L.A. COUNTY: Office Market Softens as Credit Crunch Slows Dealmaking

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Fallout from the subprime meltdown has finally put the brakes on Los Angeles County’s once torrid office market. First quarter rent increases slowed to a crawl and tenants gave back more space than they leased for the second quarter in a row.

Even so, landlords managed to raise Class A asking rents a penny to $3.50 per square foot since the end of the year, putting lease rates 16 percent higher than a year ago, according to Grubb & Ellis Co.

It’s unclear, though, how long those rents can be sustained.

The county’s vacancy rate inched up to 10.1 percent compared with 9.7 percent at year’s end and 9.5 percent in the first quarter of 2007 as 626,895 square feet of space was put back on the market.

Submarkets from the Santa Clarita Valley to the South Bay experienced negative net absorption, meaning there was less space occupied at the end of the quarter than at the beginning. Only a handful of areas, including Hollywood-West Hollywood, Century City, downtown and El Segundo, saw the amount of vacant space decrease.

Indeed, more tenants appeared to be taking off for cheaper digs before their leases even ended. By the end of the first quarter, nearly 4 million square feet of space was available for sublease, around 21 percent of the total available space in the county, according to Grubb & Ellis.

“The market is definitely turning,” said J.C. Casillas, client services manager at Grubb & Ellis Research Services.

High rental rates and a slowing economy were the primary drags on the market. A protracted Writers Guild of America strike also appeared to be a factor in several media-related companies vacating space in the quarter. The result: a see-saw marketplace.

Vacancy rates rose in Santa Monica and Westwood, but fell in Century City, where asking rents dropped 6 cents to $5.08. In Santa Monica, asking rents continued to stay above the $6 level even adding 8 cents to reach an average of $6.11 but Westwood saw rents dip below that threshold, falling 11 cents to $5.94.

“Companies here are still healthy, but they’re just not growing and expanding the way they were over the last two years,” said Eric Olofson, vice chairman at Cushman & Wakefield. “The situation where landlords were able to increase rents every time a new deal was signed we’re probably at the end of that for the foreseeable future.”

Conversely, Westside tenants fleeing to the more affordable downtown market helped push up asking rents there by 14 cents from the previous quarter to $3.14. That’s close to 9 percent higher than a year ago.

In the trendy Hollywood-West Hollywood submarket where the vacancy rate over the past year has fallen to 3.9 percent from 5 percent asking rents are now 38 percent higher at $4.45. That’s up 37 cents from the fourth quarter.

It was a different story over the hill, where entertainment companies and mortgage lenders like Countrywide Financial Corp. continue to scale back operations in the valleys. Vacancy rates in Tri-Cities’ Burbank rose to 5.7 percent from 3.8 percent, and were up to 12 percent from 10.1 percent in Pasadena.

Glendale, with its cheaper rents, was the only Tri-Cities community not experiencing negative net absorption in the quarter; its vacancy rate fell to 12 percent from 14.1 percent. For example, 505 N. Brand in Glendale, a 16-story, 320,000-square-foot office tower, had more than $6 million in leasing. New tenants include American Imaging Management, a subsidiary of Indiana-based WellPoint Inc.

Glendale also became even more affordable as landlords lowered their expectations. Asking rents, while still 18 cents higher than a year ago, fell 3 cents from the fourth quarter to $2.89. Burbank rents were unchanged; Pasadena rents dropped 44 cents to $3.50, but were still the highest in the Tri-Cities.

Rents to the east also were a mixed bag, falling in the Santa Clarita Valley, East Valley and Ventura County’s Conejo Valley, but rising slightly in the Central Valley and West Valley. Notable lease deals were modest, among them ACE Insurance taking 27,184 square feet in the West Valley Corporate Center in Northridge, a complex once owned by financially struggling Washington Mutual.

In the investment market, the most activity occurred toward the end of the quarter after the Federal Reserve lowered interest rates in an effort to ease the credit squeeze.

The standout deal in the quarter was the $610 million purchase by Douglas Emmett Inc. of an Arden Realty Inc. portfolio of six office buildings in West and North Los Angeles.

Because leverage continues to get harder to come by, Darrell Levonian, executive managing officer at Charles Dunn Co., believes more owners may need to think in terms of selling off larger portfolios in smaller chunks to buyers who won’t need much extra financing.

“While it’s harder on the debt side, there’s plenty of equity out there chasing quality, well-positioned, and well-located real estate across the board,” Levonian said.

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