WESTERN SNAPSHOT, JULY 2007

Los Angeles Office Market

Brush fires are not the things burning out of control in Los Angeles this season. The office market has become a veritable inferno with “hot spots” all throughout the Westside. With market conditions squarely in their favor, landlords are pulling back concessions and boldly demanding record-setting prices for space in premier projects. Unlike previous booms in the office market instigated by short-term trends such as the dot-com explosion of the late 1990s, this shift in the market will have greater staying power as values in Los Angeles’ office market edge upward towards those of San Francisco and New York.

Chock Full

When it comes to L.A.’s office market, perception and reality are one and the same. The buzz generated by a new wave of private ownership and escalating asking rents aside, Los Angeles’ office market is bursting at the seams. The current average vacancy rate for Class A office space in the region is approximately 10.3 percent, hovering at the brink of single digits. On the Westside, the vacancy rate is approximately 7.2 percent and shrinking. Downtown Los Angeles is approximately 13.5 percent vacant, a major comeback for a submarket that saw vacancy rates at nearly 20 percent in the early 2000s. The Westside absorbed nearly 200,000 square feet of Class A office space in first quarter 2007, and downtown Los Angeles absorbed nearly 50,000 square feet.

Developers Get the Green Light

With healthy and steady vacancy rates, developers have been given the green light to start building, albeit cautiously. In the 1980s and ‘90s, overzealous office construction led to a glut of office space that had a shattering effect on the real estate market as soon as the economic recession hit. Now, with what seems to be a genuine need for new office space putting pressure on the market, a crop of new projects are either in the planning stages or coming on line. Recently, 2000 Avenue of the Stars, the latest addition to the Century City skyline, opened its doors at nearly 80 percent leased. On its heels are planned office projects at Playa Vista by developers Lincoln Property Co. and Tishman Speyer, along with office buildings, the first of which will break ground late this year at Howard Hughes, that was recently announced by Carr America.

What’s a Tenant to Do?

The tenant’s bind begins with rents that have either reached or are heading to historic heights. The average asking rental rate for Class A office space in Los Angeles’ Westside — which includes tony submarkets like Santa Monica, Beverly Hills and Century City — is an eye-popping $4.25 per square foot, compared to $2.88 per square foot a year ago. Even in markets such as downtown and the mid-Wilshire District, Class A space is fetching anywhere from $2.60 to $2.70 per square foot.

This perfect storm of market conditions — soaring rents, shrinking vacancy, high construction costs and few landlord concessions — have even well-capitalized tenants taking pause and carefully evaluating their options for the future. Larger tenants ranging from 50,000 square feet and up are surveying the market as much as 24 to 36 months in advance in search of lease expirations or new projects, especially if they are in need of significant expansion space. Large blocks of space are extremely hard to come by in today’s market.

Enticing landlord concessions such as free rent and generous tenant-improvement allowances are a thing of the past. Firms choosing to relocate will have to absorb a portion of the steep construction costs of building out new space.

The majority of tenants are scrambling to renew in place and secure some protection against the inevitable skyrocketing of rents. However, most tenants trying to pre-lease too far in advance will find that landlords are not looking to play ball, since there is no sign of prices cooling in the near future. Brokers that are in the trenches trying to make deals know that tenants with 3 to 5 years left on their current leases should consider themselves extremely fortunate for the moment!

Beyond 2007

Barring any unforeseen major catastrophe, Los Angeles’ office market will remain a boon for landlords. The city’s new group of deep-pocketed owners, such as New York-based Blackstone, paid steep acquisition prices for assets here, believing that Los Angeles’ office market has long been undervalued when compared to other major markets in the United States and around the world. (To put this in perspective, current rental rates in Los Angeles are still just about half those in New York and 25 to 50 percent less than in San Francisco’s financial district.) Landlords have shown extreme patience when it comes to making lease deals, and tenants are fast becoming aware that this group of owners will not rush to fill office buildings at anything less than top dollar.

Bob Safai, Rick Buckley and Gary Weiss are principals at Madison Partners in Los Angeles.

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