MARKET HIGHLIGHT, MAY 2006

NO LONELY LANDLORDS IN LOS ANGELES
Terry Reitz, Neil Resnick, Max Franco and Barry Baker

Perhaps Los Angeles’ big-city lights should double as searchlights because vacant commercial real estate space is hard to find in the well sought after market. Robust demographics and demand have landlords once again singing “I Love L.A.”

Industrial

With a vacancy rate of 2.1 percent and nearly 1 billion square feet of space, Los Angeles has the distinction of being the tightest and largest industrial market in the nation. Demand for warehouse and distribution space continues to be fueled by strong international trade. Marking another record year, the total value of two-way trade reached almost $300 billion for Los Angeles County in 2005 and 2006 is expected to be yet another record year. Although more than 3 million square feet of industrial space is under construction, that number is just .03 percent of the existing base. Net absorption for the first quarter totaled 2.6 million square feet.

The lack of supply is having a pronounced effect on activity levels. Sale and lease activity totaled more than 9.3 million square feet in the first quarter, down from 12.1 million square feet a year ago. User sales accounted for one-third of total sale and lease activity, indicating a healthy buying appetite that continues to be fueled by still relatively low interest rates. Median price per square foot for user sales continues to rise. Rents are also on the increase, as rising interest rates have tempered the sales market somewhat and brought back tenant demand. Among the first quarter’s significant lease transactions were Imperial CFS Inc.’s lease of 298,000 square feet in Torrance and Frontier Logistics’ lease of 200,892 square feet in Carson.

Buoyed by solid fundamentals, the investment market continues to enjoy feverish demand. In Rancho Dominguez, a 234,800-square-foot warehouse/distribution building sold for $20.4 million. Meanwhile in Pomona, a 365,859-square-foot warehouse/distribution facility was purchased for $24.5 million.

As the economy continues on a path of expansion, demand for industrial space in Los Angeles will remain vigorous. With gross domestic product rising at a moderate pace and estimated to have grown 3.6 percent in 2005, the overall economy is in a solid position for long-term growth. Adding to the positive economic outlook, international trade activity will remain at the hot pace of recent years. Given these factors, demand for industrial space will carry much momentum into 2006.

Supply on the other hand continues to dwindle. Shortage of available space will compel tenants to renew. Tenants with expansion requirements will leave tight submarkets for areas with larger under-construction projects such as North Los Angeles, the San Gabriel Valley and the South Bay. The combined effects of high demand and low supply will keep vacancy rates at razor-thin levels and rents increasing at a steady pace.

— Terry Reitz is a senior vice president for Grubb & Ellis Company in Los Angeles.

Office

The Los Angeles office market moved into 2006 with authority, recording lower vacancies and solid growth in occupied space. The overall office vacancy rate dipped to 11 percent at the end of the first quarter, down three full percentage points from a year ago. Net absorption was constrained by the lack of available space, but still amounted to a respectable 752,416 square feet. Vacancies were down in all of the county’s submarkets with a low of 7.3 percent in North Los Angeles and a high of 16.1 percent in the South Bay. The West Los Angeles market led the county in net absorption with 448,774 square feet, followed by North Los Angeles with 240,414 square feet. This was the North Los Angeles market’s 13th consecutive quarter of positive absorption, a testament to the consistency of that market.

All seven submarkets (downtown L.A., West L.A., North L.A., the South Bay, mid-Wilshire, the Tri-Cities and the San Gabriel Valley) that comprise the L.A. metro office market have leasing fundamentals that are moving in the same direction, with reduced vacancy rates, positive net absorption and higher average asking rents. Only two markets still post double-digit vacancy rates — downtown L.A. and South Bay. However, with the office leasing market as healthy as it presently is, it may be only a matter of time before single-digit vacancy rates find their way across the board for the L.A. metro area. As tenants scramble to find suitable space, landlords are pushing rents to new heights.

Average asking rents for the county have climbed to $2.63 per square foot, up from $2.45 per square foot a year ago. Averaging $2.99 per square foot, rents are highest in the West Los Angeles submarket, where the rate averages $3.94 per square foot in Santa Monica. Speculating that asking rental rates will continue to increase, tenants are agreeing to longer contract terms in order to lock in rates. Demand for office space in downtown L.A. will be supported by two $1 billion developments, the L.A. Live entertainment complex, which is under construction near the Staples Center, and the planned Grand Avenue mixed-use project on Bunker Hill. These new projects will reinvigorate the CBD and create more reasons for office tenants to locate there. In Burbank, M. David Paul & Associates has purchased nine acres of land adjacent to the NBC Studios lot with plans to build approximately 1 million square feet of new office space. Meanwhile, in Century City, 2000 Avenue of the Stars, a 12-story office tower with more than 700,000 square feet of space, is expected to be completed by the end of the year.

— Neil Resnick is the executive vice president and managing director of Grubb & Ellis Company in Los Angeles.

Retail

Los Angeles is home to one of the most desirable retail markets in the world as evidenced by its very low vacancy rate of just 5 percent. Retailers are eager to gain a foothold or increase their presence in this vital market. The future looks bright with Los Angeles retail sales expected to increase 6 percent overall in 2006 on the strength of an improving economy.

With such a low vacancy rate, opportunities for retailers to enter or grow in the market are being created in two ways. One way is through mergers and/or consolidation among existing retailers. For example, Federated Department Stores’ acquisition of May Department Stores will mean that some Robinsons-May stores will become Macy’s stores. However, some malls already have a Macy’s store as a result of prior mergers. In fact, some centers have two Macy’s stores and two Robinsons-May stores. This duplication creates an opportunity for another retailer to come into that space.

The other way that opportunities are being created for retailers is through new development. In Los Angeles County, there are a variety of major projects in the works. Some are updates to existing centers such as the $500 million upgrade to Westfield Topanga, which will bring upscale tenants like Neiman Marcus to this San Fernando Valley mall. Overall, however, the continued trend is toward mixed-use. The majority of these projects have a residential component, and by adding the element of living units to a center or converting parts into open-air, retail owners can provide a community vibe and increase foot traffic. A prime example is the Americana project in downtown Glendale. The $264 million development will include apartments and condominiums in addition to retail. Another project slated to break ground later this year is Inglewood Promenade, which will consist of 400,000 square feet of retail, 450,000 square feet of office and a 300-room hotel.

Retail investment sales continue at a torrid pace. Among the shopping centers that traded hands in the first quarter was Crenshaw Plaza, an 860,000-square-foot regional center in Baldwin Hills that sold for $136 million. In Los Angeles, 8000 Sunset, a 157,593-square-foot center on Sunset Boulevard was purchased for $66 million or an eye-popping $418 per square foot. Meanwhile in Torrance, the Shoppes at South Bay, a 196,912-square-foot center, sold for $55.5 million or $281.85 per square foot. Retail investment sales will continue to be strong in 2006.

— Max Franco is a vice president at Grubb & Ellis Company in Los Angeles.

Multifamily

2005 proved to be another strong year for the Los Angeles apartment market. Each year of this young century has resulted in higher prices, by every investment measure. There have been prices achieved in the sale of very ordinary properties in Class B and C locations that rival those achieved just a few years ago by properties in very desirable locations. Gross rent multipliers that were previously typical of prime areas such as the Westside, south of Ventura Boulevard, South Pasadena and coastal locations are now found nearly everywhere in the Los Angeles basin. Contributing to the strength of the market in Los Angeles County is the ultra low vacancy rate, which is currently 4 percent, and the healthy rents, which currently average $1,500 per month.

However, 2005 also revealed that there are limits. The rate of increase has clearly indicated a change beginning at the start of the year. The increases experienced during the year seemed to be focused in prime areas and newer properties. Less prestigious properties essentially topped out and remained on a plateau throughout the year.

Buyers in general seemed less eager to buy at any cost. They showed more discipline and discretion in their offers and negotiations. This resulted in fewer transactions reported and a lower dollar volume of sales in 2005 in Los Angeles County than the previous year.

Short-term interest rates continue to increase in 2006. Since the Federal Reserve Board’s program of increases began nearly 2 years ago, long-term mortgage rates have been somewhat resistant. Mortgage rates did move upward during 2005, and the expectation that they will climb further is part of the reason for the market cooling. This factor will have a bigger impact on the market in 2006. With the first quarter of 2006 in the books, there is a significantly slower market. The slowing of the residential market has been widely publicized and that has contributed to an investor pool that is more discretionary.

Condo construction has siphoned off some renters who have been able to move into ownership. However, much of the condo construction remains proposed rather than actual and completed — particularly downtown — so its true impact is still not known. The other side of the coin is that there has been little or no new apartment construction for several years in this area. Most new construction has been condos because of land costs and construction costs. When the conversion of apartment buildings to condos is added to the mix, the result is a continuing pressure for rental units. 

— Barry Baker is a vice president for Grubb & Ellis Company in Los Angeles.

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