As the length of the current recovery extends into record territory, more attention is focused on the timing of the next recession. While talking and thinking about the end of this cycle is seductive, it’s next to impossible to predict what will happen and when because there are so many significant and complex geopolitical forces involved. To quote Warren Buffet, “The light can at any time go from green to red without pausing at yellow.” With this wisdom in mind, this quarter’s update will discuss some of the regional trends that guide both our thinking and investments, keeping in mind another Buffet quote which is apt for late cycle investing, “Only buy something that you would be perfectly happy to hold if the market shut down for 10 years.” Our version of this is, “Buy good real estate.”
One of the striking trends unfolding in the region is the change in where job growth is taking place. Under normal circumstances Northern Virginia accounts for approximately 50% of job growth in the region, DC 30% and Maryland 20%. In 2018 these percentages started to shift, with 71% of new jobs created in Northern Virginia and for year-to-date 2019, 92% of job gains have been in Northern Virginia. These numbers are in advance of the ramp-up of hiring associated with Amazon HQ2.
As the most business-friendly jurisdiction in the region, Northern Virginia continues to be the leader in attracting corporate and technology tenants. Last quarter we wrote about the solid absorption of space in that market and this pace has continued into the second quarter. We also wrote about the growing number of tenants looking for space in Northern Virginia and that growth is accelerating. Eight leases in excess of 50,000 square feet were signed in the second quarter, demonstrating the breadth of the market, and we are aware of eight other tenants with requirements in excess of one hundred thousand square feet who are looking solely in the Reston/ Herndon market.
It should be noted that while job growth has been anemic in Suburban Maryland, the vibrant industrial market has caught our attention. Vacancy rates are low and with little new supply and close-in industrial land difficult to find, rental rates are rising for “last mile” locations. At Westphalia Town Center in Prince George’s County developers have received approval for a five story, four million square foot fulfillment center, presumably for Amazon. Market followers realize that Southern Prince George’s County has excellent logistical proximity to both DC and Northern Virginia.
Despite Maryland’s industrial success, the fact is that both Maryland and DC have become less business friendly. Montgomery County, Maryland has been ineffective in attracting business and has recently elected a perceived anti-business County Executive. DC has enacted a $15 per hour minimum wage, increased the real estate tax rate and raised the transfer and recordation taxes for real estate sales in excess of ten million dollars by 72% to a whopping 5% of the sales price. No wonder Virginia is increasing its market share.
The DC office market is poised for a correction based upon a significant oversupply of space as a result of overbuilding. The accompanying recent chart from JLL clearly tells the DC office story.
While demand for the best product continues to be strong, these buildings are pulling tenants away from commodity A spaces. The B market continues to be relatively tight. Tenants such as non-profits and trade associations cannot afford the higher rents, and building repositioning and repurposing have reduced the supply of B space, keeping the vacancy rate down. The commodity A market is experiencing historically high levels of vacancy at a time when lease concessions are already at the highest levels on record. Competition for tenants in this space is fierce. It is not a pleasant time to be an owner of one of these assets. If there is any good news, it is that after 2019, deliveries of new buildings will begin to decrease.
Given current dynamics in the Downtown DC market, there has been a natural investor pullback, and we are witnessing building sale processes yielding fewer offers, particularly for the largest assets. We have begun to talk about when the buying opportunity will emerge. As Warren Buffet says, “Whether we are talking about socks or stocks, I like buying quality merchandise when it is marked down.”