MARKET HIGHLIGHT, OCTOBER 2009

LOS ANGELES
Michael Gold, Scott Burns and Ronald Harris

Falling demand means L.A.’s big city lights aren’t shining at their brightest.

Office

Following trends in the larger U.S. and global economy, conditions in the Los Angeles office market continued to deteriorate though the summer of 2009. Los Angeles County’s unemployment rate reached 11.9 percent in July, up from 7.7 percent 1 year earlier, and the Bureau of Labor Statistics (BLS) estimated that 172,100 non-farm jobs were lost between July 2008 and July 2009. Area companies have conceded to a difficult business environment and lower revenue forecasts by shedding employees in record numbers and in turn reducing their need for office space.

At mid-year 2009, total vacancy was 14.7 percent, up significantly from 12.5 percent at the end of 2008. The market experienced negative net absorption of 3.3 million square feet through the first half of the year, and preliminary third quarter data indicates that vacancy continues to rise, albeit at a slower pace than has been witnessed during the past 18 months.

While previous real estate downturns in Los Angeles were triggered by excessive speculative office construction, the current rise in vacancy has stemmed from a collapse in demand. Construction has been relatively limited in the current cycle, however a handful of large projects have been delivered this year: most notably The Pointe (480,000 square feet) and 2300 W Empire Ave. (351,000 square feet) in Burbank, 207 Goode Ave. (188,000 square feet) in Glendale and the Horizon at Playa Vista project (466,000 square feet) on L.A.’s west side. Availability in these projects is currently in excess of 70 percent. Falling rents along with high barriers to entry will discourage new development for some time to come.

Rental rates in Los Angeles’ office market reached a peak of $2.91 per square feet gross in mid-2008 and have been declining for the past year. At mid-year 2009, the average asking rate for direct space was $2.75 per square feet gross, a decline of 5.5 percent below peak rents. Landlords have been slow to reduce asking rates, instead opting for generous concession packages. However, it appears that owners have finally succumbed to market realities and are lowering rents to attract and retain the limited number of tenants in the market.

General expectations of economic recovery have been pushed into 2010; as a result, vacancy is forecast to increase well into next year. A number of distressed assets are beginning to trade at a discount; new owners are purchasing these buildings at lower pro formas and will likely have have more flexibility to reduce rental rates. According to industry data provider Reis, asking rents in the Los Angeles office market will fall by 9.5 percent and effective rents by 13.2 percent by the end of 2010.

— Michael Gold is a senior research analyst at UGL Equis in Los Angeles.

Industrial

At nearly 1 billion square feet, the Los Angeles industrial market is one of the largest in the nation, and despite increasing vacancy in the past year, it remains one of the tightest. The BLS has estimated that 172,100 non-farm jobs were lost between July 2008 and July 2009. Industrial-oriented jobs have been among the hardest hit during the past 12 months. These include losses in trade, transportation and utilities (39,900); manufacturing (36,200); and construction (18,000) jobs. Slowing trade and reduced consumer spending is largely responsible for lower industrial demand in 2009.  

At the Port of Los Angeles, year-to-date TEU (Twenty-Foot Equivalent Unit) volume through August was 18.3 percent lower than the same period in 2008, and at the Port of Long Beach the TEU volume has declined 21.7 percent from 2008 levels. Container activity at the Los Angeles/Long Beach port complex peaked in 2006 when 15.76 million TEUs were handled. The forecast for 2009 is for 12.2 million TEUs, a decline of 22.6 percent.

At mid-year 2009, total vacancy was 4.6 percent, up from 3.5 percent at the end of 2008. While vacancy remains low, availability has surpassed 9 percent, the highest rate in more than 5 years. This signals that vacancy will rise further in the near-term.

With falling demand, the market has experienced negative net absorption totaling 12.1 million square feet year-to-date. Net absorption is forecast to remain negative though the end of 2009. Fortunately, new construction has been severely limited due to lack of land and the high cost for any available land. This will keep vacancy rates at healthy levels though the current downturn, yet the market has still shifted in favor of tenants. Tenants are being cautious, and there is no sense of urgency as they anticipate rents to fall further. The current average asking rate for direct warehouse space is $0.61 per square foot NNN, down from $0.66 a year ago.

Forecasts indicate that the recession and its effect on international trade as well as manufacturing are expected to level out in late 2009, with modest economic growth returning in 2010. Vacancy is projected to increase moderately and rents to decline though 2010. Since the Los Angeles industrial market is coming off of extremely tight conditions, this correction will bring welcome relief to companies in need of industrial space as the economy improves in the coming year.

— Michael Gold is a senior research analyst at UGL Equis in Los Angeles.

Retail

The Los Angeles retail market continues to feel the effects of economic slowdown and the pull-back in consumer spending. New development is virtually nonexistent due to lack of tenant demand, abundance of available space in every size range and developer’s lack of ability to finance and underwrite new projects.

The prominent leasing trend is preservation of cash flow through direct focus on maintaining and increasing occupancy as opposed to value enhancement, refinancing or sales. Property owners are pursuing short-term leases where available. Walmart, The Home Depot and Winco will take some of the available large-format box space. Other than that though, there are only a few specialty grocery stores, health clubs and other national or regional retailers actively pursuing the large vacancies.

Vacancy rates in neighborhood shopping centers have increased from 2 to 3 percent to 6 to 7 percent. Rents in -A/B+ markets are down 20 to 25 percent, with further declines. Former single-tenant pad buildings formerly occupied by banks and video stores have few tenant replacements.

In investment sales, there is a very select group of buyers in this market that have specific plans to acquire assets. Deals are starting to get done, but most investors are waiting until they believe that values don’t have farther to fall. With little to no transactions in the anchored shopping center space, it has become increasingly difficult for owners with loans coming due to secure acceptable takeout financing without infusing fresh equity into the deal. Appraisers are not coming back with valuations that are even close to what owners believe their asset is worth. Any deals getting done this year were clearly done with buyers that were willing to stretch significantly for quality at the risk of sacrificing yield.

Expect to see vacancy rates in the shops, multi-tenant pads and in-line retail space to remain largely unchanged during the rest of 2009. Overall vacancy rates should stabilize and possibly decline as some of the larger box retailers continue to absorb the higher quality space. Rental rates for all size ranges should stabilize and remain at the current levels, while retailers likely turn their focus towards the upcoming holiday season and their 2010 and 2011 expansion programs. These are tough times if you bought anything between 2004 and 2007 and need to sell or refinance today. As banks sell properties into this market, pricing will continue to deteriorate, but owners with a low basis and long-term debt will have staying power.

— Scott Burns is a senior vice president at Wilson Commercial Real Estate in Los Angeles.

Multifamily

Only 1,900 apartments are projected to come online this year, down from nearly 4,600 units in 2008. This year’s deliveries will represent only a 0.2 percent addition to inventory. Despite subdued completions, however, the vacancy rate in Los Angeles County is forecast to reach 5.9 percent by year’s end, a 160 basis-point increase.

As demand wanes, operators will lower rents and increase concessions in order to attract and retain renters. In 2009, asking rents are expected to fall 4.1 percent to $1,403 per month, while effective rents are forecast to drop 6.4 percent to $1,320 per month. Last year, asking and effective rents advanced 2.6 percent and 2.1 percent, respectively.

Sales velocity has declined 49 percent year-to-date compared with the same period in 2008. Prices have slowly declined in recent quarters. In the past 12 months, the median price was $132,500 per unit, down 4 percent from the prior year. Thus far in 2009, the median price has been $128,500, 6 percent lower than in the first half of last year.

— Ronald Harris is a senior vice president, investments, in Marcus & Millichap’s Los Angeles office.

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