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R.E. OVERVIEW/31″/1stjc/mark2nd

By JOYZELLE DAVIS

Staff Reporter

The real estate market got off to a comparatively slow start in 1998, considering the robust pace of leasing and investment activity at the end of last year.

The Los Angeles County vacancy rate remained virtually static, tightening to just .1 percent to 16.7 percent for the first quarter. Rents moved up slightly to a monthly weighted average asking rate of $1.67, up from $1.63 last quarter. (The weighted average adjusts for the amount of space available at that rent in each market.)

The lull was more a quirk of timing than a sign of impending trouble, real estate analysts say. There are a number of major leases under negotiation right now: most of the big accounting firms are selecting their new buildings in downtown, financial services firms are expanding, and several entertainment companies are shopping for new homes.

“There’s a ton of activity that’s going to land in the next six months,” said Brad Cox, director of Cushman & Wakefield Inc.

Where that activity lands, though, depends on what development proposals takes off. There is more than 2.5 million square feet of commercial development on the boards for the Westside, and that doesn’t include the 3 million-square-foot Playa Vista project.

The marketing campaign for Playa Vista will begin in earnest this spring. Meanwhile, DreamWorks SKG and the Playa Vista’s ownership group continue to negotiate whether the studio will build its headquarters there. The possible outcome of those discussions remains a “wild card” for the entertainment-heavy markets of the Westside and Burbank, Cox said.

If DreamWorks commits to Playa Vista, the studio’s space in Universal City and its smaller slots on the Westside and the San Fernando Valley will eventually return to the market. In addition, other media and high-tech companies mulling over new quarters (E! Entertainment, Candle Corp. and Carsey-Werner Co. are often-mentioned candidates) might commit to Playa Vista.

Or they might go elsewhere. There is more than 2.5 million square feet of development on board for the Westside, excluding Playa Vista. There’s another 2 million square feet entitled for construction in Burbank and Glendale. And there are millions of square feet of converted warehouses that never get figured into the office market data base.

Developers are starting to make the argument that it is cheaper to build new buildings than buy existing product. Kilroy Realty Corp. has four development projects across the county in the works, totaling $350 million.

The company looks for markets where there are barriers to entry, strong tenant demand and a growing economic base, according to John Kilroy Jr., president of Kilroy Realty Corp.

“Our leasing and development activity is the best we’ve ever seen,” he said.

The popular markets, where all of the development activity is occurring, got even more crowded last quarter. The Westside, Santa Clarita Valley and Conejo Valley market, which is home to many high-tech and financial service companies, ratcheted down their vacancy rates last quarter.

In the Conejo Valley, for example, the vacancy rate firmed to 12 percent from 13.2 percent last quarter. Beverly Hills had one of the most dramatic increases, hitting 9.9 percent from 12.6 percent at the end of last year.

Conversely, one of the normally hottest markets cooled a bit last quarter. The Tri-Cities area of Burbank, Glendale and Pasadena saw its vacancy rate rise to 11.3 percent in the first quarter, up from 10 percent in the fourth quarter. The market was dragged down by the announcement that three major tenants would not renew large blocks of space in Glendale. That, in turn, dragged on the leasing activity of two speculative projects under construction in that city. And a third project that was slated to break ground in the Burbank Media District still lies quiet and devoid of any tenant pre-leases.

As space becomes more expensive in those hot markets, adjacent office districts are expected to benefit as tenants seek lower cost alternatives. But that hasn’t really happened yet. Although the Mid-Wilshire market, downtown and the downtown Long Beach markets showed net absorption last quarter, the Los Angeles International Airport office corridor and West San Fernando Valley markets both lost tenants last quarter.

But as brokers like to note, there are nuances within each market. The Park Mile/Miracle Mile area lost about 17,000 square feet in tenants last quarter, but some buildings within the office corridor reported their best quarters ever.

Scott Murphy, a leasing representative with Prentiss Properties Limited Inc. that represents the 6500 Wilshire building, said he felt confident enough last quarter to hold out for higher rental rates. The management bumped its rates by 25 percent last year to a monthly asking rate of $2 per square foot.

“We’ve seen a lot of tenants come our way because the prices on the Westside are just getting ridiculous,” he said, noting that the Beverly Hills-adjacent office building signed 100,000 square feet in lease renewals and expansions last quarter.

The Westside posted a monthly average asking rental rate of $1.99 per square foot, up from $1.98 in the fourth quarter. But the true rental rate is not reflected in a snapshot statistic. Escalator clauses, such as inflation indexes, are now commonplace on the Westside.

“Once you bake those mid-term bumps in,” said Jerry Porter, president of the commercial brokerage firm Metrospace/CRESA, “the real rent is a lot higher.”

While the Westside is unequivocally a landlord’s market, the status of downtown the county’s largest office market with almost 30 million square feet remains in flux.

Growth among existing financial services firms and law firms chipped away at some of the empty space, pushing the vacancy rate to 18.2 percent, compared with 18.9 percent for the fourth quarter.

Most of the big accounting firms laid claim to the major remaining blocks of space in the Bunker Hill trophy towers last quarter, but some space remains available in Citicorp Center and First Interstate Tower.

Nonetheless, downtown is expected to be the epicenter of investment activity for the rest of the year. Groundbreaking took place last quarter for the Staples Center sports arena, which is expected to give an after-hours life to what has been strictly a 9-to-5 district.

Most of the other investment quality office buildings in the county are going for prices at or above replacement cost (meaning that it is less expensive to develop a new building than to purchase an existing structure).

“Everyone’s standing outside the pond waiting to jump in,” said Steve Marcussen, senior vice president at Cushman Realty Corp. “Downtown is perhaps the last lagging market in the country, the last value play for a lot of investors.”

So what’s stopping them from jumping in? Just a few building sales closed last quarter (the 275,000-square-foot Wilshire Bixel building was the most notable), and a few more came under contract (801 Tower and Figueroa Plaza).

Marcussen said the leasing activity isn’t quite solid enough to deliver the predictable cash flow that real estate investment trusts want to see before they buy. So far, Equity Office Properties Trust is the only REIT to invest in downtown.

The Chicago-based REIT has firmed up its rental rates and successfully leased up its two downtown office properties, 550 S. Hope and 2 Cal Plaza.

Not surprisingly, Equity is still bullish on the market.

“People are finally starting to realize that downtown is one of the financial centers of the world,” said Peter Adams, senior vice president at the Chicago-based REIT. “It’s been fashionable for so long to bash L.A. and downtown, that people had forgotten its fundamental strengths.”

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