Northern Virginia Development
Soars as Metro Area Sprawls

A gusher of spending by the Pentagon and other federal agencies is driving a strong and expanding commercial real-estate market in Washington's Northern Virginia backyard. The region's booming economy, rising rents and falling vacancies have given office developers the confidence to ratchet up construction, even as military cutbacks loom on the distant horizon.

Duke paid about $855 million for a portfolio of Northern Virginia properties, including this 239,945-square-foot building offering shuttle service to the Pentagon.

Just across the Potomac River from the nation's capital, the greater Northern Virginia region, which includes nine counties and additional cities, is part of the larger Washington metropolitan area and is home to some 2.4 million residents. Anchored on the east by the Pentagon in Arlington, Va., the area is dotted with both historic sites and employment hubs such as closer-in Alexandria, popular with government agencies and contractors, as well as Reston and Tysons Corner, which have a strong tech presence. Job levels rose 3.2% in May from a year earlier, more than twice the national pace, according to the Bureau of Labor Statistics.

For now, developers are betting the good times will continue to increase rents and drive demand for places to live, work and shop. An estimated 5.2 million square feet of new and largely speculative office construction is on tap to be delivered through 2008, equal to about 4.4% of the inventory in the close-in counties of Arlington, Fairfax and Loudoun and the city of Alexandria, according to Cushman & Wakefield, the real-estate services firm. The area's retail inventory also has grown about 15% from 2001 to 35 million square feet, led by a strong push into the region from high-end grocery stores such as Harris Teeter Inc., says David Dochter, a retail broker with Cushman & Wakefield.

The region's economic strength can be traced to the 1980s, when President Reagan began to outsource many government functions previously performed by federal employees in government buildings to contractors located in the suburbs, says John McClain, an economist at George Mason University's Center for Regional Analysis.

That trend gathered steam in the past five years, though Mr. McClain expects federal spending in the region to moderate from the average 7% increases of recent years. Some areas are bracing for the impact of last year's decision by the Base Realignment and Closure Commission to relocate about 20,000 military and civilian employees out of about 6.8 million square feet of leased space, much of it in Arlington, Alexandria and Falls Church, onto military bases, to cut costs by 2011, according to the Department of Defense.

Many developers say they aren't concerned about the base-realignment decision, in part because it will happen over such a long time frame. Jim Evans, regional managing director for developer Tishman Speyer's Washington region, characterizes his firm's decision to begin construction on two Northern Virginia projects totaling about 434,000 square feet with no tenants on hand as a "managed risk," worth taking given the strong recovery of rental rates. If the economy does slow, he says he expects developers will scale back their plans. "None of us want to be caught overbuilding."

Rising prices have prompted some buyers to wonder how much higher office-building price tags can go. The average price per square foot in Northern Virginia paid through June 29 of this year rose to $304, up from $265 last year, though below the $406 fetched to date in the capital, according to Real Capital Analytics, a New York-based real estate research firm.

Indianapolis-based Duke Realty Corp. shelled out about $855 million for a portfolio of more than 2.9 million square feet of office and light industrial properties and developable land in Northern Virginia, a price that Duke Chief Executive Denny Oklak acknowledges as steep but worthwhile given the market's prospects for continued job and population growth. "We're 100% sure we bought at the top of the market," Mr. Oklak says. "But if you have good assets, over time you'll still do fine."

Email your comments to rjeditor@dowjones.com.