BY: SCOOT WINGRAT AND WILL WHEATON
Summer is in full swing, and the Baltimore office market is heating up.
A cultural shift led by millennials is revitalizing downtown into a desirable live/work/play destination, replacing vacant and aging office product with luxury multi-family units. Many core suburban submarkets such as Columbia, Maple Lawn, White Marsh, and the I-83 Corridor are seeing vacancy rates in the single digits, down from as high as 15 percent after the recession of 2008-2009. This improvement in fundamentals is spurring numerous new developments across the Baltimore region, but until new office product delivers, the supply of quality office space available for lease will continue to shrink.
Underpinning the improvement in market conditions has been strong job growth since the beginning of 2014. Through this April 2016, the Baltimore market has added 31,900 new jobs year-over-year, outpacing the Washington, D.C., market as well as the national average. Baltimore’s suburban markets, in particular, have seen solid job growth, adding more jobs as a percent of total employment than suburban D.C. markets in Maryland and Virginia. Baltimore City added 4,500 jobs during this time, but job creation has not been as robust as its suburban counterparts. Roughly 45 percent of all jobs in the Baltimore market are office using with the professional and business services sector, including a rapidly expanding technology presence, adding the most jobs in the past year.
The composition of Baltimore’s central business district has changed considerably in the last 10 years. From 2005-2013, the Baltimore region’s population aged 20-34 grew 18.3 percent, the fifth highest growth rate of the 20 largest metropolitan area’s in the country. As millennials began to migrate downtown, businesses were relocating to waterfront locations such as Pratt Street and Harbor East, leaving a glut of older office space behind. The confluence of these circumstances provided developers with an excellent opportunity to purchase centrally located, architecturally significant properties at well below replacement cost. Office-to-residential conversions have helped drive down the vacancy rate by taking obsolete inventory out of the market, and since 2010, almost 2 million square feet has been converted to high-end residential units.
Declining vacancy, rising rents
Baltimore’s office vacancy spiked to a high of 16.1 percent in mid-2010 and as a result of reduced inventory and strong job growth has steadily receded to 12.1 percent, the lowest annualized rate since 2000. Rents began a protracted decline from 2008-2014 but remained relatively consistent, falling only 6.5 percent from peak to trough. From the second quarter 2014 to present, rents have rebounded 4 percent and currently average $22.92 per square foot, the highest point since Q3 2009. Absorption has been positive every year for the last 10 years and, with nearly 1 million square feet of preleases in new construction scheduled to deliver this year, this trend is expected to continue in 2016. Although there is 1.4 million square feet currently in the development pipeline for this year, 67.3 percent of that space is already spoken for, with no space available for lease remaining in developments delivering in Baltimore City.
As a result, Baltimore City is starved for high-quality office space. Best-in-class newer product along the Inner Harbor is generating rents in the mid-$30’s, with vacancy in the 5 percent to 7 percent range. Marketing time for available space is only seven months compared to 19 months for traditional Class A space and 23 months for the market as a whole. Class A rents have risen a respectable 8.9 percent to $25.56 a square foot since hitting bottom in Q2 2014 while rents in Class B buildings have been stagnant, vacillating between $20-21 a square foot for almost a decade. Both urban and suburban product in comparable submarkets is similarly priced throughout the region.
Investment Sales and Development Robust
Improving market fundamentals has caused investors to take notice. Investment sales transactions for office properties in the Baltimore market totaled $970 million in 2015, an all-time high. Several prominent buildings that make up Baltimore’s skyline traded hands last year, including theTransamerica Tower at 100 Light St., One South Street, the Pandora Tower at 250 W. Pratt St, and the Bank of America Tower at 100 S. Charles St. In addition, several more were offered for sale and are expected to close in 2016. Most notably, 100 E. Pratt St closed in March, and in what is expected to set new pricing records for the Baltimore Market, the Legg Mason Tower at 100 International Drive is rumored to still be in play.
Confidence in the market combined with the shortage of newer Class A options has prompted many developers to move ahead with ambitious new projects that will redefine the market. In Baltimore City, Under Armour’s explosive growth will add 13 million square feet of office space and thousands of residential units in Port Covington, and work continues at Harbor Point as the second phase of the 27-acre, 3-million-square-foot development kicked off this year. COPT is also following through on its urban infill strategy and unveiled its plans for Canton Crossing, a 10-acre, mixed-use waterfront development that will ultimately include 1.1 million square feet of office space with apartments and retail.
In the suburbs, Columbia’s long-awaited makeover is coming to fruition as Howard Hughes Corp.’s Crescent development gained its first tenant, signing MedStar Health earlier this year. The developer hopes to transform Columbia from the quintessential car-centric suburb to an urban live/work community that will have 1.5 million square feet of office space upon completion. In White Marsh, St. John’s Properties is planning to add 500,000 square feet of office space at its Greenleigh at Crossroads development, and in Owings Mills, David S. Brown Enterprises will deliver its first office building in the 1.2M SF Metro Centre project.
Since 2014, strong job growth combined with reduced inventory in the central business district and historically low levels of new construction has contributed to an improvement in office market fundamentals across the Baltimore MSA. But while numerous developments are in the planning stages, the pipeline scheduled to deliver in 2016-2017 is not sufficient to fill the immediate need for high-end Class A office space in the region.
Until developers take the risk to build spec, tenants looking for Class A space will face increased rents and fewer space options in core submarkets across the region.
Will Wheaton is senior research Manager at Cresa Washington D.C., and Cresa Baltimore. Scott Wingrat is managing principal at Cresa Baltimore.