actively marketing in the Washington metro area. There is now 5.1 years worth of inventory of product on the market at current rates of sales velocity in the metro area. Arlington/Alexandria and the District are well below the metro average.
Sales pace: Projects that have sold out in the past two years have averaged about three sales per month in the Washington metro area.

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Class B Apartments: Mid-Year 2009

Rents Weaker, Vacancy Edges Up.

Class B apartment rents are down and vacancy rates are up year-over-year.

Average effective rent decreased to $1,335, down 0.7% from a year ago.
Vacancy increased by 140 basis points to 4.6% during the same period.

Value-Added Strategy: Renovation

Opportunities continue for renovating existing B and C grade properties. In our view, these opportunities can be the most profitable where the rent spread is widest between Class A and Class B (or Class C) rents (because units can be renovated; rents can be raised correspondingly; and still represent a discount to prospective tenants compared to Class A rents). Owners appear to be recognizing this, as Delta has noted an active renovation environment, especially in Suburban Maryland and Northern Virginia.

Sales of Apartment Buildings: Market on Hold Until Values Established

During the first five months of 2009, there have been two Class B apartment sales noted, one high-rise and one garden property totaling 435 units. Last year at this time there had been nine garden and mid-rise properties sold for an average of $104,051 per unit and two high-rise sales averaging $233,141 per unit.

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