For the past several years, Los Angeles has been one of the most stable office markets in California and the country as a whole. Now, as the national economy slows, Los Angeles is starting to experience the flat rents and slowdown in leasing occurring elsewhere.
In contrast to Orange County, which is at the heart of the subprime fallout, and San Diego, which is seeing noticeable softening, the shift in Los Angeles is more subtle.
In general, tenants still face a tight market with few landlords compelled to lower rents or increase concessions. Even so, rents ticked down slightly in the fourth quarter, falling by 1 cent. Prior to this quarter, rents had increased during every quarter since year-end 2005.
For most of 2007, the amount of space leased ran about 20% below its historical average of 15.8 million square feet a year. The slowdown is occurring at the top tier of the market, as tenants have been pushed to class B and C properties by spiking class A rental rates.
Availability is creeping up as demand slows and a handful of new buildings open. Just less than 3.3 million square feet of new construction was delivered in 2007, with more than 7 million square feet under construction or planned. The overall availability rate inched up to 12.6%, a year-over-year increase of 0.5 percentage points, while the class A rate (13.1%) rose by 0.6 percentage points from a year ago.
The key question on everyone’s mind is the depth and length of the downturn. Some analysts anticipate that the spreading financial turbulence will spur a recession and an increase in availability as tenants give back space.
So far, the market has not been flooded with sublet space,the amount of vacant space increased from 2.4 million square feet a year ago to more than 3.3 million square feet at the end of 2007.
The economy is slowing but it will take some time for the impact of the housing market/subprime mortgage crisis to play out. Not much will change for tenants looking for space in the next few quarters,the market remains relatively tight, particularly for those needing big blocks of space. Unless a protracted recession ensues, tenants should not anticipate a dramatic shift in the office market for the next few quarters. A more gradual softening is likely.
Landlords still do not feel pressure to increase concessions or lower rents. Owners who bought at the height of the cycle in 2007 will be particularly inflexible when it comes to lowering
asking rents. These owners are more likely
to increase concessions before they budge
on rents.
Non-institutional landlords who have owned assets over multiple cycles are likely to have some pricing flexibility and will be able to snare prime tenants by lowering rents. Tenants should also look for quality built space and consider options in peripheral locations and emerging markets.
Rents Flat
Overall rent was essentially unchanged, slipping from $2.70 in the third quarter to $2.69 in the fourth quarter. Between the first quarter 2006 and the fourth quarter, overall rent increased by an average of 3.4% every quarter. Class A monthly rent ticked down from $2.87 to $2.86, while class B and C rent jumped from $2.11 to $2.20. Overall and class A rents were still up by 14.7% and 14.8%, respectively, year-over-year. Class A rents slipped in multiple submarkets including Santa Monica (down 0.2% to $5.07) and Miracle Mile (down 2.9% to $3.03).
But class A rents continued to appreciate in most submarkets. In the South Bay, the rate grew by 5% for the quarter and 13.4% year-over-year. The Westside’s class A sector registered the highest year-over-year increase, up by 24.2% at $4.15.
Leasing Well
Quarterly leasing totaled 3.1 million square feet, just 1.3% under third quarter’s level but 9.7% above the total in fourth quarter 2006. Lofty class A rents are pushing some tenants to class B and C properties; class B and C deal volume was up by 34% from a year ago.
Trailing four-quarter trailing leasing (the sum of all leasing in the past four quarters) reached 12.5 million square feet, down by 18.3% from a year ago, and class A trailing leasing equaled 9.9 million square feet (down 17.2%).
Overall and class A trailing leasing have both been running around 20% below their five-year averages of 15.4 million square feet and 12.3 million square feet since first quarter of 2007. The South Bay, with 2.7 million square feet in overall trailing leasing and 2.1 million square feet in class A volume, was the only area to surpass its historical average.
Availability Ticks Up
The overall availability rate inched up in the fourth quarter, rising by 0.1 percentage points from 12.5% to 12.6%. The class A rate declined from 13.2% to 13.1%, while the class B and C rate increased from 10.8% to 11.3%. New space availability and decreased leasing pushed up availability during 2007. On a yearly comparison, the class A availability rate increased by 0.6 percentage points.
The growth in class A availability has been particularly strong in areas such as the West San Fernando Valley, where the rate rose year-over-year by 10.2 percentage points to 22.6%, and Fox Hills/Marina, where it grew by 9.9 percentage points to 15%. In contrast, the class A rate in the South Bay area declined by 1.2 percentage points compared to a year ago.
Submarket Focus
As rents continue to spike in Westside, new space scattered throughout the region is starting to draw interest from tenants. The Hollywood submarket is setting trends for unique mixed-use properties. In early December, Manhattan-based Clarett Corp. and James Nederlander unveiled plans for a 10-story office tower to be constructed atop the Pantages Theater. The 200,000-square-feet mixed-use building on Hollywood Boulevard will be the first new class A building in Hollywood in several years.
Clarett is also the developer for Blvd6200, a 1 million-square-foot mixed-use development surrounding the Pantages Theater. In Playa Vista, two new buildings, each 229,496 square feet, are under way at Horizon Playa Vista. The buildings are scheduled for delivery at the end of this year.
Finally, the redevelopment of downtown (particularly the proliferation of mixed-use properties) is proving its appeal to law firms and architects fleeing the expensive Westside submarket.
Analysis by Studley Inc.
