While the pool of tenants shopping around for office space has grown in recent years, their signed leases remain at a fraction of pre-pandemic levels, forcing landlords to stitch together smaller deals to make up for the loss of larger commitments.
Landlords such as CP Group and DRA Advisors are investing heavily in capital improvements to best position properties to attract any and all tenants interested in taking on new space. The firms, the joint owners of the CapRock office campus in greater Washington, D.C., recently landed four new leases for their three-building Bethesda, Maryland, complex.
The deals total about 35,000 square feet, adding to the momentum the joint venture has generated since it acquired the former Democracy Center buildings at 6901, 6903 and 6905 Rockledge Drive in 2022.
Across the country, property owners are contending with this new leasing reality in which many are scrambling to balance tepid, but positive, demand among companies with deal sizes that have shrunk by an average of up to 20%, according to CoStar data.
That juggling act is expected to further complicate the national office market's recovery efforts as it stumbles to backfill hundreds of millions of square feet tenants have collectively ditched over the past decade, driving vacancy rates up to record highs.
Wide-ranging sizes
The latest string of CapRock deals range between a full, more than 18,000-square-foot floor down to a less than 2,400-square-foot speculative suite. The new and incoming tenants include insurance brokerage NFP, the Montgomery County Employee Retirement Plans, endocrinology practice Ryse Health and nonprofit organization Hydrocephalus Association.
CP Group and DRA Advisors paid $69.5 million in September 2022 for the portfolio deal, according to CoStar data, far less than the $280.5 million that seller PGIM paid when it acquired the campus in 2007.
The three buildings were collectively about 60% leased at the time of the deal with PGIM, creating a runway for the new owners to kick off a $12 million overhaul in an effort to boost the property's occupancy.
With new indoor and outdoor amenities, upgraded lobbies and common areas, as well as the addition of new speculative suites, much of the joint venture’s repositioning efforts have been focused on luring the growing cohort of tenants on the hunt for upgraded, but smaller, spaces.
"We have experienced strong leasing momentum in recent months, fueled by the demand for amenity-rich suburban offices with custom-designed workspaces,” CP Group Senior Vice President Josh Edwards said in a statement. He added that CapRock’s transformation into an “amenity-rich environment” has made it possible to attract a broad range of tenants that — while they may start small — have access to any additional space that can support future growth.
The recent activity across the roughly 719,300-square-foot campus is in addition to the nearly 100,000 square feet of leases CP Group and DRA Advisors signed late last year.
Shrunken expectations
That focus on attracting more, but smaller, deals has spread among landlords competing to fill space.
Los Angeles-based real estate investment trust Kilroy Realty acknowledged in its last earnings call that it lost out on several deals because it didn’t have the smaller, more flexible spaces that an increasing number of tenants are looking to fill.
Douglas Emmett, another West Coast-focused landlord, has all but abandoned hopes of backfilling large move-outs by landing large, single-tenant deals. Instead, the REIT has broken up big vacancies with plans to reposition some as multitenant properties.
What’s more, executives have said the strategy is best for its bottom line.
"Larger tenants may mean fewer leasing transactions, but because of the concentration of risk and higher [tenant-improvement expenses], we prefer the stability of smaller, high-end tenants,” Douglas Emmett Chief Investment Officer Kevin Crummy recently told analysts.
The median lease size across its portfolio is just 2,400 square feet, according to information filed with the Securities and Exchange Commission, and fewer than 30 of its tenants occupy more than 40,000 square feet.
For the record
Bernie McCarthy, Amanda Davis, Danny Sheridan and Patrick Hall of JLL represented the landlord in all transactions.