One of the trademarks of a recession is that growth declines across multiple sectors, typically in key components of the economy. By this standard, the country is facing its first recession since 2001.
Los Angeles is the nation’s second largest metropolitan area in terms of population and workforce and benefits from a diverse and balanced economy. However, it cannot fully escape the impact of a serious national downturn.
A controlled development pipeline, particularly when compared to those in nearby markets such as Orange County and San Diego, was crucial to the stability in the office market, and the current supply pipeline remains under control. In the past two years, inventory has only increased by 2.6%. Another 4.1 million square feet is currently under way and 32% of this is preleased.
The number of layoffs, the amount of space shed by companies and the contraction in demand are so extensive, though, that availability of space is increasing even with the controlled amount of new supply.
In terms of financial sector employment, Los Angeles ranks second in size only to New York. At the end of the second quarter, the financial sector in Los Angeles had lost about 34,000 jobs, an 8.6% decline. The larger issue in Los Angeles is that the layoffs are starting to slow the growth in related professional and business services firms.
Countercyclical sectors, particularly health and education companies that continue to expand in spite of the economic slowdown, are now even more critical to the leasing market.
Tenants have become less bullish in their expectations and are taking longer to make decisions. Leasing remained tepid in the third quarter, totaling 2.9 million square feet, a 17.9% drop from the second quarter.
Landlord’s Response
Landlords have also accepted that the recession will not be over soon and are starting to adjust their expectations. Owners who acquired properties at the top of the market and raised rents to match the prices they paid have been feeling pressure for several months. As sublet space mounts, the market will not support these inflated rents.
Most landlords will continue to stick with increasing concession packages before they lower face rents. Some asking rents are already starting to slip, though, primarily because of sublet spaces that are discounted by 15% to 30% compared to direct rents.
Los Angeles ranks 10th out of 42 markets in terms of the increase of sublet space over the past year. Six of the top 10 markets are in California or Florida, including OC, which ranks just above Los Angeles with a 30.5% jump. The amount of vacant sublet space,3.7 million square feet,remains well below the peak amount of vacant sublet space of 6.9 million square feet in the third quarter of 2001.
Tenants are starting to move on some of the sublet space, which accounted for just less than 15% of leasing activity in the third quarter. Rents are just starting to come down as the amount of sublet space increases,
since the average asking rent for sublet space is discounted by 11.7% compared to direct space.
Available Space
As local companies continued to shed space, the overall availability rate of 14.9% rose for the sixth consecutive quarter. The rate was at its highest since the third quarter of 2005. Availability continued its ascent in many of the region’s most expensive submarkets.
Quality office space in Beverly Hills/West Hollywood crossed the 10% mark for the first time in three years. The spike in Westwood/West Los Angeles was even more substantial, with the class A rate increasing to 11.7%,also the highest level since the third quarter of 2005.
In contrast, the availability rate fell in less expensive areas, including around the airport and West San Fernando Valley.
Overall asking rent increased by 1.2% in the third quarter, rising to $2.68 per square foot per month, but was down by 0.6% from a year earlier. This is the first time asking rents have declined on a year-over-year basis since the fourth quarter of 2004. Class A rent jumped by 1.6% to $2.89.
Overall leasing activity fell by 17.9% from the second quarter to 2.9 million square feet. As tenants continue to tighten their belts, leasing activity in the most expensive submarkets is well under its historical average.
As landlords grow increasingly concerned with securing their tenant rosters and cash flow, tenants may be able to negotiate favorable lease terms even through simple lease restructures. The increase in sublet supply as well as some new buildings under way will also force landlords to compete if they want to retain the tenants they currently have and entice others to relocate. Tenants who are facing lease expirations in the short term can already find discounted opportunities.
Analysis by Studley Inc.
