Forecast: fluffy clouds

By late last year, Virginia Gov. Terry McAuliffe categorized Virginia’s economic outlook for 2015 as “very perilous.” Federal budget cuts and sequestration continue to cast an aura of uncertainty. Plus, the state closed out the third quarter of 2014 with fewer new jobs than the national average, a slowdown based in part on the slump in federal spending.

Yet despite the economic woes, the new year is shaping up as a good one for commercial real estate. Some sectors, such as retail and health care, are seeing lots of new development as the economy slowly shifts from the effects of the recession into a more normal trajectory.

“This is a state that has weathered the Great Recession quite well,” says Anirban Basu, chief economist for Associated Builders and Contractors Inc., a Washington, D.C.-based trade association.

Yet some areas of the state haven’t fared as well as others. Northern Virginia and Hampton Roads have been feeling pain from federal budget cuts since 2011 and especially since sequestration took effect in early 2013, says Basu. As a result, “Northern Virginia is now staring at more vacant office space than has been witnessed in a quarter century.”

The vacancy looms despite the fact that Northern Virginia has seen some growth in the technology sector among businesses that aren’t federal contractors, as well as lots of commercial development along the Dulles corridor driven by the construction of Metrorail’s new Silver Line.

Meanwhile, Roanoke’s economy is growing at its fastest rate since the recession, according to data from the U.S. Bureau of Economic Analysis.
And Richmond, which also is racking up numbers not seen since before the 2008 crash, has been rebounding strongest of all Virginia localities. Basu attributes the good showing to the region’s “shockingly diverse” economy and a major retail construction boom, being led by “a significant rebound in consumer confidence.”

During the past 18 months some secondary markets such as Richmond have picked up in terms of market fundamentals and investor interest, says Steve Sadler, CEO of Richmond-based Allegiancy, a commercial real estate management firm overseeing more than $300 million in assets stretching from Pennsylvania to Texas. “Of all the areas where we’re active, Richmond is one of the more interesting and upbeat,” he says.  Because the region isn’t dependent on any one industry,“that stability is attractive to investment capital,” he adds.

“We’re finally feeling very healthy,” says Brett McNamee, a senior vice president with Divaris Real Estate Inc. in Richmond.

Grocery store wars
McNamee says retail is leading Richmond’s commercial market, with vacancy rates down to 6.3 percent, the lowest since 2008. Much of the new retail development is being driven by what brokers are calling the “Grocery War.”

A slew of grocery-anchored projects are in the pipeline. Leading the way is the New York-based, family-owned supermarket chain Wegmans, which McNamee jokingly calls “the 500-pound gorilla.” Wegmans is entering the Richmond market with two 100,000-plus-square-foot stores in the Short

Pump area and Midlothian, which will begin construction this year and open by summer 2016.

Wegmans also will open its first Charlottesville location next year. All three stores will anchor shopping complexes.

Meanwhile Martin’s Food Markets already opened its own super-sized, 74,000-square-foot location in Midlothian in November and is said to be scouting other locations for expansion. Kroger also is adding new locations in the state, including a new Kroger Marketplace that opened in December in Suffolk.

North Carolina-based gourmet food store Southern Season opened in Henrico this past summer, and Whole Foods Market announced plans to build a second store in the Richmond area, anchoring Sauer Center, a planned mixed-use development on Broad Street near Richmond’s Fan District.

At the West Broad Marketplace complex in Henrico County’s affluent Short Pump area, Wegmans and Cabela’s, a retailer of upscale outdoor recreation gear, will be the anchor tenants.

Mixed-use, live-work-play developments that combine retail, residential and office are also a hot trend, as evidenced by several recent projects in Henrico County (Staples Mill Centre and West Broad Village) and Roanoke, where Richmond-based WVS Companies is developing The Bridges. The $150 million riverfront project will combine offices, apartments and retail with a kayak launch and promenade along the Roanoke River. The project is expected to be completed in the early 2020s.

Health care drives development
Health care is one of the drivers in mixed-use development around the state.Early this year Henrico-based developer Stanley Shield Partnership plans to open the first medical office buildings in its $50 million, 160,000-square-foot Short Pump Medical Center complex in Henrico County. Bon Secours is working with Henrico-based Atack Properties to build Bon Secours Short Pump, a $50 million, 115,000-square-foot “medical village,” and Henrico developer The Lingerfelt Cos. just completed the 6,000-square-foot Medarva Stony Point Surgery Center at the Notch at West Creek, a mixed-use development near the Henrico-Goochland line.

In Hampton Roads, Virginia Beach is looking to develop 1,100 acres of unused city land in Virginia Beach’s Princess Anne Commons into a medical park containing health-care providers and medical researchers.

“We continue to see an increase in patient demand for medical space and aging demographics support that. We see a demand from doctors … to participate in ownership of the real estate and we see a demand from investors wanting to invest in medical development particularly because the average medical tenant is a relatively loyal tenant,” says Brian Witthoefft, a principal with Lingerfelt.

The growing numbers of aging baby boomers also are driving construction of assisted-living communities and nursing homes. For example Friendship Retirement Community in Roanoke County is building a $13 million, 73,000-square-foot patient rehabilitation center that will open this fall. The retirement community has been expanding quickly, adding a new, independent living apartment building last summer.

In Virginia Beach, Roanoke-based Medical Facilities of America is building the $17 million, 69,883-square-foot, 120-bed Princess Anne Health and Rehabilitation Center, which will open this spring.

In the industrial sector, Virginia continues to draw distribution centers. The Richmond region is a hotspot for development because of its central shipping location on the Eastern seaboard.  During the past few years, centers have been built or announced by a number of major players, including Amazon, Medline, Philip Morris USA, Lumber Liquidators and The Vitamin Shoppe.

Data centers represent another sector expected to see continued rapid growth in 2015. The Ashburn area of Loudoun County is home to 56 data centers, totaling about 5.9 million square feet. Up to 70 percent of all Internet traffic flows through Loudoun’s “Data Center Alley,” which could become the world’s largest data center hub this year, possibly as soon as March, according to county economic development officials. Major players such as Digital Realty, RagingWire and DuPont Fabros all have expanded operations there in recent months.

Data centers, though, are the exception in Northern Virginia’s office market, which “is very slow right now,” says Scott Homa, a director of research with JLL. Northern Virginia’s economy is largely driven by federal spending and contract work. “We’ve had gridlocked government for a long period of time. We’ve had sequestration and cuts in defense spending.” The outlook for federal spending going into 2015 still is very uncertain, adds Homa. “The tenant base has been totally handcuffed due to the current political state.”

Demand for office space in Northern Virginia remains subdued, and rents are mostly stagnant. In the third quarter of 2014, vacancies increased to 19.7 percent, the highest point since 2003. Contractors such as McLean-based Booz Allen Hamilton and Falls Church-based Northrop Grumman have been reducing their workforces and their real estate portfolios in recent years. Even federal agencies are downsizing; the Fish and Wildlife Service moved from a 250,000 square-foot space in Arlington to an 182,721-square-foot space in Falls Church.

“There’s real stress in Northern Virginia,” agrees Sadler, adding that companies are now seeking one- and two-year leasing agreements, not decade-long deals as in the past. “That’s very difficult for the property owners,” he says. “You don’t have pricing power.”

The office story is brighter in Richmond where the overall vacancy rate stood at 10.1 percent at the end of the third quarter. There’s just over a million square feet of vacant space now, about two-thirds less than in 2011, says Mark Douglas, senior vice president with Cushman & Wakefield | Thalhimer. Tenants in need of a large footprint will find slim pickings since several recent transactions have gobbled up large, Class A spaces. 

One of the deals involved Henrico-based McKesson Medical-Surgical Inc. In November it announced plans for  a $10 million relocation and expansion in a 168,500-square-foot space that was formerly part of the corporate headquarters for the now-defunct electronics retailer Circuit City. 

Looking ahead, Basu notes that a rising tide lifts all boats. “The U.S. economy appears to be gaining momentum,” he says. “It certainly helps that gasoline prices have fallen, which further bolsters consumer and industry confidence. It’s also likely that federal government rightsizing won’t have quite as much as impact on the state in 2015 as it did in 2013 and 2014. 2015 should be a better economy in Virginia and that should spell better times for commercial real estate.”