The commercial real estate market lurched into hyperdrive in the first quarter, with tenants devouring office and industrial space throughout Los Angeles County and rents exceeding their past peak on the Westside.
"The market's really entered into near hysterical proportions. Many brokers around town remind me of taxicab drivers in a hurry," said Carl Muhlstein, vice president at Cushman Realty Corp. "Space is disappearing and entitled land is becoming even a rarer commodity."
With the level of new construction far short of demand by fast-growing dot-coms, telecom firms and even a few "Old Economy" companies, office tenants in L.A. County moved into 1.5 million more square feet of space than they vacated during the quarter, according to Grubb & Ellis Co. That's about 300,000 more square feet than L.A. County tenants absorbed in the first quarter last year.
Industrial tenants were even hungrier, leasing or buying 10.6 million square feet in the quarter from the San Gabriel Valley to Ventura County. Developers are frantically trying to keep pace, with 10.3 million square feet of industrial space currently under construction.
It's little surprise then that rents continued inching up while vacancies maintained their downward slide. Overall, the average monthly office asking rent climbed to $2.23 per square foot countywide, up from $2.18 in the fourth quarter of 1999. The countywide office vacancy rate slid to 12.5 percent in the first quarter, down from 16.7 percent in the fourth.
But those numbers belie exactly how hot the market is in certain areas, chiefly the Westside, where monthly asking rents are flirting with $4 a foot for top-tier buildings.
Meanwhile, the office markets in downtown L.A., Mid-Wilshire, Century Boulevard and the San Gabriel Valley still have a lot of catching up to do, although each area tightened in the quarter.
Pockets of activity
Out of 27 submarkets tracked by Grubb & Ellis, only five had negative net absorption for the first quarter (meaning more space was vacated than moved into). In three of those submarkets the West San Fernando, Conejo and Santa Clarita valleys the amount was extremely small and attributed to movement around the market, said Regina Burke, client services manager at Grubb & Ellis.
Westwood and Central Torrance had more-sizable negative net absorption, but only because tenants have signed leases but not yet actually moved into 1100 Glendon Ave. in Westwood and the former Epson headquarters in Torrance, Burke said.
Downtown had positive net absorption but can't seem to get its vacancy rate down from around 19 percent. Almost 900,000 square feet of sublease space is still weighing on that market, as well, as a result of corporate mergers and acquisitions, Burke said. But new tenants, including TelePacific Communications, are slowly chipping away at the glut.
Also, telecom companies continue to lease space in older high-rises, and a handful of dot-coms are setting up shop. EStyle Inc. is in the process of expanding its space at 865 S. Figueroa St. which is almost full for the first time in nine years.
"Downtown's getting ready to explode. They're coming. We were waiting for all the Old Economy companies to show up and they're not. It's over. The New Economy is getting ready," said Steve Marcussen, senior vice president at Cushman Realty.
One of the most significant deals to hit downtown in recent months could bring a lot more tech tenants. Infomart Holdings unveiled a $60 million proposal to purchase and redevelop the 60-year-old U.S. Postal Service Terminal Annex into a facility for technology, telecom and e-commerce tenants, with 1,000 jobs projected.
But that's in the future. The real action today continues to unfold on the Westside, which has the talent pool, amenities and creative office space that dot-coms crave but little is available.
Running out of space
The Westside's highest vacancy rate 7.2 percent in Beverly Hills would be enviable in most other places. And Santa Monica is essentially out of space, with a vacancy rate of 1.9 percent.
"The Westside is just on fire. People are going on Slauson, where no one would go before," Marcussen said.
Even the most Old Economy-oriented submarket on the Westside, Century City, has little space, at 5.0 percent vacancy. The biggest lease deal of the quarter there was Fox Entertainment Group's $275 million renewal at Fox Plaza.
At $3.20-$3.50 per square foot, it seems like Fox got a good deal, considering asking rents at Westwood Gateway, Lantana Center and MGM Plaza in Santa Monica are moving close to $4 per square foot, a price that formerly only the ocean-view 100 Wilshire tower could command. For most tech-oriented tenants, price is a secondary consideration to location, functionality and how quickly they can get up and running.
"There are two schools of thought. One is that these are the highest rents we've ever had and they won't go higher, which I discount," Marcussen said. "The other side of the coin is that rents are $10 per square foot in San Francisco, so West L.A. being on the way to $4 looks like a bargain."
Robert Chavez, president of the Staubach Co.'s L.A. division, said he doesn't see prices escalating forever because there are just too many alternatives, including downtown and Mid-Wilshire.
"A few landlords are starting to say, ('There's no rate that) tenants aren't willing to pay.' That's a little overzealous," Chavez said. "There's always someplace else to go that's less expensive."
Indeed, price-conscious tenants have ventured beyond the traditional confines of the Westside, to Howard Hughes Center, Torrance, El Segundo and elsewhere in the South Bay. Arden Realty Inc. recently began construction of a 12-story office building at Howard Hughes Center a year ahead of projections because of the strong leasing activity on another building currently under construction there.
"The Westside has expanded itself out from the perspective of tenants to include Howard Hughes, which was never considered by most tenants. The cutoff was Marina del Rey as recently as the last six months," said Bradley Gross, vice president at Lee & Associates.
It's not just affordable rents that are drawing tenants southward; it's also the large amount of available space in these areas. Gross said he counted close to 30 blocks of space greater than 60,000 square feet along the 405 corridor, mostly clustered in El Segundo, LAX and farther south in the South Bay, including some former aerospace facilities.
"There are very few opportunities for what is traditionally considered creative space (on the Westside)," Gross said.
As strong as the market is, there is relatively little new development. Countywide, 2.8 million square feet of office space is under construction a drop in the bucket compared to the overall inventory of nearly 160 million square feet.
The new space should be absorbed handily if current trends continue. About 40 percent of the new space under construction in the Santa Clarita and San Fernando valleys is already preleased, and 90 percent of West L.A.'s space under construction is preleased, according to Grubb & Ellis.
The dearth of new office construction becomes clear by considering that a market is said to be in balance when the amount of new space under construction is sufficient to handle three years worth of tenant absorption. Given current absorption rates, L.A. County should have about 18 million square feet of new office space under construction, rather than 2.8 million square feet.
The development scene
Boding well for the county's softest office markets, none of the new space is under construction there. Downtown, Wilshire Center, the South Bay and San Gabriel Valley are all devoid of office construction activity. The action is almost exclusively concentrated in the San Fernando Valley and on the Westside.
The Water Garden's second phase in Santa Monica is essentially all spoken for, with more potential deals than space available. And Hines has three suitors for its Lantana West project in Santa Monica and hopes to start construction on the remaining low-rise buildings by the end of the year.
Also on the horizon: Sunset Millennium in West Hollywood, Playa Vista in Playa del Rey and a new tower in Century City by JMB Realty Corp., none of which are under construction yet.
The jury is still out on two other projects that are trying to reinvent themselves amid a hot market: Spieker Properties' re-christened Santa Monica Gateway the green building alongside the San Diego (405) Freeway in West L.A. that sat unfinished for more than a decade and the Pacific Design Center in West Hollywood, which is looking to bolster its office roster, but is far from major freeways.
Some observers chalk up the conservative approach to new construction to memories of the last building boom, which was a major factor in the real estate recession of the early to mid-1990s. Preleasing and equity requirements for new projects are more stringent than in the past, and developers now know only too well that by the time a proposed project becomes a reality, the market can turn.
"Developers certainly don't want to get caught in a downturn," Chavez said. "It's not like the sky is full of cranes now."
Also hovering over the good news is a topsy-turvy Nasdaq stock market and the almost-certain consolidation among L.A. dot-coms. Smart landlords are keenly aware of the potential for blocks of sublease space to come on the market, should just a few tenants merge or be acquired.
"It's fueling a lot of absorption," Burke said of the dot-coms' growth. "(Landlords) are nervous if they see they're really dependent on that tenant profile."
Another sector where strong demand and limited supply are fueling rent hikes is the apartment market. Average rents countywide increased by 1.7 percent in the first quarter, to $808 a month, according to Marcus & Millichap. The vacancy rate stands at about 5 percent.
Responding to the tight market conditions, developers are building large projects in downtown, the Westside, San Fernando Valley and Fairfax District. But with available land scarce, rehabs and smaller infill projects are more the order of the day in most areas. Also, most of the new apartment construction is at the high end of the spectrum, which is some cause for concern, industry observers said.
"Construction going on now is nowhere near satisfying the demand for housing, especially if the economy continues this good," said Maya Mouawad, a division research manager at Marcus & Millichap.
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