WESTERN SNAPSHOT, NOVEMBER 2005

Los Angeles Office Market

Preiss

The metropolitan area has a total inventory of approximately 375 million square feet of office space with about 11,000 buildings. The 12 submarkets that make up the region are Burbank/Glendale/Pasadena, downtown L.A., Mid-cites, Mid-Wilshire, San Fernando Valley, San Gabriel Valley, Santa Clarita Valley, the South Bay, southeast Los Angeles, east and west Ventura County, and West Los Angeles.

On the development side, the overriding trend is a virtual dearth of office activity in established areas caused by high land values and driven by residential development and a rising cost of construction. The Los Angeles City Council is currently considering a moratorium on the conversion of office and low-income high-rise space to high-end loft residential in the downtown market because of the displacement of low income wage earners.

At the end of third quarter 2005, new office projects under construction in Los Angeles' metro area totaled 1.75 million square feet. This represents a small number relative to the total inventory, particularly when you consider that the majority of this is seen in two projects.

These projects are the 2000 Avenue of the Stars development, consisting of 790,000 square feet of space, in West Los Angeles. Trammell Crow Company is the developer. The other is The Pinnacle at Media Center in Burbank, a 225,000-square-foot project by J. David Paul Associates, which, incidentally, is pre-leased.

Meanwhile, the investment market for office buildings in Los Angeles is extremely strong with fierce competition prevailing for every opportunity.

This interest is fueled by low interest rates and few viable investment alternatives providing comparable returns, resulting in a great deal of money being placed in L.A. metro real estate. This explains an increased price per square foot and lower cap rates for investment grade properties.

A look at the first 6 months of this year is instructive. During this period, total office building sales rose compared to the same period a year earlier. Through June of this year, 135 investment transactions of buildings 15,000 square feet or larger were recorded for a total sale volume of $2.8 billion, an average of $188 per square foot. Last year 152 transactions were completed for a total sale volume of $2.35 billion, an average of $176 per square foot (source: COSTAR). Meanwhile, cap rates dipped, averaging 7.32 percent compared to 7.94 percent in 2004.

On the leasing side, strong employment growth and minimal new construction have driven vacancy rates down and absorption up in the metro area. The region averaged 9.3 percent vacancy and average asking rental rates of $25.65 per square foot, up almost 4 percent from the end of second quarter.

West Los Angeles continues to be the hottest market with an 8.6 percent vacancy and average asking rental rates in all building classes of $33 per square foot. Conversely, the softest market is the South Bay area, encompassing a region essentially from Los Angeles International Airport south to Long Beach, which grapples with a 15 percent vacancy and average asking rental rates in all building classes of $23 per square foot.

Among significant lease transactions closed in recent months are a lease for 225,000 square feet by Warner Brothers at The Pinnacle at Media Center in Burbank; a lease for 117,000 square feet by the Los Angeles Unified School District at 1055 W. Seventh St. in the downtown L.A. market; and a lease for 42,389 square feet by Omnicon/Chiat Day at The Gehry Building in Marina del Rey. World-renowned architect Frank Gehry and Larry Field of NSB Capital Partners are the owners of that property.

A standout investment sale was the acquisition of a 493,000-square-foot office building at 3900 Alameda Ave. in Burbank for $167 million, representing $338 per square foot and a cap rate of 6.1 percent. Less than 2 years earlier, the same building sold for $234 per square foot.

Looking forward to 2006, expect increasing office space absorption stimulated by continued job growth and a stable economy. With the exception of the aforementioned Avenue of the Stars development, very little new office product is scheduled for delivery. This will result in higher rental rates and movements of tenants from hot Westside markets to outlying markets in search of lower rents. For example, there is a difference of $12 per square foot annual asking rental rate between Santa Monica and El Segundo, a distance of just 11 miles.

Barring a major catastrophe such as an earthquake, terrorist attack or a housing market meltdown, the office market in L.A., characterized by increasing rents and fewer concessions to tenants, will continue strong while favoring owners.

Michael Preiss is director of corporate services for The Klabin Company in Los Angeles.

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