COVER STORY, OCTOBER 2006

HIGH OFFICE
Job growth, barriers to entry boost California’s office market.
Brian A. Lee

Foundry Square I in San Francisco

“In San Diego, what used to be more of a ‘mom-and-pop’ ownership landscape has turned into a more sophisticated office market with REITs and institutions becoming the primary owners of key assets, leading to a more professional and long-term approach to asset management and investment,” says Manos.

He maintains that California’s hot office investment market has not yet reached its peak. The influx of capital from both foreign and domestic investors must land somewhere, and “real estate is still a safe bet.” Despite lower cap rates in Southern California’s major markets, the upside in leasing means opportunities to increase the return on investment in a relatively short amount of time.

“We believe the downtown L.A. office leasing market will continue to tighten due to ongoing corporate migration and growth,” says Manos. “New development as well as significant redevelopment is bringing more retail and residential to the downtown market, making the area an even more desirable place to both work and live.”

In August 2006, Trizec Properties signed nearly 190,000 square feet of new and expansion leases at three of its downtown L.A. office properties. Most active in downtown Los Angeles and San Diego, Trizec office holdings in Southern California comprise 18 properties totaling 8.5 million square feet.

In the west Los Angeles office leasing market, Frank Campbell, vice president of leasing for Equity Office Properties in Los Angeles, says that highly desirable Santa Monica properties are nearly full, limiting the options of companies in search of 20,000 square feet or more. Demand in Santa Monica is coming from media-related, high-tech entertainment, Internet and computer firms — “convergent technology companies.” For example, Yahoo!’s 2005 lease of 65,000 square feet at the former Colorado Center in Santa Monica will expand to 230,000 square feet by 2008.

 Lease renewal and expansion are also the themes in San Francisco’s central business district (CBD), according to Ken Churich, vice president of leasing for Equity Office in San Francisco. “San Francisco’s CBD market is tight,” he says. “Vacancy rates are decreasing, and large spaces are hard to find. Companies are taking advantage of the spaces they already occupy by renewing their leases.”

The need for large blocks of space spurred Equity Office to begin development on the 335,000-square-foot Foundry Square I, located in the city’s South of Market submarket and scheduled for completion in December 2007. Barclays Global Investors has leased 96 percent of the development —  “the third largest deal in San Francisco history,” says Churich.

Doug Holte, Hines’ western regional partner and director of Hines’ Orange County and San Diego operations, notes the urbanization trend occurring in the former area.

“Orange County, specifically Irvine, has traditionally been more of a suburban market with decentralized office districts and campus-style developments, mostly lacking architectural distinction,” he says. “Now we’re seeing more of a true CBD emerging with the introduction of high-rise residential towers and new office towers with a focus on timeless architecture, creating a sense of New Urbanism in this premier, master-planned community.”

Michelson Drive, the location of Hines’ 2211 Michelson office tower (the developer’s first Orange County project), is right in the middle of this movement. Slated for completion in May 2007, 2211 Michelson is a 12-story, 265,000-square-foot, Class A office tower project located in the John Wayne Airport submarket of Irvine.

Historically, Orange County office lease rates have lagged behind those of its neighboring Los Angeles and San Diego competitors, but the emergence of the John Wayne Airport submarket has closed the gap, according to Holte. “This shift in fundamentals can be directly tied to an abundance of land being absorbed for new high-rise residential developments, dramatically raising the barriers to new office developments,” he says.

Active in almost every major market in the West, Hines’ biggest concentrations are in California, followed closely by Seattle.

©2006 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.