The threat of automatic spending cuts by the federal government caused companies to press the pause button on real estate expansion in the Baltimore region during the third quarter, according to analysts.
"It reflects the nature of the economic drivers in the region," said Robert Manekin, managing director of Colliers International's Baltimore office.
Federal agencies and contractors make up a large percentage of office tenants throughout Central Maryland, and uncertainty about the national budget has caused them to be more cautious about leasing new space, he said.
Quarterly reports by three major commercial real estate brokerages released last week concluded that the potential for "sequestration" — the automatic cutting of the federal budget scheduled for Jan. 2, unless Congress and President Barack Obama reach a spending agreement — was the major factor determining Baltimore-area companies' real estate decisions in July, August and September. Economists and pundits have taken to calling the start of the new year the fiscal cliff, not only because of sequestration but because income tax cuts ushered in by President George W. Bush are scheduled to end.
In addition to Colliers, Cushman & Wakefield and CBRE Group Inc. published analyses about the performance of Baltimore's commercial leasing market over the past three months.
"There is still a dramatic improvement from where the metro region was three years ago," Manekin said. "The bad, but not horrible, news is that it is hard to get a handle on where we are going."
Since the middle of 2010, office vacancies in and around Baltimore have declined steadily, according to Colliers, from just over 15 percent to under 13 percent. At the beginning of 2008, just after the recession began, the metro office vacancy rate was about 12 percent, the firm's analysis shows.
In downtown Baltimore, which includes the central business district and adjacent areas such as Harbor East, the decline has been even more dramatic. In mid-2010, Baltimore had an office vacancy rate of about 19 percent. Now it is below 15 percent. However, that's still well above the pre-recession level, which was below 12 percent.
"Though these are signs that the regional market in general is rebounding from the recession, full recovery in this market is not expected to gain much momentum in the last quarter due to lack of government economic leadership and indecision, causing many office users to delay their real-estate decisions until after the election," according to Colliers' metro Baltimore market report for the third quarter.
Chip Olsen, senior managing director of CBRE Group's Baltimore office, said in a recent statement that the fear of sequestration was prompting many government contractors to seek short-term leases with termination rights.
Despite such cautious behavior, bright spots still exist in Baltimore's office market, experts say.
"Baltimore's a little more removed than suburban Maryland" from the Washington-centered federal workforce, said Paula Munger, a regional research director for Cushman & Wakefield. For that reason, she said, Baltimore's downtown, home to many law firms and financial companies, may not be as affected by federal indecision as other areas.
For instance, she said, tenants and landlords in Northern Virginia — a hotbed of defense contractors — are bracing for federal spending cuts. Defense expenditures would be reduced by about $500 billion over 10 years if the sequestration goes into effect.
Even Howard County, which has many national security and cybersecurity contractors, is not as threatened by federal cuts as Northern Virginia, Munger said.
By Colliers' account, Howard County's office vacancy rate declined from the second to the third quarter, from 13 percent to 12.2 percent. Meanwhile, the average rental rate in the county rose, to $23.62 per square foot, which is roughly similar to the rate for the entire region.
"We're surprised that we're still seeing this demand" in Howard, Munger said. "I think we should still see some decent demand into the end of the year … depending on what happens with the economy."
Continued Munger: "If the government is hiring contractors, then things are looking OK — and apparently they are" in Howard.
Kevin Wille, a senior vice president with CBRE Group in Baltimore, agreed with Munger's assessment. The Baltimore region's two major military zones — Fort Meade in Anne Arundel County and Aberdeen Proving Ground in Harford County — continue to draw new tenants, he said.
"I don't think you'll see the fiscal cliff relative to those two markets; they'll continue to grow," Wille said. That growth has really helped to offset some of the corporate declines throughout the region, he said.
Although downtown Baltimore, like other parts of the metropolitan area, experienced increased vacancies during the recession, Wille said the city center still was holding onto important tenants. In the past year, insurance and financial services firm Transamerica, law firms Ober¿Kaler and Miles & Stockbridge, and PNC Bank all have moved, or signed on to move, to space along Pratt Street, he pointed out.
Even if it's not easy to find companies that have expanded in downtown, it's a good sign that major players are sticking around, Wille said.
Harbor East, the mixed-use complex that has sprouted up at the end of President Street over the last decade and lured Legg Mason from the central business district, also is continuing to thrive. According to Cushman & Wakefield's calculation, Harbor East's vacancy rate is now about 10 percent — compared to a vacancy rate of more than 18 percent in the more established business district centered on Pratt Street.
"Harbor East was very hot during the first and second quarter," Wille said. "It did cool off a little bit in the third quarter, but I think long term they're going to continue to see activity."
One region of Baltimore that will hurt for some time is the business district above Lombard Street, away from the Inner Harbor, Manekin said. Vacancy in that zone is as high as 35 percent, analysts say.
Sequestration or not, there's only one way to reduce the amount of empty space in older buildings that are farther from the Inner Harbor, Manekin said.
"The growth of the economy, the demand for more space, is the only way those issues are going to be addressed," he said.
Office vacancy in metro Baltimore, Q3 2012
Inventory (square feet)Vacancy rateAverage rental rate (per square foot)
Source: Cushman & Wakefield of Maryland Inc.