MARKET HIGHLIGHT, FEBRUARY 2007

LOS ANGELES MARKET HIGHLIGHT
Kelly Brennan, Ken McLeod and Barry Baker

Despite a sluggish residential market and lower transaction volumes, there’s still no complaining about Los Angeles’ market fundamentals. Commercial real estate players continue to be drawn to the big city lights for big-time opportunities.

Office

Los Angeles County office market fundamentals, leasing and vacancy rates continued to improve in 2006. Direct vacancy in the county dropped to 9.8 percent in fourth quarter 2006, down from 11.2 percent in fourth quarter 2005, marking the first return to single-digit, year-end vacancy since 1999. With 16.6 million square feet leased through fourth quarter 2006, the county’s leasing activity fell short of the 17.6 million leased in 2005. Total annual absorption of 3.9 million square feet through fourth quarter 2006 is also slightly less than the 4.5 million leased the previous year.

Westside landlords continue to push rates higher as strong tenant demand, especially among entertainment and law firms, continues to outpace supply. While overall rates for the market average $3.08 per square foot per month, tenants are paying more than $4 per square foot per month for Class A space. Monthly asking rates in Santa Monica have reached $6.50 per square foot, pricing many tenants out of this desirable market. Average monthly asking rents at 2000 Avenue of the Stars are close to $4.50 per square foot and expected to reach $5 per square foot by early 2007. As a result, tenants have begun migrating to neighboring markets where they can pay substantially less for comparable high-quality space. In 2007, the west side market is expected to remain tight, with escalating rates pending completion of construction projects mid-year 2007 through 2008.

Substantial migration from west side businesses, outside the entertainment and media industries, to downtown L.A. is expected as leases expire and large tenants seek economically feasible large blocks of space. Compared to $2.29 per square foot and 11.7 percent the previous year, Class A direct average rental rates in the downtown averaged $2.60 per square foot per month and Class A direct vacancy was 14.6 percent at year-end 2006.

In November, Herbalife announced a relocation of its corporate headquarters from West L.A. to L.A. Live. Herbalife signed a 10-year lease agreement with AEG to occupy 60,000 square feet in early 2008.

Downtown L.A. experienced substantial sales activity in 2006, with 1.4 million square feet in four buildings changing hands, the majority of which resulted from Brookfield’s acquisition of 601 South Figueroa, 333 South Hope St. and 725 South Figueroa. Other notable sales include Broadway Partner’s acquisition of the 48-story, 444 South Flower St. tower from Beacon Capital Partners, and Beacon’s acquisition of the 16-story 600 Wilshire building from Legacy Partners.

Tenant demand remains strong in L.A. North despite monthly average asking rates increasing to $2.27 per square foot per month from $2.11 per square foot per month last year and vacancy decreasing to 6.9 percent from 9.2 percent at the end of 2005. Despite the lack of available space in the area, approximately 450,000 square feet of office space are under construction, primarily in the Valencia/Newhall and Thousand Oaks/Newbury Park submarkets.

Considering the overall affordability when compared to the west side, Los Angeles South is proving an attractive option despite increasing rates. The L.A. South office submarket continued to tighten in 2006 with vacancy rates dropping to 17.4 percent from 18.9 percent and asking rates increasing to $1.85 per square foot per month from $1.77per square foot per month the same time in 2005. Negatively impacting the overall market was the approximately 500,000 square feet vacated by Nissan in the fourth quarter, causing a 1.6 percent jump in vacancy at the close of the year.

The acquisition of Arden Realty Inc. by Trizec Properties, Inc. (and, in turn, its acquisition by Brookfield Properties) and the purchase of Equity Office Properties by The Blackstone Group illustrate that Los Angeles remains a robust and desirable investment market.

— Kelly Brennan is director of research at Cushman & Wakefield of California in Los Angeles.

Industrial

The Los Angeles industrial market grew tighter and more expensive in 2006, further emphasizing the strength of market fundamentals that continue to draw tenants and investors.

Last year, approximately 35.2 million square feet of industrial space, predominantly warehouse and distribution product, was leased in Los Angeles County, an 11.7 percent increase compared to 2005. By year-end 2006, the overall industrial vacancy rate decreased to 2.8 percent, a 9.7 percent decrease compared to the previous year. Overall vacancy in warehouse and distribution product declined to 2.6 percent from 3 percent last year. Approximately 4 million square feet of industrial space were absorbed in 2006, most significantly in the L.A. Central market where 2.4 million square feet were absorbed.

Landlords took advantage of the tightening market and strong tenant demand in 2006 to raise asking rates. The average asking rental rate for all property types averaged $0.60 per square foot per month at year-end 2006, an 11 percent annual increase. Asking rental rates for the warehouse/distribution sector increased to $0.58 per square foot per month in 2006, an annual increase of 7.4 percent.

Roughly 4.3 million square feet of new industrial product were delivered to the L.A. County market in 2006, down from 5.9 million square feet in 2005. Commercial developers are faced with numerous barriers to building, including a scarcity of developable land, tough competition from residential developers, and the high costs of building materials. At year-end, 1.8 million square feet remained under construction.

Sales activity excelled in 2006, approaching 22 million square feet, approximately 70 percent of which was sold to investors. By comparison, investors and users combined acquired a total of 20.6 million square feet in 2005.

The vast portfolio of properties purchased by Prudential Real Estate in 2006 underscores the demand for investment space in the Los Angeles South area. Citing strong fundamentals, Prudential purchased more than 50 industrial buildings in the submarket, thus becoming one of the largest landlords in the South Bay submarket based on both square footage and number of buildings.

Future demand for growth may result from the passage of Proposition 1B, which will finance $19.9 billion for transportation improvement projects designed to relieve congestion, improve movement of goods and enhance the safety and security of the transportation system. This will provide time and cost savings for logistics providers and other transport-related companies concentrated in Los Angeles.

Los Angeles County will continue to be a highly desirable location for international trade and regional operations. Given the market’s diverse industry mix with a concentration in logistics, high technology, telecommunications, manufacturing and warehouse/distribution, the continuing economic momentum, coupled with business growth and capital spending, is expected to further enhance demand. As construction costs further escalate and competition from developers continues, tenants will likely see rental rate appreciation along with investors facing higher prices on quality products throughout the market.

— Kelly Brennan is director of research for Cushman & Wakefield of California in Los Angeles.

Retail

As 2007 gains footing, the Los Angeles retail market remains tight in terms of the rental market and strong in terms of investment sales.

In the past 12 to 18 months, the retail market has seen a slight softening of consumer prices (i.e., gasoline prices). The softening of prices and strong consumer confidence have increased consumer spending producing strong sales and an invigorated local economy; retailers remain profitable and the stock market remains robust. Due to these conditions, retailers are able and want to expand. Potential tenants are willing to pay increased rental rates in a tight rental market where there is very little vacancy.

With vacancy so low, it is not surprising that developers are still constructing neighborhood and community shopping centers at a healthy rate. More than 300,000 square feet were built in 2006, with most of it being absorbed immediately. One of the largest projects completed last year was the expansion of the Del Amo Fashion Center, a regional mall in Torrance, California. The new outdoor promenade, which opened in September, features an 18-screen AMC theater as well as many tenants new to the South Bay, including Anthropologie, Cohiba Cigar Lounge, Lazy Dog Café, Lucky Strike Lanes, RA Sushi and Urban Outfitters. Another notable retail development that broke ground in 2006 was Downtown’s LA Live. Fueled by the recent influx of housing developments downtown, LA Live features a plethora of retail from high-end restaurants to specialty stores.

As the Federal Reserve has maintained steady and low interest rates, the demand for retail investment properties in the Los Angeles area remains high. Many qualified buyers are looking to place their money — a lot of money. Unfortunately, there are too many dollars chasing after what is a small volume of good investment properties. Bolstering this high demand are buyers with time constraints — this includes those in a 1031 exchange and certain institutional buyers. As for neighborhood and community shopping centers and strip centers, the dollar volume of recent transaction has decreased by approximately $1.25 billion, and the number of transactions has decreased by about 10 percent from 2005 to 2006. Despite this apparent slowing of the retail investment market, cap rates remain relatively steady. The bottom line is that there are a lot of buyers but not enough properties on the market to accommodate them.

— Ken McLeod is vice president of Grubb & Ellis Company’s West Los Angeles office.

Multifamily

The Los Angeles apartment market is like the mythical hydra that continues to regenerate itself no matter what happens. Even with rising interest rates, tighter lending standards and a general market slowdown during 2006, the market remains solid.

The main difference in the apartment market today, compared with the very heated market of the past several years, is that investors have become more restrained and conservative. Every building that comes to market is not immediately snapped up or bid above the asking price in a buyers frenzy. Buyers are showing more discretion in their decision to invest.

The Los Angeles apartment market has several characteristics that distinguish it from many other markets in the country:

· The greater Los Angeles population continues to grow from both natural increase and in-migration (some legal and some illegal)

· The economy has been vibrant and job growth continues to be strong

· The City of Los Angeles has a rent stabilization ordinance that limits annual rent increases and protects tenants from eviction without cause

· The vacancy rate in Los Angeles is miniscule and the obstacles to construction of new apartments are great

Housing prices have been so high in the greater Los Angeles area that a large percentage of the population is destined to be permanent renters. Although there’s been a pause in rent increases over the past 6 months in some submarkets, rental rates are continuing to grow for the most part.

As 2007 begins, the level of interest in apartment properties remains high. There is still greater investor demand than supply on the market. If property in a desirable location is offered at a price in excess of a 5.5 percent capitalization rate, with a demonstrable opportunity to increase rents over time, the property will be quickly sold. If the property is in a less desirable location, the market will demand a lower price. In such cases, over-priced properties remain on the market for weeks and weeks while their prices are incrementally reduced.

The activity in multifamily development during the past several years has been dominated by the construction of condominiums and the conversion of buildings to condominiums. This ground nearly to a halt in recent months and has not shown signs of recovery so far. There are many infill development projects that got caught in the downturn, remaining on the market at prices dramatically too high for anyone to risk at this time. If there are any foreclosure opportunities in this marketplace this year, they will likely involve unsold condominiums, probably in an unsuccessful conversion from apartments or a downtown loft project.

With that exception, the apartment market in the greater Los Angeles area remains strong and resilient. It might take some major economic upheaval to alter that course and finally cut off the heads of the hydra.

— Barry Baker is vice president of Grubb & Ellis Company’s West Los Angeles office.


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