No one's predicting a downturn anytime soon, but the Los Angeles County real estate market's furious "bubble" runup of earlier this year is downshifting to a more balanced, moderate pace.
"Demand has retreated from frenzied to just crazy. It may seem like a subtle distinction, but it's had an impact. The deal cycle has slowed a little," said Matthew Miller, a principal at Cresa Partners and a tenant broker.
In other words, lease deals are taking weeks instead of mere days to complete and subleases are actually hitting the market, rather than being scooped up before the space is officially available.
"It's a much more controlled, calm marketplace with more reason behind it," said Ian Strano, senior vice president at First Property Realty Corp., who represents landlords. "The sizzling hot activity is gone."
The county's overall vacancy rate barely budged during the second quarter, moving down to 12.9 percent from 13 percent in the first quarter, according to Grubb & Ellis Co. Net absorption at 483,474 square feet was one-third the amount absorbed in first quarter, when tenants moved into 1.5 million square feet more than they vacated.
Ten submarkets experienced negative net absorption in the second quarter, with downtown having the dubious distinction of giving a whopping 714,804 square feet back to the market, due in part to sublease space opening up from Atlantic Richfield Co.
Rents on the rise
Despite the relatively moderate absorption, office rents continued their upward climb because little new space was added to the mix. Countywide, rents edged up from an average of $2.21 per square foot per month in the first quarter to $2.28 a foot.
"As long as occupancy rates stay flat or get better, that's fine," said Craig Silvers, senior analyst in Sutro & Co.'s research department. "When you have rising rents and occupancy declines, that's when you have a problem, when you've reached the limit."
While the market fundamentals remain strong, "demand is beginning to slow a little," Silvers said. "Part of it is due to the Nasdaq correction and focus on profitability by startup companies. Demand is still strong, but it's not overwhelming the way it has been."
Indeed, the IPO craze has cooled, and while venture capitalists are still funding startups, they've become more selective.
Regina Burke, client services manager at Grubb & Ellis, said the tapering off in activity could have a couple of possible sources.
"Part of it is because there's not a lot of space available and markets kind of breathe sometimes," Burke said. "It was a slow quarter, but it's not a trend yet."
Burke noted that employment growth remains strong, and that's a driving force of the real estate market.
"On the other hand, everyone who's been in real estate a long time knows this moves in cycles," she said. "We're watching it. It's the kind of market where there could be a change in direction. Who knows?"
Dearth of new development
Constraining the market is the fact that supply "is nowhere near adequate," Silvers said. About 3.2 million square feet of office space is under construction on an inventory of 162.6 million square feet countywide. Almost half the new building activity is concentrated on the Westside, mainly in Santa Monica, Marina del Rey and Culver City, which remain among the hottest submarkets in the county.
Santa Monica's vacancy rate is only 1.7 percent an increase from the first quarter's rock-bottom rate of 0.6 percent and the marina and Culver City have only a 3.3 percent vacancy rate.
Two projects account for much of the Westside square footage under construction: the second phase of the Water Garden in Santa Monica, which is 80 percent pre-leased, and Howard Hughes Center, where leasing activity has been brisk on a building that's still seven months from completion. The east and west San Fernando Valley are also seeing new construction, as is the Santa Clarita Valley.
Industrial developers are much busier than office developers, with 15 million square feet under construction, according to Grubb & Ellis. But with a 4.3 percent countywide industrial vacancy rate, no one seems concerned about overbuilding.
"It's one of those markets where almost everything you build is leased by the time you complete construction," said Rooney Daschbach, vice president at the Trammell Crow Co.
Jim Jacobsen, a partner at brokerage Lee & Associates, said even the retrenching by some office tenants has been more than offset by strong demand from entertainment and law firms, and well-capitalized tech companies.
"Stronger companies are making up for ones that aren't," Jacobsen said.
One notable difference today compared with a few months ago is that tenants aren't taking "huge amounts of extra space," he said. And where there used to be 10 firms competing for one deal and landlords could pass up one offer only to replace it in a matter of days, there are fewer but all credible contenders.
Those firms that did bite off more than they could chew in the first few months of the year are trying to sublease the extra space.
"There are more opportunities and subleases. People are coming and going faster than ever before," said Steve Marcussen, senior vice president at Cushman Realty Corp.
Eyeing the bottom line
Despite the rise in rents, there are signs that some tenants are becoming somewhat price-sensitive, and the huge appreciation of the last few quarters is slacking.
"Landlords continue to push the envelope and tenants are beginning to say no," said Robert Chavez, president of the L.A. division of the Staubach Co. brokerage.
Some Westside landlords are starting to realize that they overreached the market, brokers say.
"I don't think we will see rents appreciate this year to next, like they did last year to this year," said Mark Sullivan with Julien J. Studley.
While price-sensitive tenants have been willing to move south to the Howard Hughes Center and Los Angeles International Airport area, and east to hip, converted warehouse space in Hollywood, few have ventured to Mid-Wilshire or downtown.
"We just haven't crossed the great divide," Sullivan said. "Tenants were willing to go to Miracle Mile, but that's leased."
Trouble remains downtown
Downtown's office market can't seem to shake its prolonged slump, despite some positive developments. The vacancy rate inched up to 22.2 percent in the second quarter from 20.4 percent in the first. The softening occurred in spite of leasing by telecom companies, and against a backdrop of large-scale new projects.
The good news is that those projects do not consist of office buildings, they are cultural and religious landmarks-in-the-making the Disney Concert Hall and Cathedral of Our Lady of the Angels, respectively. The bad news is that those kinds of projects, while exciting, don't necessarily translate into an improved office market. Not yet, anyway.
One bright spot for downtown landlords is that the relatively high vacancy rate hasn't dampened rent appreciation. The average monthly asking rental rate rose from $2.06 per square foot in the first quarter to $2.11 in the second, an indication that tenants are willing to pay a little more, especially in light of the disparity with Westside rents.
The real development action downtown, aside from the two major projects, is in the residential sector. In early July, G.H. Palmer Associates opened the first 92 units of its Medici apartment complex on Seventh Street just west of the Harbor (110) Freeway, and nearly all the units were immediately leased, with a waiting list for the next 120 units, which are to open in mid-August. This comes despite rents that start at $1,200 a month for a one-bedroom apartment.
Over in the Old Bank District, Gilmore Associates plans to welcome its first tenants in mid-August as well, and several other apartment and loft projects are in the works.
The largest by far is Lennar Corp.'s still preliminary plans to assemble as much as 25 blocks near Staples Center for a sprawling residential development.
"I'm very optimistic and bullish. We're finally working toward having a 24-hour downtown. Restaurants are full," Marcussen said. "All these pieces add up."
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