MARKET HIGHLIGHT, FEBRUARY 2008

LOS ANGELES
Laurie Lustig-Bower, Kadie Presley, Mitz Maton Klaus, Sam Alison, Michael Preiss and David Prior 

Los Angeles has experienced some moderation as national economic challenges have arisen, but the market’s stellar real estate fundamentals keep it one to watch in the West.

Multifamily

According to the Winter 2008 Torto-Wheaton Multi-Housing Outlook, the vacancy rate for 2007 in Los Angeles was 3.4 percent and is expected to rise to 4.4 percent in 2008. It is forecast that rental rates will rise marginally in 2008 at a rate of 1.1 percent, down from 2007’s pace of 3.9 percent. The good news is that within the Los Angeles market there seems to be a strong and upward trend in growth for personal income, population and job growth, which will help drive rental rates for future years.

During 2007, cap rates in Los Angeles’ multi-housing sector climbed slightly with the 12-month average hitting 5.4 percent in third quarter 2007, up from 5.1 percent a year earlier, according to Real Capital Analytics. The change in cap rates will not profoundly affect core properties in the best L.A. submarkets as these areas still have great appeal to pension funds, but it’s the markets with greater appeal to private investors where cap rates may move more dramatically. Apartment REITs are reporting that they are seeing cap rates increase as much as 25 basis points for West Coast apartment deals.

In 2008, it is thought cap rates will increase; rather than trading between 4 and 4.5 percent, deals will trade between 4 and 5 percent for prime locations and between 5 and 6 percent for next-tier sites and for older product.

Condominium development has slowed significantly. In the past 18 months, the pendulum has swung from condo development to development of apartment communities. However, super prime locations are still attracting the high-end condo developers as the high-end market seems to be undervalued in comparison with other cities. Many would-be condo projects designed in 2007 will be entering the market in 2008 as apartments. The Torto-Wheaton Multi-Housing Outlook estimates that in some markets almost half of recently completed or converted condos will be renter-occupied in the next 2 years.

More foreign investors and developers are coming to the U.S. and Los Angeles in particular. The weak U.S. dollar coupled with what is considered more reasonable — and seemingly undervalued — pricing makes Los Angeles particularly attractive to foreign buyers.

East Los Angeles, Hollywood, the San Gabriel Valley and South Bay cities are projected to outperform the overall Los Angeles market in rent growth over the next 2 years. According to Torto-Wheaton, Hollywood and the San Fernando Valley saw 200 percent more units built in their respective submarkets in 2007 versus 2006. However, in the next 2 years, Hollywood is expected to outperform relative to metro Los Angeles while the San Fernando Valley is expected to under perform.

According to Real Capital Analytics, sales volume for Los Angeles for the first 9 months of 2007 was $3.31 billion, with leading buyers being Archstone, Kennedy Wilson, Stellar Management, JPI Multi-family and Equity Residential. The top sellers were Archstone, Klingbeil Capital, Essex Property Trust, Kennedy Wilson and JH Snyder.

The residential market is in a state of correction. The multifamily market will remain sluggish as inventory continues to grow and cap rates soften 25 to 50 basis points due to more restrictive financing options. This is a very good market for the investor who has the ability to use low leverage to take advantage of a market with fewer buyers now as the leveraged buyers aren’t able to get the financing that was available before summer 2007.

— Laurie Lustig-Bower, executive vice president, and senior sales directors Kadie Presley and Mitz Maton Klaus are based in CB Richard Ellis’ Beverly Hills, California, office.

Retail

The Los Angeles retail market is healthy as 2008 begins, particularly in terms of retail sales growth, occupancy rates, rental growth, absorption and development of infill shopping centers. There are several sizeable new projects opening this year, including Americana at Brand lifestyle center in Glendale, redevelopment of a portion of Westfield’s Century City regional center and large community centers in Huntington Park and Pacoima.

Occupancy rates remain high for all center types, including an estimated 95 to 97 percent for all L.A. retail centers larger than 50,000 square feet. As such, all indicators are that the market is healthy across the board, inclusive of lifestyle centers, enclosed malls, regional community centers, and neighborhood and community centers.

There are instances where shops are staying vacant longer, but, ultimately, spaces are being leased and tenants are opening for business. To provide context, viable retail space that became vacant in the last 5 years had letters of intent in place prior to the end of an existing tenancy. Now, vacated shop space may remain unoccupied for 6 months or longer before a new tenant moves in.

Momentum in the grocery sector is strong with same store sales increasing for chain grocery stores, new stores opening in urban areas and existing stores undergoing major capital improvements. Based on reported sales, Ralphs, Vons and Albertsons have done a good job of bringing customers back. Wal-Mart has opened Supercenters in Pico Rivera, Rosemead, Santa Clarita and Antelope Valley. Otherwise, there is little to no competition from Supercenters in core L.A. urban areas. Whole Foods Market recently opened an 80,000-square-foot store in Pasadena.

The national chains are investing capital to upgrade their stores with new graphics, and fixtures, etc., and local chains are backfilling vacated grocery buildings with ethnic markets. According to various media reports, Tesco, the United Kingdom’s largest grocery chain, is opening 12 new Fresh & Easy stores in Los Angeles in 2008, with more to come if its concept proves to be successful. All in all, the food market is very healthy in L.A. County.

The L.A. retail investment market continues to offer superior returns to investors compared to non-real estate classes, and the all-end yield from retail appears to be higher than other sectors of real estate. Retail is still, relatively speaking, a bargain compared to other real estate classes. For the 12-month period ending September 2007, 130 centers sold in Los Angeles at prices of $5 million or higher, at an aggregate volume of $2.86 billion. This was a 1 percent increase from the prior 12-month period.

The current challenge facing buyers in Southern California is obtaining financing that supports the cap rates sellers are looking for. While market conditions and product scarcity justify what owners believe their property to be worth, interest rates are making transactions more difficult to complete. Pricing for retail assets has somewhat stabilized, and velocity has slowed, but prices have not declined significantly in the L.A. County retail market, particularly in the A and B asset classes.

— Sam Alison is a senior vice president for CB Richard Ellis in Los Angeles.

Office

In West Los Angeles, a chronic imbalance between office supply and demand reached the tipping point in 2007. This forced some tenants, in search of lower rent, to move east towards downtown and south towards Los Angeles International Airport. It also prompted developers to begin construction on major developments to meet pent-up demand. Savvy investors who understood the long-term effects of this imbalance pushed west side office sale prices to unheard of highs based on the significant rental rate upside and, while it lasted, the abundant underwriting alternatives. The ripple effect from this submarket’s activity was felt throughout much of Los Angeles County and continues today, but these trends will slow through 2008, the degree of which will depend upon larger economic issues that have yet to fully unfold.

Although rental rates rose on average 10 percent countywide in 2007 to $31 per square foot in fourth quarter, certain submarkets saw increases of as much as 22 percent (Beverly Hills), 21 percent (Century City) and 18 percent (Santa Monica). Overall, average rental rates in these and other upper west side submarkets now stand at $48 per square foot, as compared to $39 per square foot just 1 year ago.

Many investors foresaw this rental growth and aggressively pursued acquisitions, pushing sale prices to historic highs. Hines purchased the One Wilshire building in August for $287 million ($433 per square foot) and 12100 Wilshire in November for $225 Million ($643 per square foot). 520 Broadway in Santa Monica changed hands again in April for $75 million ($672 per square foot), almost 3 years to the day after it last traded for $31.6 million ($283 per square foot).

Many see further increases still. Blackstone’s acquisition of Equity Office’s Los Angeles portfolio is a case in point. Just more than a year ago the average asking rent over the portfolio was $46.80 per square foot. Today some of these same buildings command asking rates as high as $96 per square foot.

2007 saw the completion of several new major office developments, including 2000 Avenue of the Stars in Century City, a 775,000-square-foot Class A office building. In first quarter 2007, this JP Morgan-backed project came on line at previously unheard of rental rates ($54 per square foot). When construction was complete, the $275 million dollar project was 53 percent pre-leased and 85 percent leased by year’s end.

Several major developers including Lincoln Properties, Tishman Speyer, IDS, The Carlyle Group and Equity Office followed suit with approximately 4 million square feet of office space in entitlement or under construction in Playa Vista, on the lower west side. These new deliveries are one reason for a slight up-tick in vacancy rates to a countywide average of 8 percent. Given the high cost to entry, continued office demand and rent growth is a pre-requisite for these developers’ success. It will help that there are very few large blocks of space currently available.

2008 will see a slowing in the trends outlined above, the degree of which will depend upon larger economic factors. UCLA Anderson’s 4th Quarter economic forecast stops short of predicting a recession, but does call for many difficulties ahead in 2008. Macro-economic issues include the serious downturn in the residential market, until now a primary force behind California’s economic growth. There has been and will continue to be significant job losses in related service industries. Most recently, the California State government has declared a fiscal emergency, announcing a $14 billion state budget shortfall, the effects of which have yet to be seen. Expect the local economy to ride out these difficulties, and in 2008 the office market will remain stable with moderate leasing activity. There will be a return to healthier vacancy rates, which were as low as 4.5 percent in some submarkets a year ago.

— Michael Preiss is an office broker, corporate services, for The Klabin Company/CORFAC International in Los Angeles.

Industrial

The value and scarcity of land are essentially precluding the development of large industrial buildings in the Los Angeles metropolitan area while re-focusing activity on the purchase and reconfiguration of existing properties, primarily for the burgeoning logistics market serving the nation’s largest port complex. The logistics market permeates Southern California’s entire industrial sector, though numerous manufacturing and service companies are remaining and, in fact, expanding. This includes aerospace, telecom, entertainment and technology companies, many of whom have to be in this market.

Still, the logistics market represents the iceberg of activity. This is borne out by the recent acquisition by First Industrial Realty Trust of a vacant 356,000-square-foot industrial facility in the South Bay area of Rancho Dominguez. First Industrial demolished 150,000 square feet of the building and created a new 200,000-square-foot building featuring substantially increased trucking and container storage facilities specifically to serve activity at the ports of Los Angeles and Long Beach.

The overriding message is that developers that are not afraid to tear a portion of a building down and create quality product are the ones who will be successful in the long term.

Concurrently, the capital market’s activity has slowed, but only relatively when compared to highly fueled conditions that prevailed earlier. Yet, leasing activity continues strong and industrial rents are holding up.

The aforementioned conditions are largely responsible for a nation-leading industrial vacancy rate of less than 3 percent in metro Los Angeles. Not surprisingly, the better quality industrial buildings are not remaining on the market long if priced right.

Hot submarkets are those that are generating buildings of 10,000 square feet and under for sale. The South Bay submarket continues to be desirable because of its proximity to the ports and companies migrating south from the pricey west side, where rents are 20 to 50 per cent higher.

AMB Property Company and First Industrial are among the most active investors/ developers in the market, while warehousing and transportation/logistics companies remain the primary tenant segment.

In the investment arena, some investors continue to be very aggressive while others have taken a step back since fourth quarter 2007. But, overall, the market needs to buy, so look for the investment market to hold up well.

Looking ahead through 2008, expect vacancies to remain low in a more challenging market caused, ironically, by its own strength due to paper-thin vacancy, low turnover and an absence of new product. What this means is that adding value to existing product by recon-figuring that product for the dominant user segment — notably logistics — will be the primary play in metro Los Angeles this year.

— David Prior is president of The Klabin Company/CORFAC International.

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