MARKET HIGHLIGHT, OCTOBER 2008

LOS ANGELES
Dana Brody, Chris Houge, Hunt Barnett, John Ellis and Ken McLeod

The big city lights of Los Angeles are shining brighter on some sectors — multifamily and industrial — than others, but there’s still plenty of activity to go around.

Multifamily

The Los Angeles County multifamily market continues to be one of the strongest sectors throughout all divisions of commercial real estate. The strength of the multifamily segment is directly tied to the demand for rentals as the housing market declines. The apartment rental market has picked up steam as many future and former homeowners find themselves now renting indefinitely. Even with home prices starting to fall, purchasing a home in Los Angeles County remains unaffordable for most, forcing many prospective homeowners to remain renters until home prices drop significantly. In the meantime, as more people enter and re-enter the L.A apartment market, demand continues to push rentals rates up.

According to RealFacts, the rent for an average one-bedroom unit in L.A. County has jumped more than 10 percent in the last 2 years. From second quarter 2006 to second quarter 2008, the cost rose from $1,390 to $1,550 per month. In addition, the average two-bedroom/two-bath unit climbed nearly 12 percent during the same 2-year period, rising from $1,784 in 2006 to $2,019 in 2008.

As rental rates rose, more rental units were being added to the market. In L.A. County, 2,685 new units were added to the market in 2006 and 2,505 in 2007. With the addition of more than 5,000 units and the increase in rental rates, the vacancy rate between second quarter 2006 and second quarter 2008 only rose about 2 percent, keeping unit absorption strong even as rental rates climb. Since the housing market hit its peak in 2006, the demand for rentals has kept multifamily the strongest investment option in the commercial real estate arena.

The sales market has also been very solid, as transaction and dollar volume remains very high. A popular trend with many investors and developers has become mixed use, allowing property owners to develop ground-floor retail space for higher rents and have apartments above. The trend has also been embraced by the City and County of Los Angeles, especially along transportation corridors such as the Metro’s Red Line, as a way to ease congestion while providing housing.

In terms of highest number of sales, downtown Los Angeles and Hollywood have been the hottest multifamily submarkets throughout Los Angeles. As downtown begins to attract more and more residents, the demand for housing has also gone up. Retailers and amenities have started to pop up everywhere to service this new breed of urban dweller, highlighted by last year’s opening of Ralphs in downtown L.A., which quickly has become one of the grocer’s highest profiting branches in the country. The other hot submarket, Hollywood, has experienced a renaissance of sorts itself as the city strives to become more than a tourist hub.

— Dana Brody is an associate vice president in Grubb & Ellis’ West Los Angeles office.

Office

The state of the Los Angeles office market is much like the economy: not that great, but not that bad either. Leasing and sales activity have definitely slowed down, with deal velocity down 70 percent from a year ago, by our estimate. Still, the numbers from second quarter 2008 were impressive: the L.A. market was a slender 8.7 percent vacant, one of the lowest figures in the nation, while lease rates held steady from quarter to quarter, according to CoStar.

Larger deals are still happening. In the second quarter, the largest deal was for 420,000 square feet for Fox Interactive Media at Horizon at Playa Vista, a development of Lincoln Property Co. In a nearby campus, Belkin Electronics has leased 120,000 square feet in four build-to-suit buildings. The project is a joint venture of Tishman Speyer and Walston Street Capital.

South Bay, especially El Segundo, is one of the busiest leasing markets in the region. In the past quarter, South Bay saw at least two mammoth deals: Raytheon signed a lease for 345,377 square feet at 2220-2222 Imperial Highway in El Segundo, while DIRECTV took 205,222 square feet at 2230 E. Imperial Highway. In downtown Los Angeles, the law firm of Latham & Watkins leased 298,000 square feet at KPMG Tower.

Despite the real estate credit crisis, some notable portfolio sales have occurred in Los Angeles in the past 3 months. In March, Arden Realty, a unit of GE, sold 400 and 600 Corporate Point in Culver City to Transwestern Investment Company for $125 million. In June, the same seller traded 1.4 million square feet in six buildings in West Los Angeles and Warner Center to Douglas Emmett Inc. for $610 million. Another notable sale was that of 5055 Wilshire Boulevard in the Miracle Mile area. The buyer, Somerset Group of New York, paid $48 million for the 170,000-square-foot-building. The seller was San Antonio, Texas-based USAA.

True, some parts of the market are hurting, especially those where the mortgage industry had a big presence, including Warner Center, Glendale, Santa Clarita and Calabasas. Further west, toward Thousand Oaks, the market is taking on extra inventory due to shrinkage at Amgen, one of the area’s largest private employers.

However, L.A. is doing well on the whole. The major reason, in this view, is the manageable amount of new office space coming on line — about 5.26 million square feet this year across the county, according to CoStar — combined with a diverse economy that can offset the fallout from industries experiencing hard times. Unlike previous slowdowns in the real estate market, developers and investors are not in distress, and very few have been forced to sell their assets at deep discounts.

The busiest development markets are the Tri-Cities area of Burbank, Glendale and Pasadena with 1.49 million square feet under construction, followed by West Los Angeles, Wilshire Boulevard and the San Gabriel Valley, each with about 750,000 square feet on the rise.

— Chris Houge and Hunt Barnett are principals at Los Angeles-based Madison Partners.

Industrial

The huge Los Angeles County industrial market is a relatively bright spot in an otherwise gloomy economy. As of mid-year 2008, total county inventory stood at 1.084 billion square feet. With the exception of the Antelope Valley, there is very little land available for new development. For the year ending June 30, 2008, the net increase in total inventory barely exceeded 3 million square feet or a 0.3 percent increase in total inventory. Supply constraints cause most major property investors to regard the Los Angeles industrial market as the Number 1 industrial market in the country in terms of anticipated investment performance.

At a low of 3.2 percent in fourth quarter 2006, the vacancy rate now exceeds 3.6 percent, due to net absorption being essentially zero in the last 18 months, and may approach 4 percent by year’s end. This is still a tight supply and supports increases in rents of 4 percent in 2008, from an average of $0.54 to $0.56 per square foot per month.

The credit crunch has affected the sales volumes in the county, although to a lesser degree than other property types. Industrial property sales in Los Angeles County peaked in third quarter 2006 with 292 properties changing hands. During second quarter 2008, there were 169 industrial property sales, reflecting a 42 percent volume decline. However, the decline in volume has not translated into any measurable price decline, with the average price per square foot hitting $117 in mid-2008, compared to $112 a year earlier. Demand is driven by both institutional investors and by owners/users, especially those with strong banking relationships, while high-leverage buyers have been forced to the sideline. However, equity investors have maintained an aggressive buying posture, which will generally keep cap rates at or slightly below the 6 percent benchmark for Class A product.

Birtcher Development & Investments and Cornerstone Real Estate Advisors LLC are slated to complete the 551,900-square-foot Birtcher Distribution Center at Paramount in early 2009. The Kroger Co. signed a 30-year, $207 million lease for the warehouse/distribution center in late 2007. The effective lease rate was quoted at $1.04 per square foot per month. The new development will service Kroger’s 266 Ralphs and 103 Food 4 Less stores throughout Southern California. In first quarter 2008, Birtcher and Cornerstone also acquired a 608,200-square-foot, fully occupied warehouse and distribution center, located at 9400 Santa Fe Springs Road in Santa Fe Springs, from Northwestern Mutual Life Insurance Company for $68 million.

The tight market conditions have brought about escalating land values, noting again that most major development sites in the Los Angeles Basin are created by the demolition, clearing and redevelopment of previously developed sites. With land prices in the $30- to $45-per-square-foot range in many areas — and sometimes significantly higher, especially closer to downtown — long-term investors look carefully at the value of the underlying land for Class B and C properties.

The recent decline in shipping volume at the ports is resulting in slight negative absorption in this South Bay submarket. However, L.A. County vacancy rates are expected to remain below 4 percent. Looking beyond the current downturn of 2008 and 2009, market fundamentals will restore a positive pricing trend in a market that is severely constrained by a lack of available land.

— John Ellis is managing director of Integra Realty Resources in Los Angeles.

Retail

The Los Angeles retail market has not totally escaped the effects of the economic slowdown. The housing slump, soaring gasoline and food prices, and rising unemployment all have taken their toll. However, the city’s retail market hasn’t been hit nearly as hard as other markets around the country. While retailers may have scaled back in other areas, closing stores and curtailing expansion plans, Los Angeles with its millions of consumers, many of them affluent, is still a place in demand. Vacancy has risen, but still stands at just 5.5 percent.

 While retail construction has slowed, there are still significant projects in the area. The majority are mixed-use, combining retail with residential. One of the biggest is L.A. Live, a 4 million-square-foot retail/entertainment complex next to the Staples Center in downtown Los Angeles. With the recent tenant signing of Trader Vic’s for more than 8,000 square feet, the developer AEG, a subsidiary of the Anschutz Co., has leased all of the rentable space in the $2.5 billion project.

In Santa Monica, Macerich is redeveloping Santa Monica Place, an enclosed mall that is being transformed into a 550,000-square-foot open-air retail center that will connect with the Third Street Promenade, three city blocks of retail stores, restaurants and entertainment. The new center will be anchored by Bloomingdale’s and Nordstrom.

Hollywood is another retail development hot spot. The 1 million-square-foot Hollywood & Highland retail-entertainment center, owned by CIM Group, has ignited a surge of development in the area. More than 1 million square feet of new retail space there includes 61,500 square feet at Hollywood and Vine, which features a W Hotel & Residences and apartment complex by Gateway Capital and Legacy Partners; a 60,000-square-foot Whole Foods Market on the ground level of a $225 million, 300-unit apartment complex by Camden Property Trust; 175,000 square feet at Boulevard 6200, a $350 million mixed-use project by Clarett Hollywood LLC; and a Target.

In Glendale, The Americana at Brand, a $400 million urban multi-use development community, was 98 percent leased when it opened in May. The 15.5-acre shopping complex features 75 retail stores, 338 residential units, restaurants, an 18-screen multiplex and a 2-acre public park. Developer Caruso Affiliated also developed The Grove, a hugely successful lifestyle center adjacent to the historic Farmers Market on Third and Fairfax.

In downtown Culver City, a mixed-use development attracted a significant new tenant in Room & Board, a Minneapolis-based furniture retailer. Room & Board signed a lease for 40,000 square feet of space at the 118,500-square-foot Plaza at Culver Studios. The store will open in early 2010.

There are numerous other smaller projects throughout Los Angeles, which follow this theme of residential combined with retail. It appears to be a trend that will be around for while.

— Ken McLeod is vice president in Grubb & Ellis Company’s West Los Angeles office.

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