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As Class B leasing fundamentals tighten, investors follow to the capital markets

  • ​Leasing fundamentals in the downtown Class B market are ever-tightening: redevelopment activity has decreased the supply of Class B space by 9% since 2010. That reduction, combined with a diversification of the tenant base toward Class B-focused tenants, has pushed rents upward by 8.6% since 2010 and compressed vacancy to just 8.2%. For comparison, vacancy in the Class A (non-Trophy) market sits at 18.4%.
  • Investors have taken notice of the B market’s performance, pouring increased capital into the segment. Combined 2016-2017 Class B asset sales have accounted for 50% of overall downtown activity, up from less than 30% in 2010.
  • Cap rates for Class B buildings in the DC core have steadily compressed, down from 10.9% in 2000 to sub-5.5% today. Pricing has accelerated – doubling between 2000 and 2010, and more than tripling to reach an average of $551 p.s.f. in 2017 with some long-term stabilized leased assets that have also been recently repositioned buildings trading for +/-$800 p.s.f.
  • The Class B market’s new reputation has made its way around the globe: foreign investors have historically opted for DC’s stable, low-yield, Trophy-quality assets, and Class B purchases have come mostly from local investors. That story is vastly different in 2017, with 81% of Class B volume driven by foreign buyers YTD. As foreign investment in DC ticks upward year after year, competition for B product will become increasingly fierce.
  • Increased investment activity may present further challenges for tenants seeking Class B space. The high bases at which investors are acquiring Class B assets indicate that buyers are underwriting additional rent increases, at the very least, and possibly even redevelopment plays that will further shrink the city’s Class B offerings.

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