Mid-Year 2021 Broker Commercial Real Estate Insights
Exclusive content for Kenwood Investors.
Since it’s mid-year 2021, we wanted to provide you with some different perspectives about the various leasing markets where our properties are located and how these markets are performing now compared with pre-COVID-19.
We asked three brokers — Michael Elardo from CBRE, Bethany Hobbs from Mackenzie Commercial, and Cole Spalding from NMRK — to provide their insights on the following markets: Baltimore-Washington Corridor warehouse, the Columbia, Md., office, and the Fairfax City, Va., office.
We think you will find their comments and insight to be both timely and helpful. The common thread in all their assessments is that the markets are improving, not only from inquiries and tours conducted but also from actual leases being signed. In one case, leasing activity is so robust that rental rate increases have exceeded 25% from pre-COVID-19 conditions.
Baltimore-Washington Corridor Warehouse/Distribution Market Summary
Written by: Michael Elardo, CBRE
The Baltimore-Washington Corridor is a 50 million square foot warehouse/distribution submarket, principally defined as Howard, Anne Arundel, and southwest Baltimore counties, with the majority of the buildings located within a 10-minute drive time along I-95 between the east-west arterials of Route 100 and Route 32.
The institutional real estate community considers this area as a top 10 investment market, as it provides less than a 90-minute drive time to 10 million of the most affluent people in the country, spanning both the DC and Baltimore metropolitan areas.
The warehouse market comprises both smaller bay warehouse buildings, which are home to many sales and service companies, with spaces ranging from 5,000 to 25,000 square feet, as well as more traditional distribution users who occupy 40,000 to 60,000 square feet. Many properties in this submarket are older and contain smaller truck courts, which work best for those smaller users.
COVID-19’s Impact on the Market
Like every market around the country, the BWC hit the pause button in March 2020, albeit briefly. What followed was an unprecedented run of leasing activity and rental rate increases never before witnessed in this submarket.
Over the past 15 months, virtually every available Class A vacancy throughout the market has been leased. Activity was principally led by e-commerce/last-mile delivery, medical distribution, food & beverage, and building supply sectors.
Larger users have dominated the leasing activity as over 3 million square feet of available Class A space was leased in chunks of 90,000 to 150,000 square feet throughout 2020. During 2021 we have witnessed the return of the mid-size 40,000-60,000 square foot tenant, and the Class B market has ridden the market wave contributing to a current all-time vacancy low of 4.5%.
Accordingly, rents rose dramatically during this period; Landlords have been reevaluating asking rents on a biweekly basis as competitive spaces were leased, and users scrambled for available space. Second generation Class A rents escalated nearly 30% from $6.95 per square foot pre-COVID-19 to current asking rates of $9.75 per square foot, and Class B rates have increased from $5.75 in Q1 2020 to a current range of $6.75 to $7.75 per square foot, depending upon the property’s functionality and location — an average increase of approximately 25%. Annual rental rate increases are consistently 3% for five- to 10-year leases, although some institutional owners are beginning to introduce up to 4% annual escalations.
Absorption and Development Pipeline
The market’s overall net absorption increased to over 1.6 million square feet in 2020, a 100% increase over the average absorption rate for the preceding seven years. Additionally, there was no new construction in 2020 and the only 2021 delivery is a 200,000-square-foot “build to suit” for Amazon in Hanover, Md. Looking into the future, there are five proposed projects, representing over 1million square feet, that could deliver in 2022, and asking rates are approaching $10 per square foot NNN.
Howard County Office Leasing Market Summary
Written by: Bethany Hobbs, MacKenzie Commercial
The Howard County office leasing market, and Columbia in particular, remains healthy. Howard Hughes and other recent Town Center developments have raised the bar for the quality expected from Class A space. As a result, rental rates at the high end have increased. Demand for Columbia office space has remained steady over the past decade.
COVID-19’s Impact on the Market
COVID-19’s impact on this market has been minimal and short-lived as compared to other major metro markets and surrounding suburban markets. Although there are several large tenants like Tenable, a computer security service company, this market is primarily medium and small businesses. While larger companies have pursued a more cautious approach to returning to their offices, small- and medium-sized companies have acted more decisively and have returned in greater numbers. These smaller companies were more anxious to return to normal, to exit their home offices, as well as to set their own protocols and vaccination requirements. Small spaces in particular have been in high demand in a post-COVID-19 world and business suite operators are seeing brisk activity.
Rental rates and concessions have not changed significantly since February 2020, with the exception of free rent. Typically, a tenant might have experienced one to two months of free rent in early 2020 for a five-year lease compared to three to four months in Q3 2021. Landlords still are recapturing free rent primarily by offering it outside the lease term, thereby maintaining their face rental rates.
Tenant Improvement Costs Have Increased
One troublesome impact on the office market is tenant improvement costs. Skyrocketing supply pricing, unstable availability of construction materials and maintaining a healthy labor force have affected office leasing. These increases not only are impacting the overall transaction costs but are leading to longer delivery times. Many articles have been published about higher lumber and metal costs, but it is also the chemicals that form the compounds in resins, glues, paints, sealants, etc., that were impacted by mandated COVID-19 plant closings and the 2020 storms in Texas. For example, you may be able to find a supply of flooring materials, albeit with a delay in shipping, and yet you can’t secure the compound necessary to install it. Meanwhile, landlords and tenants are having to share in these increased costs. As a result, some tenants are seeking “spec-ready or plug-and-play” options or are willing to accept the space in its as-is condition.
Over the past 16 months, the Columbia office submarket has demonstrated its resilience. While the vacancy rate increased during COVID-19, that rate is already decreasing. The office market vacancy rate traditionally hovers at around 10% vacancy with occasional variations up to approximately two points.
New Development and Future Opportunities
New development in the Columbia area is limited by supply and zoning. There is some opportunity in the Columbia Gateway area and in the Route 1 corridor with most sites already controlled by a developer. There are also opportunities to renovate or redevelop older projects in good locations.
Looking to the future, rents will likely remain steady until construction prices stabilize and until users decide what their post-COVID-19 office needs to look like. Stabilization could take approximately 12 months assuming no economic surprises. After that, we could see rents move upward in the next 12 to 18 months.
Finally, an emerging COVID-19 impact is the demand for high speed internet access. Many office buildings in Columbia don’t offer it or it is extremely difficult and/or expensive to secure from a provider. Some large tenants are demanding it as a condition of renewing. Where fiber service exists, it will be a valuable amenity going forward.
Fairfax City Office Market Summary
Written by: Cole Spalding, NMRK
As we begin to emerge from what some might say was one of the most catastrophic economic recessions in recent history, many investors in real estate are asking themselves, “what happens going forward?”
For purposes of this summary, I will focus on office leasing in the Fairfax City submarket. As a commercial real estate broker, it is very easy for me to point to a clear distinction of pre-COVID-19 and post-COVID-19 leasing activity.
Pre-COVID-19 leasing was brisk, with decisions being made in a timely manner, and the overall economic outlook seemed extremely positive. With the initial outbreak of COVID-19, all these previous statements were turned upside down. However, as summer of 2021 approaches, there is renewed leasing activity, tours, and general interest from companies exploring their real estate options. Rents and concessions have remained relatively stable. The more challenging component of the traditional office leasing equation has been tenant improvements costs for new transactions. With construction costs at record highs, landlords only have so many concessions to offer and still make their numbers work. Typically, a longer lease term represents one solution to make up for higher tenant improvements or free rent, but many tenants are still struggling to come to grips with longer terms. Companies are evaluating their office space needs. I am finding that companies are making real estate decisions, just more slowly and cautiously.
Although my crystal ball is still foggy, there is a definite sense of optimism in the air. Many companies that have given back space or are thinking about giving back space have not seen a significant reduction in revenue. It was easy for a CFO at a large government contracting office to consider shedding office space during the pandemic as a cost savings tool. Now, as companies evaluate their workforce strategies and how to manage their employees, I suspect that we will see less 100% remote work forces and more hybrid models which include more in-person attendance. Rent growth will likely remain flat for the next 12-24 months as suburban office markets need to backfill vacancies that did occur during the pandemic along with clearing out the sublease availability. Some tenants believe that there is a potential opportunity to reduce their rent significantly and that landlords are desperate. I am not seeing landlords who are capitulating and tenants are not finding the deep discounts they had hoped for.
A submarket like Fairfax was seeing relatively healthy rents and occupancy pre-COVID-19. As the recovery continues, the market should see tempered improvements in rental rates and improved occupancy levels.
Connect with Kenwood Management
Kenwood Management hopes you enjoyed reading these brokers’ perspectives on the markets. This material was generated exclusively for investors within our Kenwood Community. If you enjoyed their insights and think we should include similar content in future articles, please let us know. As always, you can reach us by clicking the button below!