Dulles Slows Down

Corridor’s Growth Spurt Stalls Along With Real Estate Trends

By Alejandro Lazo

Monday, November 12, 2007

Few places have epitomized the recent boom in commercial real estate better than the busy arteries that connect Dulles International Airport with the rest of the Washington region.

In Reston and Herndon alone, 15 new buildings totaling nearly 2.8 million square feet of office space have risen since 2005. As an office market, the Dulles Corridor surpasses Tysons Corner in raw square footage.

Companies such as Sprint, Sallie Mae and Volkswagen have located operations there. The corridor has seen job growth of 24 percent over the past seven years.

But now this fast-growing suburban business hub is headed for a pause.

With federal contracting slowing from its recent boom, and as the national and regional economies soften, the current wave of construction projects is likely to leave empty buildings. Few new office projects are expected to get started in the near future, as developers focus on finding tenants. The process is likely to take at least two years, given historical trends, according to developers and brokers.

“There is going to be a lot of competition for tenants out there, and I am not going to paint a pretty picture,” George F. McKenzie, chief executive of the Rockville-based Washington Real Estate Investment Trust, told analysts during a conference call last month. “Activity has not been as good as one would have expected over the last 12 months.”

Completed in July, the Washington REIT’s Dulles Station West sits empty a few turns off the toll road, the first element in a future office park. The project is the first ground-up office development in the 47-year history of the company, which invests mostly in existing commercial property.

“This is our only significant vacant project,” Sara Grootwassink, chief financial officer for Washington REIT, said during a recent tour of the property. “But we also have realistic expectations: You don’t open up a building like this and expect it to be 100 percent leased.”

Proximity to a future Metro station along the toll road and high visibility from that highway will help attract clients, Grootwassink said. Yet when the firm bought the land and development rights for the building in December 2005, the potential to build a second, larger building was part of the deal. While that opportunity remains, the space will become a park for now.

“It is a factor of the market, obviously,” Grootwassink said. “We would not plan on the second one until the first one was leased.”

New Center of Gravity

The last time Northern Virginia’s commercial real estate market slowed was after the tech bust of 2001, when dozens of dot-com start-ups went out of business. But that downturn was relatively short lived. After the terrorist attacks of Sept. 11, 2001, the federal government began pouring money into national security programs, with many of those dollars going to contractors in Northern Virginia.

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Dulles Area Growth Slows

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The area around Dulles Airport added office space at a rapid rate from 1999 to 2002, but growth slowed as vacancy soared. Construction in the area is booming again but heading for a pause. (Source: CoStar Group Inc.) ()

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The workforce within eight miles of Dulles Airport grew 24 percent from 2000 to 2007. How employment in the area's largest industries has changed. (SOURCE: ESRI analysis of InfoUSA data) ()

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Developers have added office space around Dulles Airport in two distinct phases. From 1998 to 2002, buildings were opened to satisfy demand created by the tech boom, although some of that space did not become available for lease until the tech boom's end. From 2003 to 2007, developers added space to meet demand from federal contractors, whose business increased as the government spent more on national security programs. (Source: CoStar Group Inc.) ()

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The Dulles area’s relatively inexpensive real estate became a draw for many businesses. In the latest quarter, for example, rents for the Dulles area were $29.81 per square foot, compared with $47.94 in downtown Washington.

For some companies, the availability of more affordable housing for new workers west of the airport in Loudoun was what made the difference. Booz Allen Hamilton, a McLean consulting firm, began an expansion into Herndon in the fall of 2005. Its decision to expand in the Dulles Corridor was based largely where its growing workforce would live. Many employees have settled into new developments along Route 7 in Loudoun, according to Gary Lance, a senior director of facilities and administrative services for the firm.

“We looked at the demographics of the people we were hiring, and that was kind of the center of gravity out there,” Lance said.

Photo: David Murray

In Reston and Herndon, about 2.8 million square feet of office space has risen since 2005, but growth in the suburban business hub is now starting to slow.

Avoiding the heavy traffic of Tysons Corner and the District is another motivating factor for many who choose to work in the offices around Dulles, even though congestion there has worsened in recent years.

On a recent morning, Mark N. Sibley, a crisis manager for Booz Allen Hamilton, sat on the 10th floor of his company’s sleek Herndon outpost, keeping tabs on co-workers in California at the height of the wildfires. Two open laptop computers and a digital clock with five time zones rested on his desk. Outside his window, a cold wind whipped and howled as rain fell along the busy toll road just a few blocks away. He shuddered at the idea of a long commute.

“That was one the main reasons I wanted to come out here, is to be closer to home,” said Sibley, who commutes from Leesburg. “I am able to work a little longer, but still get home in time to get the kids to bed.”

Silver Lining in the Slowdown

While the Dulles area doesn’t have a clearly defined Main Street, the Reston Town Center comes close. As a magnet for private enterprise, the development along Reston Parkway stands apart. Three new office buildings being built there by developer Boston Properties already have commitments to lease 85 percent of the available space.

But more than drawing office tenants, the town center has turned into a slice of semi-urban life in the suburbs, drawing crowds to its open plazas and wide sidewalks. Come lunchtime, the tables of the restaurants — Clyde’s of Reston, McCormick & Schmick’s or the Market Street Bar and Grill in the lobby of the Hyatt Reston — bustle with business clients.

When Clyde’s Restaurant Group opened its Reston location in 1991, the chain did not have many competitors, said Claude Andersen, the firm’s corporate operations manager. That has changed over the years.

“What a lot of that development has brought has been a lot of very good competition for us,” Andersen said.

Along the way, the Dulles area has become a bustling business community in the outer suburbs — an elusive goal to suburban leaders across the country. The Dulles Regional Chamber of Commerce, for example, has expanded from about 650 members in 2000 to about 960 currently, most of them small businesses in the hospitality, professional services and financial services industries.

“It’s been growing like crazy, and it’s been one of those situations where the growth has been . . . more reactionary,” said Danny Vargas, chairman of the chamber.

The Dulles area reignited as an office market in 2005 as leftover space from the dot-com era filled up. Vacancy rates had by then declined to the point where developers felt comfortable putting shovels into the ground again.

Most of that new construction has been speculative, meaning tenants were not lined up before the projects commenced. The first batch of buildings is now complete and more are on the way, hitting the area just as the market slows again, underscoring the cyclical and unpredictable nature of real estate.

“The good thing about a breather is it gives you a chance to think strategically” Vargas said. “Job growth will continue, business growth will continue, perhaps at a slower pace, but it gives you a chance to think . . . about things like housing, workforce, transportation and infrastructure.”

Christopher B. Leinberger, a visiting fellow with the Brookings Institution, concurred that a slowdown will allow the region to catch up in terms of planning.

“This is a natural occurrence,” Leinberger said. “It’s about time that we had a little downturn. And while real estate developers don’t like to hear this, ultimately, it’s a good thing because there are a lot of inefficiencies in the market.”

Even with a slowdown underway, some major leases have been signed. Most prominent among them was Volkswagen of America snatching up a six-story office building in Herndon. The law firm Whitney, Bradley & Brown has agreed to take almost 90 percent of JBG Companies’ Reston Heights building.

Other developers, however, have suffered from bad luck. Northrop Grumman was set to consolidate part of its workforce into one of the new speculative projects in Herndon when the contractor reneged, choosing to keep workers in existing locations.

Another Herndon project, Overlook Tower Phase I, is scheduled to be completed early next year. The developer, Michael Vardell, said he has been busy trying to close a deal to bring at least one tenant to the property. Vardell has a second building, EastPointe, under construction in Reston. Despite the lackluster activity the area has yielded in recent months, Vardell remains confident in the future of his projects.

“Leasing real estate is not like selling boxes of cereal where so many fly of the shelf every week,” Vardell said. “It kind of goes in fits and spurts. Certainly, if it was easy, everyone would be doing it.”

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