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Outlook for Frederick County’s Commercial Office Market

High vacancy rates have created a renter’s market for Frederick office space.

051012-1In our last post, MacRo Report shared an overview of the 1Q 2012 performance of the U.S. commercial office market and broke out some statistics for Frederick. Although vacancy rates for Frederick area office spaces have begun to tick down, and small businesses are coming back into the market, commercial lease rates in this area continue on a downward trend. We spoke with Rusty McCabe, Assistant Vice President at McShea & Company, about the near-term outlook for Frederick’s office market.

MacRo: Costar reported this past quarter that small businesses are back in the commercial office market across the nation. Are you seeing that trend in Frederick as well?

McCabe: Definitely. Most lease deals we have done for the past couple of years are smaller deals, under 5,000 sq. ft. and in the $2000-3000 per month range of rent mostly. And during the past couple of months the little guys are really coming out, those in the 2,500-3,000 sq. ft. range.

Now that vacancy rates are starting to drop, are rents rising in this region?

Right now there is a lot of downward pressure on lease rates. You have got to be competitive if you want to make a deal. The only larger tenant deals we are seeing now in Frederick are lease renewals. In most of those cases, the tenant will tour the market, get leverage, and go back to the landlord asking for a better deal. Tenants are finding good deals now, spaces that were going for $26.50 a couple of years ago are now $20 and under.

What is putting so much pressure on lease rates in Frederick?

Frederick vacancy rates are still fairly high [nearly 16%].  A more healthy vacancy rate for Frederick is between 12-10%. Also, businesses are starting to look at flex space as an alternative to traditional office buildings, because flex is $2-3 sq. ft. cheaper in price. St. John Properties, which has about 200,000 sq. ft. of empty flex space sitting on the market in Frederick, has recently become a lot more aggressive and responsive in making deals. A number of tenants are getting quotes from St. John to use as leverage when they renegotiate leases with their current landlords.

Is shadow space still a drag on the Frederick market?

Definitely. We recently saw a large tenant in Frederick with a 3-year lease on nearly 10,000 square feet of Class A office space come to the landlord asking to downsize to the best half of that space, and asking that the $60,000 in retro-fit costs be covered by the landlord. Where lease renewals are concerned, tenants are in the driver’s seat right now. Many need to downsize because of the economy, and they are coming to landlords to ask “do you want to keep me?” Landlords need to renegotiate lease terms in this market to keep tenants; 90% of the time when they renegotiate they keep the tenant.

Costar also reported that there is currently a severe shortage of small office spaces under 10,000 sq. ft. in D.C. and Bethesda because so many smaller businesses have entered the market there. Will that trickle up to Frederick and impact the market here?

Increased activity in D.C.’s office market has been a rent driver for the Frederick in the past, and eventually we will see smaller tenants forced to come north to find office space.

And in terms of larger businesses, companies will start to look north to relocate to cheaper spaces located closer to where their employees are living—this seems to happen in cycles every five years or so. Frederick has very little Class A office space, really only five or six buildings, so it won’t take much activity to put upward pressure on Class A rents in Frederick.

However, office vacancies in Gaithersburg are at about 30%. I own a building near the Kentlands that had a law firm as the sole tenant. When the firm needed to move to expand, my partner and I eventually found five smaller tenants to replace it. Recently, some of our tenants renegotiated their monthly rents down 50%, because that is all the market will bear right now.

Until office lease rates start rising in northern Montgomery County, we won’t see much business migration from the D.C. region to Frederick. There isn’t a significant enough difference right now between prices per square foot in Frederick versus Montgomery County.

Rusty McCabe is Assistant Vice President of Leasing and Sales for McShea & Company, Inc.  McShea is a privately owned, full-service real estate services company founded in 1983 and operating throughout the Washington metropolitan area.

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Rocky Mackintosh, President, MacRo, Ltd., a Land and Commercial Real Estate firm based in Frederick, Maryland. He is an appointed member of the Frederick County Charter Board. He also writes

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