In the previous two posts, I argued that we have a serious shortfall in the supply of new housing at every price level and that this drives up housing costs. Now I’ll take a look at retail and office space to try to offer some perspective on what’s going on in the market for commercial real estate and what it says about consumer preferences, our economic well-being, and what we can do to adapt to attract and retain employers and their employees in the future.

Our Retail and Office Markets

Even as many other parts of the country – and the DC region – are dealing with a glut of retail space, Montgomery County’s retail supply is, overall, strong and balanced. The main problem is that like everywhere else, too much of our brick-and-mortar retail space is occupied by merchants who sell the kinds of goods that have in the past been associated with department stores, such as apparel, sporting goods, and furniture. Neighborhood goods and services, or what some call “convenience” retail, such as hardware stores, dry cleaners, etc., are in relatively short supply. The shakeout among merchants who sell goods that used to be offered almost entirely at brick-and-mortar stores but are now readily available online, will create continued disruption in local commercial real estate, but the opportunity for neighborhood-serving retail may fill in the gap.

Unfortunately, our office vacancy rate approaches 15 percent. But to put this in context, here’s a chart that shows office vacancies in every DC-area jurisdiction:

As you can see, we have one of the lowest vacancy rates in the region. Only the District of Columbia has a lower vacancy rate. Some have pointed out that our office vacancy rate would look much worse if our most successful submarket, Bethesda-Chevy Chase, were excluded. That’s true, but if Tysons were excluded from the Fairfax numbers, its vacancy rate would look terrible. Don’t misunderstand me – an office vacancy rate of almost 15 percent is not good. But what does this data really tell us?

For one thing, elevated office vacancy rates reflect a national trend as employers rethink their needs for office space. Both government and private sector employers are steadily reducing square footage allocated for each employee. Many employers are adopting open floor plan offices, encouraging employees to work from home or in the field, or trading larger, less expensive buildings in suburban office parks for smaller spaces with higher rents in urban areas with more amenities.

Take a look at this breakdown of office vacancy within Montgomery County:

These charts illustrate a trend that has happened elsewhere in the region and across the country. Like many other places, we’re experiencing much more success attracting employers to urban areas like Bethesda, Rockville and downtown Silver Spring. This mirrors a similar trend in housing preferences.

The best example of this trend is the relocation of Marriott International’s headquarters from Rock Spring to downtown Bethesda, where employees will have access to restaurants and retail options as well as easy access to transit. In searching for its second headquarters, Amazon clearly prioritized access to these amenities.

The fact that Montgomery County retained Marriott and is among the Amazon HQ2 finalists shows that our emphasis on creating high quality urban places near transit is working. The result is that even as vacancy rates remain stubbornly high in places like Rock Spring, demand for office space in downtown Bethesda is strong enough to support investment in new buildings.

Landlords face major challenges in finding new tenants for suburban office parks. The may fill the space at lower rents, but in some cases, they will need to reposition their properties or even redevelop sites with a mix of residential and retail together with office space. The county is trying to assist by providing more flexibility in a new master plan for Rock Spring, for example, and in the zoning code.

Next: Real Estate Development *Is* Infrastructure