MARKET HIGHLIGHT, MAY 2005

LOTS IN LOS ANGELES
Daniel Bercu, Steve Algermissen, Lane Schwartz, Michael Preiss and David Prior

Decreasing vacancies, solid rent growth, housing affordability issues and an ever-present scramble for available land are some of the major dynamics in the Los Angeles commercial real estate market. The intense competition to address market needs and make the most of available space has yielded such things as industrial condos, mixed-use developments and downtown residential conversions.

Retail

The Los Angeles retail market is the largest and most dynamic trade area in the United States. Its streets are a virtual laboratory for cutting-edge stores, developments and legal paradigms. Many of the world’s most unique merchants are born in the streets of Los Angeles and migrate quickly around the globe. The most innovative developers push the limits of architecture and materials to stand out amongst the millions of square feet of gross leasable area. Lastly, there are the city governments that attempt to instill order amidst the chaos of 13 million people trying to coexist between ocean, desert and mountains.

The finest stores in the world are now opening in previously considered “terra incognita.” Paul Smith will join Adidas and Marc Jacobs this month on a stretch of Melrose Avenue in West Hollywood, an area most recently populated by antique stores, personal training spas and dry cleaners. Until recently, stores of this magnitude rarely strayed beyond the confines of the Beverly Hills triangle. Nearby, Third Street offers an array of wonderful merchants from Siegerson & Morrison to Trina Turk. This virtual explosion of first-rate merchants has pushed vacancy rates to well below 5 percent on the west side of Los Angeles.

Aggressiveness, coupled with a cast-iron stomach, has always been a vital attribute for a Los Angeles developer. Today’s uber-competitive market brings out the most creative solutions from our development community. Rick Carusso, the industry gold standard for quality, is especially active in submarkets such as West Hollywood and now Glendale. CIM Group, backed by the financial might of CalPERS, continues to dominate in Hollywood and further east in downtown Los Angeles. Downtown is especially hot with new projects almost outnumbering permanent residents at present.

The Los Angeles investment sales sector in 2004 was very robust with 33 transactions in excess of $20 million totaling $1.76 billion and 8.6 million square feet. Notable transactions include the partial-interest sale (50 percent) of Del Amo Fashion Center to J.P. Morgan Fleming by The Mills Corp., the sale of Trizec Properties’ Hollywood & Highland project to CIM Group, the sale of Manhattan Village Shopping Center by RREEF and the sale of the West Hollywood Gateway to ING Clarion.

The city of Los Angeles is scrambling to bring order to the chaos of this retail real estate and population explosion. Nearly all new projects — retail or otherwise — have a residential component to satisfy the unsatiable appetite for housing. Developments like Playa Vista on the west side have created a unique zoning plan that creates a delicate interplay of housing, shopping, offices and public space. Downtown Los Angeles is working closely with The Related Companies and Anschuntz development to weave Grand Avenue and The Staples Center projects into the urban framework. On the retailer side, cities have had their hands full trying to balance the residents’ needs for affordable goods, while often trying to keep out merchants like Wal-Mart, which satisfies those very same demands.

All in all, it’s a fine time to be shopping, dining or developing in Los Angeles. The air is cleaner than usual, freshened by the wettest winter in a hundred years. People are spending money again, and restaurants and stores are full. Hot dining spots require advance reservations, and people are carrying shopping bags through malls, not just peering through store windows. About the only people who are unhappy are those value investors looking to find double-digit returns or hurried shoppers who need to locate a convenient parking space.

— Daniel Bercu is western regional director of retail services for Cushman & Wakefield in Santa Monica, California. Steve Algermissen is senior director of the Financial Services Group in Cushman & Wakefield’s downtown Los Angeles office.

Multifamily

Apartment owners in Los Angeles should continue to enjoy a bright outlook as home affordability continues to decline and the local economy expands. In addition, apartment construction is slipping as many builders shift their focus to the condo market. The investment forecast for improving economic conditions and apartment market fundamentals will keep numerous investors active in the market.

Most new condos coming online, especially those downtown, have price tags in excess of $500,000, and housing affordability is a low 14 percent. Thus, the majority of the 50,000 households entering the county this year will be confined to the rental market. Additionally, the construction forecast bodes well for investors, as apartment development is settling into a pace of 5,000 to 6,000 units per year, which is expected to last until 2007. Of the 5,000 units being completed in 2005, roughly one-third will be luxury apartments built downtown.

Further fueling demand for apartments is the recovery of more than 100,000 jobs that were lost from 2001 to 2003. Employment growth will continue in 2005 with the creation of 60,000 more jobs. Apartments in prime employment growth areas are already starting to show improvement in fundamentals. In the South Bay, the expansion of defense-related firms has increased demand for local apartments, and vacancy declined by 80 basis points, to 3.2 percent. Further improvement is expected the rest of 2005, and investors in the submarket can expect revenue, on average, to rise by more than 5 percent as vacancy falls below 3 percent and rent growth exceeds 4 percent.

Across the metro area, owners can look forward to positive forecasts for vacancy and rent. Declining affordability among for-sale housing units will increase apartment absorption and help vacancy to recede by 20 basis points in 2005 to 3 percent. Class A apartments will post the greatest improvement this year, dropping 50 basis points to 4.5 percent. The tightening market and growing renter pool will allow owners to achieve rent growth of 5 percent this year to $1,280 per month. The only submarket not expected to show improvement in 2005 is downtown, as 1,600 units come online and owners are forced to increase concessions to attract new tenants.

The gap between buyers’ and sellers’ expectations is widening, and sales velocity is slowing, but a price correction is not expected amidst tightening market conditions. The number of sales peaked in first quarter 2004 as buyers felt an urgency to purchase properties before interest rates rose, but the number of transactions receded during the year. Nonetheless, the median price still increased by 10 percent in 2004 to $105,000 per unit. Institutional-grade properties posted the highest price growth last year, increasing 25 percent to $130,000 per unit, as REITs and other large investors came looking for stable investments, and local apartments fit the bill.  Some submarkets are expected to perform especially well in 2005, including west San Fernando Valley and South Bay, where numerous high-paying jobs are being created and vacancy is low.

— Lane Schwartz is the regional manager of Marcus & Millichap’s Los Angeles office.

Office

A firming up of office space rents after 3 soft years stemming from the dot-com bust, increased leasing activity marked by fewer concessions during the past 6 months and the continued conversion of functionally obsolete properties to residential and mixed-use projects constitute the primary trends in Los Angeles’ office market.

There is also the conversion of high-rise office space into purely residential uses. The net effect is a negative impact on overall office inventory, particularly when you consider that there is virtually no new construction of office space in the market.

Meanwhile, the overall vacancy rate in the Los Angeles area has decreased due to several reasons, including ongoing healthy absorption, the evaporation of sublease space, the removal of traditional office space from the market and the aforementioned lack of new construction. Vacancy rates range from 13 to 15 percent countywide and are edging downward. Rental asking rates range from $2 to $2.75 per square foot in the county to more than $4 per square foot for select trophy properties.

The city of Santa Monica persists as perhaps L.A. County’s hottest office market, both from leasing demand and investment perspectives. Space is being absorbed rapidly in this market with rates rising from $2.50 to $3 per square foot and up. There are several new office projects in Santa Monica, some of which feature a retail component.

A spectacular new 22,000-square-foot office building at 1315 Lincoln Blvd. features office space on the top floor and retail beneath with asking rents starting at $2.75 per square foot NNN. The project provides generous five-per-1000 parking. Additionally, the “Clock Tower Building” at 225 Santa Monica Blvd., with ocean views, is a conversion of an older Art Deco-styled 12-story office building. The property was rehabilitated into a high-end, modern creative office space. Rents range from $2.85 per square foot to $4.15, with several floors already leased.

Active tenants in the market include Yahoo!, which recently leased 229,000 square feet of office space at Colorado Center for its Southern California regional office, and Symantec, a software company planning a 150,000-square-foot build-to-suit campus in Culver City.

Investment sales also continue to be strong. Last summer, Equity Office Properties paid $443.6 million for six buildings comprising 1.1 million square feet of space at Colorado Center. More recently, Maguire Properties purchased the 331,000-square-foot Lantana Center in eastern Santa Monica for $136.8 million, including entitlements for an additional 200,000 square feet of space.

Strong leasing activity should continue, serving to reduce vacancy rates further, spike rents and slash concessions. This will be accompanied by the continued stability of historically high sales prices and ongoing redevelopment.

However, with increasing redevelopment of traditional office space for alternative uses, the overall office inventory will become an issue as new construction lags behind demand. To begin countering this, many tenants are expanding their geographic outreach.

Looking forward, anyone targeting the Los Angeles area office market is well advised to keep a close eye on the residential housing market because Southern California’s economy has been driven by consumer spending, much of which has been derived from the build-up of home equity.

Unless other sectors of the local economy pick up the slack from a potential reduction in home equity strength, we could experience a sharp drop in consumer spending that will ultimately impact all real estate sectors.

— Michael Preiss is a broker at The Klabin Company in Los Angeles.

Industrial

It’s a whole new ballgame when it comes to the life cycle of the lease negotiation process in the Los Angeles industrial real estate market. Specifically, the time involved to close a transaction — from executing the proposal to lease signing — has been substantially reduced. This represents a marked shift in the dynamics of the market and interaction between landlord and tenant. A clear example of this is that tenant concessions have been virtually squeezed out of the industrial market.

An accompanying and noteworthy trend is the ongoing, red-hot market for small for-sale industrial buildings, a product which not coincidentally is the focus of most new developments in the region.

Concurrently, there is a significant number of industrial buildings erected approximately 30 years ago that are undergoing extensive refurbishment — major body sculpting, if you will. The strategy is to bring these facilities in line with the functional demands of the market, notably from the logistics business sector. This refurbishing may include increasing yard areas to a minimum of 130 feet — up from the former standard of 100 feet — and the introduction of a higher ratio of doors per square foot of building space.

Golden Springs Business Center is one of the most well conceived master-planned major industrial developments in the entire Los Angeles area. The Santa Fe Springs property currently comprises 3.6 million square feet of Class A industrial and distribution buildings set on 265 acres.

The industrial vacancy rate for Los Angeles County has dipped under 4 percent and continues to fall. The South Bay submarket posts a vacancy rate of less than 3 percent. Meanwhile, asking rates for industrial buildings are at least 15 percent higher than a year ago for second-generation buildings. However, new buildings in prime in-town locations are asking in the 60-cents-per-square-foot range or higher.

While the logistics community is the primary tenant sector driving the L.A. industrial market, there’s been strengthening of a diverse tenant pool. This includes health care, financial services and assembly activities.

Historic land-grant companies are pacing the development community today, notably Watson Land Company and The Carson Companies. Other active developers include Proficiency, Sares-Regis, ProLogis and the Tejon Ranch Company, which has massive holdings adjacent to Interstate 5 at the Kern County border. Land-grant companies are spreading their geographic outreach from their traditional South Bay area stronghold by purchasing raw land for speculative development.

On the investment side, there are diminishing opportunities and intensified competition as bidders for top quality properties are pushing cap rates to 6 percent and lower.

For the balance of 2005, expect continued strong absorption. Yet if tenants have an immediate need, they will discover few choices in the market. From an owner’s perspective, the market is extremely healthy. Brokers, meanwhile, may be challenged because of a lack of product.

— David Prior is the president of The Klabin Company.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.