RESEARCH MARKET REPORT

DISTRICT OF COLUMBIAOFFICE | Q2 2017

State of the Economy p.2

Leasing Activity p.3

Development Pipeline p.4

Market Outlook p.5

Market Breakdown p.6

IN THIS ISSUE

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL2

A slight up-tick in leasing velocity last quarter was not enough to propel the Washington, DC market’s second quarter net absorption. The three largest leases for the quarter were all Federal renewals. The Department of Education’s 314,243-square-foot lease at 550 12th Street, NW led the quarter’s leasing activity when they signed in early May of this year. On the brighter side, because these leases were renewals, there was little to no contraction. Additionally, owners continue to be bullish with development in the District. Several new projects broke ground in the second quarter bringing the total square footage under development to just over 6.5 million square feet, nearly double what was under construction just a year prior.

Economics

During the second quarter of 2017, the District of Columbia’s economy grew by 0.22 percent or 0.87 percent annually. This was the slowest rate of growth since the third quarter of 2013 when it was 0.14 percent. The recent high water mark of economic growth for the District of Columbia occurred during fourth quarter of 2015 when the economy grew by 0.60 percent or 2.44 percent annually.

While slower than previous quarters, economic activity generated new jobs in the District of Columbia, but not in office-using sectors. During the quarter, total non-farm employment increased by 0.14 percent, but in the office-using sectors employment fell by 0.54 percent. The professional and business services industries were the largest and most impactful to the office sectors that reported job loss. During the quarter, nearly 1,460 of these jobs evaporated, resulting in 600 jobs lost for the year. Significant job loss also occurred in the government sector of the economy. During the quarter, the Federal Government shed 1,450 jobs, bringing the year-to-date loss to nearly 620 jobs. The advocacy industry was the only sector of the economy in which office-using employment increased. During the quarter, about 180 of these jobs were created. However, employment in the sector was down for the year with nearly 510 positions being eliminated during the first quarter of 2017.

Market Indicators

Q2 2017 Office Market All Classes Class A Class B & C

Vacancy Rate 11.3% 12.5% 9.5%

Change from Q1 2017(basis points) 21 33 4

Absorption (Square Feet) -305,992 -281,262 -24,730

New Construction (Square Feet) - - -

Under Construction (Millions Square Feet) 6.51 5.88 0.63

Asking Rates Per Square Foot Per Year

Direct Asking Rate $54.96 $59.69 $45.51

Change from Q1 2017 $0.73 -$0.12 -$1.07

Summary Statistics

Year-End Projection

VACANCY

Q2 2017

NET ABSORPTION

CONSTRUCTION

RENTAL RATE

DC Development: No Signs of Slowing

$59.69

$45.67

$38.13

$35

$40

$45

$50

$55

$60

$65

Class A Class B Class C

Direct Asking Rental Rates By Class

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL 3

Demand

Weakness in the job market continued to translate into lower demand for office space. During the quarter, 305,992 square feet of space was given back to the market, bringing the year-to-date net absorption to negative 353,261 square feet. This is only the second time in five years that net absorption in the DC market has been negative for two consecutive quarters. As long as both the Federal Government and the legal industry continue to consolidate their footprints, and the office-using employment growth remains lackluster, space will continue to be returned to the market.

Falling demand during the quarter was most pronounced in Class A product, with 281,262 square feet of space returned to the market. Even when total demand was negative in the recent quarters, demand for Class A space remained strong because of the flight to quality. While one quarter does not make a trend, continued lack of demand for Class A office space could have major implications on the underlying market fundamentals.

District of Columbia—Office Market—Leasing Activity | Q2 2017TENANT ADDRESS SUBMARKET - CLASS LEASE TYPE LEASED SPACE (SF)

GSA - US Department of Education 550 12th Street, SW Southwest - A Renewal 314,243

GSA - Department of Homeland Security (DHS) 1120 Vermont Avenue, NW East End - B Renewal 119,719

Consumer Financial Protection Bureau (CFPB) 1990 K Street, NW CBD - A Short-Term Renewal 96,000

Goodwin Procter, LLP 1900 N Street, NW CBD - A Relocation/Consolidation 75,000

Washington Gas & Energy Services, Inc. 1000 Maine Avenue, SW Southwest - T Relocation/Consolidation 70,063

Bank of America 1800 K Street, NW CBD - A Relocation 61,722

Research Triangle Institute 701 13th Street, NW East End - A Renewal/Expansion 52,274

Hollingsworth LLP 1350 Eye Street, NW East End - A Renewal 48,543

Morgan Stanley 1747 Pennsylvania Avenue, NW CBD - A Expansion 40,329

-1,000-800-600-400-200

0200400600

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Net Absorption

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL4

Supply

For the second quarter in a row, more than half a million square feet of space broke ground in the District. At 286,850 square feet, One Freedom Plaza, located at 1301 Pennsylvania Avenue, NW, was the largest new project to break ground in the second quarter. It is the future home of mega law firm Kirkland and Ellis, which pre-committed to roughly 70 percent of the building. The two other significant ground breaking’s include 2100 K Street, NW and 1900 N Street, NW, both commenced on a speculative basis. It is rumored, however, that Goodwin Proctor signed a letter of intent at 1900 N Street. Both of these projects illustrate how confident owners are on starting high-quality projects in good locations despite the perceived downsizing of tenants and the weakening of the real estate fundamentals.

With 6.5 million square feet currently under construction or renovation, the amount of product being developed is over three times what it was just three years ago. It is clear that owners believe that tenants will continue to flock to new high-end construction. Looking from the outside, with vacancy expected to increase and little to no positive absorption expected in the near future, it would seem a mistake to go speculative in construction. Tenants, however, continue to prefer new high-end space to commodity A and developers are willing to risk short-term vacancy to capture these tenants.

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Development PipelineDeliveries, Under Construction

Deliveries Under Construction Availability

Q1 2017

Q2 2017

Q32017

Q4 2017

Q12018

Q2 2018

Q3 2018

Q42018 2019+

Sources: CoStar Group; Colliers International

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL 5

Vacancy On the heels of the second straight quarter of falling demand for office space, the vacancy rate rose 20 basis points to end the quarter at 11.3 percent. This matches the five-year high, and there are no indications of making significant strides back down. Both the direct and sublet vacancy rate increased in the second quarter, which rose 10.3 to 10.4 percent and from 0.8 to 0.9 percent. Most notably, there was a 30-basis-point increase in the Class A vacancy rate to 12.5 percent, which broke a three quarter trend of vacancy decreases. It is expected, given the amount of speculative construction in the pipeline and limited tenant demand, that this will not be the ceiling of vacancy but likely the floor for the next 18 months.

Rental Rates

Despite negative demand for two quarters in a row and vacancy on the rise, rental rates continued to increase, jumping over 70 cents to $54.96 per square foot during the quarter. This rise was fueled by the increased Class B rental rate, which rose by over a dollar to end at $45.67 per square foot on a full service basis. The Class A rental rate decreased slightly from $59.81 to $59.69 per square foot. It is unlikely this will continue as new space delivers to the market and drives the trophy and Class A market rental rate averages up.

Outlook

Going forward the Washington, DC market will become even more bifurcated than it already is. Trophy developments will continue to poach tenants out of aging space at a growing rate. Deliveries of these trophy developments is expected to send commodity A vacancy upwards. With over 6.5 million square feet under construction and even more scheduled to break ground in the near future, commodity A buildings will have to cut rates to compete for demand. The difference in average rental rates between trophy and commodity A already has a larger delta than Class C and commodity A space, and that should increase going forward.

10.0%

10.5%

11.0%

11.5%

Q3

2014

Q4

2014

Q1

2015

Q2

2015

Q3

2015

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2015

Q1

2016

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2016

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Q2

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Vacancy Rate

$50

$51

$52

$53

$54

$55

$56

Q3

2014

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2014

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2015

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2015

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($/S

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ross

)

Direct Asking Rental Rate

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL6

District of Columbia—Office Market—All Classes | Q2 2017

MARKET EXISTING INVENTORY NEW SUPPLY YTD NEW

SUPPLY UNDER

CONSTRUCTION ABSORPTION YTD ABSORPTION

OVERALL VACANCY

RATE

DIRECT ASKING RATE

DISTRICT OF COLUMBIACapitol Hill 5,320,095 - - 1,172,877 -19,010 -111,809 9.1% $55.68

Capitol Riverfront 5,030,678 - - 364,000 101,783 122,629 23.2% $48.30

CBD 44,043,913 - 115,338 2,295,228 -60,441 -173,768 7.7% $57.11

East End 47,349,427 - 94,273 1,374,574 -419,615 -193,786 13.5% $59.44

Georgetown 3,191,258 - - - -29,640 -30,801 6.9% $52.74

NoMa 10,980,509 - - 522,550 -68,560 -54,870 12.1% $52.24

Southwest 11,867,749 - - 757,010 174,956 56,978 12.2% $46.15

West End 4,482,399 - - - -2,201 39,431 9.9% $54.90

Uptown 10,926,481 - - 23,140 16,736 -7,265 12.1% $42.85

District of Columbia Total 143,192,509 - 209,611 6,509,379 -305,992 -353,261 11.3% $54.96

District of Columbia—Office Market—Class A | Q2 2017

MARKET EXISTING INVENTORY NEW SUPPLY YTD NEW

SUPPLY UNDER

CONSTRUCTION ABSORPTION YTD ABSORPTION

OVERALL VACANCY

RATE

DIRECT ASKING RATE

DISTRICT OF COLUMBIACapitol Hill 2,941,200 - - 643,077 -7,567 -28,865 9.0% $59.42

Capitol Riverfront 3,809,851 - - 364,000 104,408 121,479 8.7% $49.05

CBD 21,160,056 - 115,338 2,250,920 -28,357 15,737 9.4% $64.38

East End 33,322,908 - 94,273 1,374,574 -486,642 -153,429 15.2% $63.17

Georgetown 1,641,799 - - - -16,785 -15,392 7.7% $57.81

NoMa 9,001,182 - - 522,550 -52,577 -38,887 13.7% $53.14

Southwest 9,161,084 - - 729,010 179,031 61,053 13.2% $46.78

West End 2,850,081 - - - -3,607 31,686 15.1% $54.95

Uptown 2,193,535 - - - 30,834 47,011 5.0% $49.50

District of Columbia Total 86,081,696 - 209,611 5,884,131 -281,262 40,393 12.5% $59.69

District of Columbia—Office Market—Class B & C | Q2 2017

MARKET EXISTING INVENTORY NEW SUPPLY YTD NEW

SUPPLY UNDER

CONSTRUCTION ABSORPTION YTD ABSORPTION

OVERALL VACANCY

RATE

DIRECT ASKING RATE

DISTRICT OF COLUMBIACapitol Hill 2,378,895 - - 529,800 -11,443 -82,944 9.3% $50.89

Capitol Riverfront 1,220,827 - - - -2,625 1,150 68.3% $39.00

CBD 22,883,857 - - 44,308 -32,084 -189,505 6.1% $48.39

East End 14,026,519 - - - 67,027 -40,357 9.3% $45.78

Georgetown 1,549,459 - - - -12,855 -15,409 6.2% $36.64

NoMa 1,979,327 - - - -15,983 -15,983 4.6% $29.00

Southwest 2,706,665 - - 28,000 -4,075 -4,075 8.8% $44.57

West End 1,632,318 - - - 1,406 7,745 0.6% $44.00

Uptown 8,732,946 - - 23,140 -14,098 -54,276 13.9% $42.60

District of Columbia Total 57,110,813 - - 625,248 -24,730 -393,654 9.5% $45.51

DISTRICT OF COLUMBIA | OFFICE MARKET REPORT | Q2 2017 | COLLIERS INTERNATIONAL 7

Inventory by Class(Square Feet)

-2,839Office Jobs Lost

6,509,379Under Construction

(Square Feet)

0New Deliveries(Square Feet)

-305,992Absorption

(Square Feet)

$54.96 Direct Asking Rate

11.3%Vacancy Rate

SECOND QUARTER 2017

OVERALL QUICK STATS

Class A60.1%

Class C 4.6%

Class B35.3%

High barriers to develop in traditional locations has opened other areas for commercialization. The unfettered success of the Wharf has completely transformed the former Federal enclave. Phase I from a commercial standpoint continues to bring in coveted tenants including Washington Gas this quarter. Phase II was announced earlier this quarter to break ground in the third quarter of 2018. This 1.2 million square foot development will include three office towers, retail and luxury condominiums and has 10 different architects working on it. There will also be improvements to the marina and outdoor public space.

8 North American Research & Forecast Report | Q4 2014 | Office Market Outlook | Colliers International

Copyright © 2017 Colliers International.The information contained herein has been obtained from sources deemed reliable. While every reasonable effort has been made to ensure its accuracy, we cannot guarantee it. No responsibility is assumed for any inaccuracies. Readers are encouraged to consult their professional advisors prior to acting on any of the material contained in this report.

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FOR MORE INFORMATIONDavid Parker Regional Managing Director+1 202 728 3541david.w.parker@colliers.com

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Andrew Wellman Research Analyst+1 202 534 3632andrew.wellman@colliers.com