SLOWDOWN—Restrained Market Braced to Endure Slowing Economy

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Businesses are downsizing, lenders are skittish and Westside tech companies have packed up, leaving a ton of sublease space available in their wake. It’s the kind of situation that should strike fear in the hearts of landlords, property managers and developers. Except for one major difference: The lessons of the previous economic slowdown have stuck.

While talk of a national economic downturn is rife, many local industry observers agree that Los Angeles real estate will be insulated from any coming slump by the restraint that has prevented the sort of overbuilding that took place in the 1980s. That discipline, the officials concur, will prevent an abundance of space coming into the market only to sit vacant for the duration of the coming economic struggle.

“The nice thing that’s going on in this market is there is not a lot of space under construction and much of that space is committed,” said John Miller, regional president of developer Legacy Partners Commercial.

It wasn’t dumb luck or any particular acumen on the part of developers, however, that kept them from going out and putting up buildings on spec when the economy recovered in the later years of the last decade, Miller said.

By holding the reins on lending, traditional financing sources compelled developers to slow down and take a long look, particularly when pondering a speculative project.

“Lenders didn’t turn on the spigots, political and entitlement approvals got much harder (to obtain), and we had oversupply from the last building splurge,” said Larry Kosmont, a partner in real estate consulting firm Kosmont Partners.

Even without much new construction over the last several years, the Westside still will struggle to recover from the dot-com fallout, according to Hunt Barnett, senior managing director at Insignia/ESG. According to his calculations, there are about 1 million square feet of sublease space available on the Westside (others claim it’s twice that) and there has been slow activity in filling it so far this year. Barnett predicted, at best, a flat market and, at worst, a decline of as much as 15 percent in rental rates on the Westside for the remainder of the year.

“We’re still seeing a sizeable disconnect between the expectations of tenants which is that the market has come down dramatically and the expectations of landlords that life is still beautiful,” he said.

Reality is somewhere between those extremes, according to Barnett, but more landlords are beginning to change their tunes and are negotiating with more realistic goals than they once achieved.

“The good news is on the supply side,” said Stuart Gabriel, director of the Lusk Center for Real Estate at USC. “We are not overbuilt and are not nearly at risk of imbalance.”

Lack of overbuilding isn’t the only factor that could work to protect the region from big jumps in real estate vacancy rates. With an economy more diverse now than it was during the 1980s, when defense ruled the roost, the region can more easily survive industry-specific hits than it did when the defense industry downsized.

Cody Plott, president and CEO of Colliers Seeley International Inc., calls it a “Pillsbury Doughboy” effect “what shrinks in one area will come back in another” and it’s that effect he believes will rekindle a once-hot Westside market that has dramatically softened.

However, Jonathan Larsen, senior vice president at Trammell Crow Co., said the Westside is not out of the woods yet.

“I just think there’s some sublease space and direct space (available) and there’s not that many solid new companies coming into Los Angeles right now,” Larsen said. “If the landlords are willing to modify rents, they’re going to lease it, but if they don’t, tenants are going to go looking elsewhere.”

“I think entertainment will make up for (the dot-com fallout),” Plott said. “The resilience of our diverse economy has shown us that there is a step up in certain areas to offset downturns in other areas.”

Even if there’s a Hollywood strike?

“I’m not an expert on that, but strikes are viewed as temporary,” Plott said. “They’re not viewed as long-term economic pushers. Strikes can last days, even hours sometimes.”


Retail warning signs

While tenant diversity and constrained supply might protect the office and industrial sectors from severe softening, the retail sector may not be so fortunate.

Kosmont said there is a real danger of retail development outpacing the number of shoppers and the thickness of their wallets. Abundant retail development in the San Fernando Valley could end up with shopping centers in that region cannibalizing each other, as they fight over the finite pool of patrons.

The largest development in the region is Zelman Development Co.’s 103-acre Burbank Empire Center project that will transform a former aircraft manufacturing site near the Golden State (5) Freeway into a 750,000-square-foot retail center, with an additional 400,000 square feet of office space and two hotels.

“Burbank may become over-retailed with this new project. It’s fully leased, but that’s a lot of retail,” Kosmont said.

Another potentially vulnerable property type, depending on whom you talk to, is what agent Steve Marcussen calls “neighborhood office buildings.” Marcussen, executive vice president at Cushman Realty Corp., said office space on streets without prestigious names could lose tenants if sublease space lowers rents in the more-established business centers.

But Mark Berman, executive vice president for Coldwell Banker Commercial Westmac, disagreed.

“The bottom line is that whether a tenant goes to Sawtelle (Boulevard) or Barrington (Avenue) or Wilshire (Boulevard) or Olympic (Boulevard) is not a function of the address,” he said. “If there’s a softening of rental rates, that’s going to be generally across the marketplace. If the rent on Wilshire decreases, the rent on Barrington will decrease accordingly.”

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