The “dot-bomb” implosion started a chain reaction that weakened the Westside office market during the fourth quarter, but the shock waves haven’t hit in the rest of the county.
Countywide, office vacancy rates continued to drop and rents continued to rise in the last three months of 2000, despite the widening effects of Internet companies going out of business, soaring energy prices and more widespread concerns about how much a slowing national economy is likely to impact Los Angeles.
The overall vacancy rate in office buildings countywide was 11.8 percent as of the end of the fourth quarter, down from 12.3 percent in the third quarter and down from 16.7 percent at year-end 1999, according to Grubb & Ellis Co.
Countywide, the average monthly office asking rent during the fourth quarter was $2.36 per square foot, up from $2.29 in the third quarter and from $2.18 in fourth quarter of 1999, back when Y2K fears were rampant and the dot-com frenzy was at its height.
But arguably the most memorable fourth-quarter action was on the Westside, L.A.’s largest and until recently hottest office market. More than 625,000 more square feet came onto the market than was leased up during the fourth quarter, according to Grubb & Ellis. That “negative net absorption” can be attributed in large part to Internet and tech start-up companies going out of business.
For now at least, the Tri-Cities market (Burbank, Pasadena and Glendale) has overtaken the Westside as the area with the lowest office vacancy rate in L.A. County.
Meanwhile, those who rode the Westside bubble during the dot-com frenzy now reflect on the “good old days” of a few months ago.
“That was the best Disneyland ride I ever had. It was a blast,” said Ian Strano, senior vice president at First Property Realty Corp. “Unfortunately there are people now that are going to get hurt. We’ve advised every one of our clients that they’re in a changing market. Those landlords who don’t alter or don’t move with the changing market, those guys who are going to stand firm, will be the landlords that are affected.”
But placing too much emphasis on the Westside’s Internet-related weakness distorts the bigger picture. Strong leasing activity in other markets far outpaced the Westside weakening.
“One of the ironies for us is we have more transactions in process now than we have had in the history of the company,” said Jerry Porter, vice chairman of Cresa Partners. “But they’re for the most part not West L.A.-based. The bubble has burst, and everybody (on the Westside) is going to suffer as a result. Santa Monica and its peripheral markets are going to feel it over the next 12 months. But it’s in the context of a healthy economic climate in a growth environment in Southern California. In two or three years, you won’t notice this has come and gone.”
Porter said Cresa Partners expects to shortly announce a number of deals that involve biomedical research, networking infrastructure and software companies expanding into larger spaces. Still, he admitted, “it’s also the case that all of these companies are suffering. It’s putting in jeopardy all of the transactions.”
Landlords who leased to dot-com companies are likely to have the most trouble weathering the next year or two. But few expect to see the level of bankruptcies that swept real estate during the recession of the early ’90s.
“The financing requirements were a lot tougher (in the early 1990s),” said Rob Langer, managing partner of Meringoff Equities, a New York City-based commercial property owner that owns a lot of office product in Hollywood. “Buyers didn’t overpay by as much as they could have (during the fourth quarter of 2000). They’re going to have a tougher time making the numbers work, but you’re not going to see nearly as many buildings going into bankruptcy or being taken back.”
Even markets where rents are declining from their recent peaks will see rents stabilize at a level above where they where at the end of 1999, noted Craig Silvers, a real estate analyst with Sutro & Co.
Bargain hunting
Deals inked in the high-vacancy submarkets of Wilshire Center and downtown L.A., the stars of the fourth quarter in terms of leasing activity, accounted for more than half of all absorption in the county during the fourth quarter.
Combined, more than 1.1 million square feet of office space was absorbed in the fourth quarter, meaning that much more space was occupied at the end of the quarter than at the beginning. In all of 2000, L.A. absorbed 4.8 million square feet of class-A office space in 2000, almost the same as the 5.0 million square feet absorbed in 1999.
Clay Hammerstein, senior managing director with Insignia/ESG, predicted that downtown L.A. would finally see its office vacancy rate drop in 2001 now that a wave of corporate mergers has come to an end.
“I think there has always been relatively robust leasing activity,” Hammerstein said. “It’s just been overshadowed by all the space we continued to dump onto the market.”
He further said that a large number of leases will rollover in the next two or three years, prompting a lot of companies to think carefully about where to locate. “There are significant tenants in the market right now,” Hammerstein said. “I think there’s going to be a lot of moving chairs. My take on it is that, if the economy cools down considerably, tenants are going to be much more price sensitive than they have been in the past. As long as there is a price difference between West L.A. and downtown, some firms will start to look downtown.”
Weak spots in the local office sector include downtown Long Beach, Burbank and Carson, where the fourth-quarter vacancy increased and rents remained flat or decreased.
Submarkets like Pasadena and the Conejo Valley have continued to perform well. “The growth out in those markets is in large part because of the affordable housing, quality of life and the ability to hire and retain employees,” Porter said.
Westside rents may drop
Although asking rents on the Westside peaked above $3 in the fourth quarter, many industry observers expect Westside rents to drop in the first half of 2001. Monthly asking rents peaked at an average of $3.77 per square foot in Santa Monica, but that once-superheated submarket had more than 245,000 square feet of office space come back onto the market during the fourth quarter.
The overall Westside office vacancy rate rose to 7.8 percent in the fourth quarter, up from 6.4 percent in the previous quarter. Industry observers expect that trend to continue through the first half of 2001 and that landlords will respond by lowering their asking rents.
“There are still more (Internet companies) today that most assuredly will not be in business in three, fourth months,” Silvers said. “Then what you’re going to see is the Old Economy businesses that have been locked out of the market will start coming back to the market slowly.”
Porter estimates that another 500,000 square feet of Westside office space will come onto the market in the first half of 2001, though he doubts that the vacancy rate will rise to the 10.5 percent level posted at the end of 1999.
“I think we’re going to be shocked to see the dearth of demand behind these companies,” Porter said. “Many of these traditional service-type companies have expanded as a result of these high-growth companies, and they’re being forced to retrench. Think of all the investment bankers and (venture capitalists) and attorneys. That’s all lost revenue to them right now.”
The effect of the “dot-bomb” has primarily been seen in “creative” office space, mostly west of the San Diego (405) Freeway, said Jeff Resnick, president of First Property Realty Corp. Since the types of tenants most interested in that kind of space are entertainment companies, pending strikes in the entertainment industry will likely make it more difficult to lease that type of space in 2001.
Another downward pressure on Westside rents: Many tenants will see their long-term leases come up for renewal in the next year or two.
“A lot of these guys aren’t going to be able to hit their renewals,” Langer said. “You’ve got people paying $1.60 rents in a $3 market. They’re going to move, and it’s going to create vacancies. In the San Fernando Valley, Mid-Wilshire and Hollywood, you’re not going to have as much pressure to bring rents down.”
In addition, the Westside office market has the most new product under construction, at 1.5 million square feet, according to Grubb & Ellis.
Those construction projects might contribute to a short-term softening in the market, but the new product itself should lease up well, Langer said.
A dearth of construction and a narrow spread between the cost of renting older buildings and brand new buildings means that many tenants will likely opt to move into the newest buildings. “That’s not net absorption, necessarily, but tenants will benefit from a market pricing that’s very flat. That bodes well for new product. They’re not competing against $1.75 (in monthly rent) opportunities.”
Its weak fourth-quarter performance gives Santa Monica the dubious distinction of joining downtown Long Beach, Carson and downtown L.A. as the only submarkets that saw negative absorption in 2000 a marked contrast to the 807,052 square feet of positive net absorption that Santa Monica enjoyed in 1999. Downtown L.A. suffered the worst negative net absorption during 2000, as expected, with 331,745 square feet emptying out, followed by downtown Long Beach with 129,157 square feet and Carson with 59,520 square feet.
Industrial strength
In the fourth quarter, the L.A.-area industrial market roared along as usual. Countywide vacancy dropped further, to 3.7 percent, as tenants bought or leased another 12.5 million square feet of space.
The amount of industrial space now under construction is less than what was absorbed last quarter and less than 2 percent of the total industrial space available, which should keep industrial space tight.
Strong leasing activity in the San Gabriel Valley led the charge, as that market’s vacancy rate dropped to 3.6 percent from 6.1 percent, with 3.8 million square feet being swallowed up. Next came Central L.A., with 2.3 million square feet of absorption and then the South Bay, with 2.2 million square feet.
In the fourth quarter, the average monthly asking rent in every market except the San Gabriel Valley had passed 50 cents per square foot, triple net (net of taxes, insurance and maintenance). The tight market in North Los Angeles which encompasses the San Fernando Valley, Santa Clarita and parts of Ventura County led the way with an average monthly asking rent of 59 cents per foot.
