The federal budget sequestration, which Congress is now debating whether to impose for a second year, has begun eating into profits for some real estate investment trusts that have headquarters or heavy investments in the Maryland suburbs of Washington, D.C.
“With the effects of the March sequester now being felt, any lingering doubts that federal government spending is a key driver of the office sector in the Washington, DC metro area were laid to rest in the second quarter of 2013,” broker Cassidy Turley said in its new Washington area office market report.
“Suburban Maryland’s numbers plummeted in the second quarter,” the report continued, with the vacancy rate rising to 16 percent from 15.7 percent in the first quarter. At the same time, the absorption rate turned negative by 127,000 square feet of space, after a strong first quarter, when 459,000 square feet of space was absorbed.
That was the worst performance in the D.C. region, with Washington registering positive absorption of 123,000 square feet and Northern Virginia’s absorption rate falling to negative 57,000 square feet from 253,000 square feet in the first quarter.
Whether companies are focused on office or residential, many took note of the impact of the federal spending crunch on their second quarter earnings.
The federal budget gridlock had left companies in something of a limbo but they are beginning to recover and move ahead with plans for office space, said George F. McKenzie, Washington Real Estate Investment Trust’s president and chief executive officer, according to a Seeking Alpha transcript of its earnings conference call.
“There is still [a] tremendous amount of uncertainty out there over what Congress is going to do or if they’re going to do anything,” he said. “I don’t think any of us know exactly how to react. ... There’s so many unknowns and none of us know how it’s all going to unravel but I think to some degree we’ve gotten back to work a little bit.”
But he added that rising interest rates have emerged as a new area of concern about federal policy. So much so that financial markets have slowed the company’s plan to sell off its regional medical office portfolio, which includes four buildings totaling 207,000 square feet clustered near Shady Grove Adventist Hospital in Rockville, plus a 125,000-square-foot building in Pikesville, north of Baltimore.
“We wanted everybody to digest what was going on in the world and come in with their best number,” McKenzie said. “We didn’t want to renegotiate after the fact with anybody. So, I would say the process has elongated, but I wouldn’t call it negative in anyway, it’s just we don’t want people to come to us after the fact and say there has been a change in the world.”
The sequestration is of little concern in the D.C. region for Government Properties Income Trust, according to David Blackman, president and chief operating officer of the Netwon, Mass.-based firm.
“We really are not seeing impact specifically on our properties from sequester,” he said Wednesday during an earnings conference call, according to a Seeking Alpha transcript. “I would expect and do see the sequester is going to have an impact on overall occupancy in that market because government contractors are likely to see some effects from sequester. Fortunately for us, we don’t have any government contractors leasing space in our buildings and the buildings we have in the D.C. market tend to be relatively strategic to the government tenants. So fortunately for us, it hasn’t had a real effect on occupancy at our portfolio yet.”
The company owns 1401 Rockville Pike, a 188,444-square-foot building in Rockville, where it rents space to the FDA, and 20400 Century Blvd., in Germantown, where the Department of Energy is the tenant.
But Columbia-based Corporate Office Properties Trust — which has been hard hit by federal budget gridlock for the past two years — will see vacancies grow further as sequestration continues, said Roger Waesche, the firm’s president and chief executive officer, during an earnings conference call last week.
“Many defense contractors completed their space rationalizations ahead of the anticipated budget cuts, while others were still in the process to rightsizing,” he said, according to a transcript provided by Seeking Alpha.
“The onset of sequestration has clearly accelerated the decision making of this latter group. As a result, we are forecasting a modest uptick in our portfolio of vacancy over the next few quarters from June 30th levels.”
The firm has sold off non-strategic properties in recent years to better focus on federal military and cyber-security tenants and related private contractors and data centers. A year ago, COPT announced that it sold 1.5 million square feet of office space for $179 million. Among the assets was 400 Professional Drive, a 130,000-square-foot building in Gaithersburg, the sale of which marked COPT’s exit from Montgomery County.
But the company remains heavily invested in buildings and ongoing development in Howard, Anne Arundel and Harford counties, where it has capitalized on the expansion of Fort Meade, the National Security Agency and Aberdeen Proving Ground.
Waesche said that some tenants will give back more space than the firm expected but others are beginning to expand. “The modest increase in near-term vacancy spurred by sequestration is very manageable, especially when weighed against the long-term value creating events that have been taking place in our development pipeline,” he concluded.
Of the 1.5 million square feet of space COPT currently has under construction, 407,000 square feet are not committed.
Waesche concluded that conditions should improve because Congress and President Obama agree that the Pentagon cannot continue to absorb $52 billion of annual sequestration cuts.
The D.C. market “continues to show signs of stress as new deliveries come online and the impact of sequestration and furloughs put a damper on the metro area economy,” said David S. Santee, chief operating officer of Equity Residential Management, during the company’s earnings conference call on Wednesday, according to a Seeking Alpha transcript. The Chicago-based firm is a heavy local investor, with 5,564 apartment units in Montgomery, Prince George’s and Charles counties.
The company added to its local investments in the last year, when it bought the 192-unit Westchester Rockville Station and the 491-unit Westchester at the Pavilions in Waldorf as part of Archstone’s $6.5 billion selloff of its apartment holdings.
But Equity reported that it has a 95.6 percent occupancy rate locally after the region absorbed more than 9,000 Class A units in the past 12 months, despite declines in government payrolls and spending. But Equity warned that as the apartment supply peaks in 2014 with 19,000 expected new deliveries, it “would expect our results to be weaker than they are today as we continue to realize positive rent growth from renewals with base rent growth under pressure.”
Arlington-based AvalonBay Communities — which bought 853 units in five properties from Archstone — reported that its suburban Maryland assets are currently underperforming the Northern Virginia portfolio.
“It’s no secret that D.C. Metro area is facing challenging headwinds in terms of new supply and weak demand,” Sean J. Breslin, AvalonBay’s executive vice president of investments and asset management, said during the firm’s earnings call last week. But he added that “We remain optimistic about the region over the long term, and recent data indicates the pace of new apartment starts is beginning to decline.”
Regency Centers Corp. announced that it bought the Shoppes of Burnt Mills, a 31,316-square-foot neighborhood center in Silver Spring, for $13.6 million.
Built in 2004, the property is anchored by a 9,306-square-foot Trader Joe’s, next to a Starbucks, Chico’s and AT&T. The center sits on Colesville Road about halfway between New Hampshire Avenue to the North and University Boulevard and the Beltway to the south.
Regency purchased the property with a co-investment partner. Regency’s share of the purchase price was $2.7 million.
Regency owns and operates 34 centers, totaling 4 million square feet, in the D.C. metro/Maryland market. The properties are managed by a 25-member team with an office in Tysons Corner, Va.