Vacancy Rate Slips as Smaller Tenants, Investors Stay Active

By MARGOT CARMICHAEL LESTER
Contributing Reporter

Investment activity continued to lead the increasingly dynamic downtown market in the third quarter.

Buildings at all levels traded hands, with many from the Class-C stock that sold for conversion to residential use. As those buildings come off the market and tenants face an increasingly competitive sublease and direct leasing environment, vacancies dipped back below the 20 percent threshold hit last quarter.

Vacancy rates in the July-September period fell to 19.9 percent from 20.6 percent in the prior period, according to Grubb & Ellis Co. More strikingly, net absorption posted a significant turnaround, with more than 200,000 square feet coming off the market. That compares to the 350,000-plus square feet put back on the market in the previous quarter.

"The positive absorption isn't the result of one large tenant coming in, but a number of small tenants expanding," said Todd Anderson, senior director with Cushman & Wakefield Inc.

The makeup of the activity pushed asking rents down to $2.27 per square foot, compared with $2.32 per foot in the April-June quarter. Brokers expect the numbers to sag even more in the fourth quarter.

"Assuming that the new owners succeed in making these buildings more attractive to tenants, they will have to rob from other buildings to fill theirs, putting downward pressure on rents," said Scot McBeath, marketing consultant with DAUM Commercial Real Estate Services."

Additionally, he said, "sub landlords need to be aggressive and charge low rent to attract subtenants and reduce the hemorrhage of money they are paying for space they make no use of."

Another factor pushing rents down: upcoming lease expirations.

"There's a huge rollover coming up where 20 percent of the premier space, or 2.4 million square feet of leases, will expire in 2006," noted Steve Bay, an executive vice president for CB Richard Ellis. "Landlords are writing down above-market rents and offering huge tenant improvements on stay-put transactions to avoid the coming glut."

This dynamic had an effect on Class-B properties as tenants found good prices on Class-A subleases. Plus, several vacant Class-C buildings were purchased in the second quarter for conversion to residential, significantly reducing that inventory.

"The result is very little vacancy in the A and C submarkets," said Chris Runyen, vice president of Grubb & Ellis' office services group. "The bulk of downtown's vacancy is clearly in the Class-B submarket." Class-B vacancy is at 24.6 percent for the third quarter.

Sales dynamic

The hottest deals downtown remained investment properties, continuing a trend that has been playing out all year.

"There have been eight buildings in the last four months that have closed or been tied up," said Jonathan Larsen, a principal at Trammell Crow Co. "We haven't had sales activity like that in years."

As with the rest of the market, the cost of money is low and investors are looking at substantial upside in filling vacant spaces as the economic recovery gathers steam. Also having an impact is the additional housing inventory and the opening of the MTA Gold Line from Pasadena.

The most significant investment deal was Mani Brothers' purchase of the 435,000-square-foot property at 801 South Figueroa St. for $105 million, or $240 per foot. Brokers said that on a per-foot basis the price received by the California Public Employees' Retirement System is the highest recorded for a downtown office building.

Also in the third, Lincoln Property Co. purchased the 388,000-square-foot building at 911 Wilshire Blvd. from TIAA-CREF for $49.2 million.

Girec Corp. put the MCI Center on the block for $125 million. The 2.5 million-square-foot office-retail-hotel complex occupies the entire block at Seventh and Flower streets. The retail component is fully leased, while the office space is almost 90 percent leased at about $2 per foot.

Jamison Properties Inc. is on track to acquire the 345,000-square-foot 811 Wilshire Blvd. for $26.5 million, or about $77 a foot. The building is one-third occupied.

Flush from its initial public offering earlier in the year, Maguire Properties Inc. agreed to purchase the 42-story One California Plaza at 300 S. Grand Ave. from Metropolitan Life Insurance Co. for $225 million. The deal will likely close in November.

The biggest deal of the quarter came as TCW Group Inc. re-upped at 865 S. Figueroa St. in a 20-year deal for 182,000 square feet. On its heels for the largest in the quarter were AIG, which renewed for 105,000 square feet for five years at 777 S. Figueroa St.; and White & Case, which renewed its 60,000 square feet for 10 years at Library Tower in a deal estimated to be worth $20 million.


Major Events:

- TCW Group Inc. renewed its 182,000-square-foot lease at 865 S. Figueroa St. in a 20-year deal.

- Mani Brothers bought 801 S. Figueroa St. for $105 million from Calpers.

- Lincoln Property Co. purchased 911 Wilshire Blvd. from TIAA-CREF for $49.2 million.

- White & Case renewed 60,000 square feet for 10 years at Library Tower in a deal reportedly worth $20 million.

- Anderson McPharlin & Conners LLP sublet 17,621 square feet and the NASD renewed its 15,485-square-foot lease for 10 years at $1.50 per square foot at One California Plaza, which went under agreement to Maguire Properties for $225 million.

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