The real estate market in the Washington Metropolitan Area continues to grow in size and prominence. With the delivery of nearly 1.8 million square feet of new space, the inventory of commercial office space in the region surpassed 350 million square feet during the first quarter of 2005. While the Washington area has grown to become one of the largest real estate markets in the country, it is the performance of this market that has caught the attention of industry analysts and investors. Total net absorption for the District of Columbia, Northern Virginia, and Suburban Maryland was nearly 2.3 million square feet during the first three months of the year. The vacancy rate improved from 9.8% to 9.5% during the first quarter at a time when most major metropolitan areas have vacancy rates well into the double digits. The growth of the federal government, government defense contractors, law firms, and the biotech industry have been the driving forces behind the local economy and are likely to continue to provide the growth and stability that have been the hallmark of this market for the past several years.

The Washington, DC real estate market has a tenant base that is steadily increasing, a long line of buyers wishing to purchase buildings, and new construction that will allow the city to grow. These three indicators have changed little during the last several years. The year-end vacancy rate has been under 7% each year since 1998; the city has been ranked as one of the top investment sales markets in the country for several years; and an average of over 2.5 million square feet of space has been delivered each year since 2000. This consistent performance, at a time when most real estate markets have faced significant challenges, is the true measure of the strength of the Washington, DC market. The size of the office market continued to grow during the first quarter and topped 110 million square feet for the first time. That growth was the result of three buildings which delivered a combined total of more then one million square feet of space. The three buildings that came onto the market; 1717 Rhode Island Avenue, NW, 100 F Street, NE, and 875 15th Street, NW, had a combined preleased rate of 92%, the second quarter in a row that the preleasing rate of new construction has been higher than 90%.

Net absorption for the first quarter 2005 was 650,000 square feet as demand for new space continues to grow. Demand is extremely high for quality buildings that are being constructed in prime locations. Trophy projects in the CBD and East End are being leased despite having asking rental rates significantly above average. Law firms and the federal government were once again the principal actors in the market. Of the three new buildings delivered, law firms are the lead tenants in two of the buildings and the Securities and Exchange Commission is the sole occupant of the third.

The sales market in Washington has been extremely competitive for several quarters. There is more demand than supply for all types of office space, from small user-owned buildings to large trophy-class office towers. Under these market conditions sale prices have soared, with several buildings selling in the range of $600 per square foot.

The Northern Virginia office market continued to improve over the first quarter, posting an improvement in the vacancy rate and strong positive net absorption. The end of the quarter vacancy rate was 10.7% compared to 11.4% at year-end 2004.

Leasing activity this quarter resembled the pace of the last 24 months as the federal government and private companies continued to take space. The U.S. government has agreed to a prelease of 350,000 square feet at the Peterson's Companies development, Dulles Discovery, in the Route 28 South submarket. Dulles Discovery, located across Route 28 from the new Air & Space Museum, could ultimately provide 1 million square feet of office space for the federal government. The deal will provide additional space for intelligence agencies that have been expanding over the past few years. In Fairfax County, the Fairfax County Public Schools (FCPS) closed on their purchase of 8115 Gatehouse Road in Merrifield.

Merrifield's vacancy was cut in half during the first quarter, in part by the FCPS's occupancy, but also by the commitment of 75,382 square feet by SRA International and 70,626 square feet by the Drug Enforcement Agency in that submarket. Other large first quarter deals included ITT for 167,000 square feet in Herndon, the American Trucking Association, which preleased 105,000 square feet at 950 N Glebe Road in Ballston, and SAIC which preleased 82,626 square feet in Chantilly/Rte 28 South.

An additional market indicator to watch closely in 2005 will be the pending construction of several speculative office buildings. After two years of net absorption exceeding 5 million square feet and an overall vacancy rate approaching single digits, savvy developers are gauging the market to determine whether 2005 is the time to break ground on planned projects, especially in western Fairfax County.

Buildings that are scheduled to break ground in 2005 include Monument 3, the last parcel available in Herndon's Worldgate development, Bridgewater Corporate Center in Fairfax and Reston Square which has a lease pending with a major tenant. In addition, many developers are vying for prime pieces of land in Fairfax County and Loudoun County. Interest in land near Dulles International Airport is notable.

Tempering some of the enthusiasm in Arlington County was a report from Secretary of Defense Donald Rumsfeld that indicates that federal contractors and other federal agencies may be held to the same security standards as those established by the Pentagon. The long-term impact of this is uncertain but Arlington officials will be keeping a close watch on the developments as will other land owners in Virginia.

For the first quarter of 2005, the Suburban Maryland Office Market comprised over 1,150 buildings, totaling greater than 78.8 million square feet of office space. The Suburban Maryland Office Market average lease rates have been on a steady increase, with rates rising from $23.39 in the fourth quarter of 2004 to $24.05 in the first quarter of 2005. The vacancy rate increased slightly from 10.6% to 10.7%. The net absorption total for the first quarter was below average with just 8,689 square feet of office property absorbed during the first quarter of 2005.

Construction activity remains steady in Suburban Maryland, with more than 450,000 square feet currently scheduled to deliver by the end of 2007. The Suburban Maryland office market continues to build steam, thanks in large part to the life sciences and biotech industries. Although improvement in the vacancy rate has been gradual, it is growth that has been sustained. There are a limited number of projects in the development pipeline for the next two years and this constriction of inventory growth should help to create a better equilibrium between supply and demand. The four projects scheduled to be completed during the next three years and they are currently 67% preleased. This market should enjoy a continued period of healthy market conditions in 2005 and 2006.