Outlook Improves as Vacancies Drop, Rates Stabilize

While the leasing market continued to grow stronger during the third quarter, investors are still bidding up office properties in the belief that the market will allow them to raise rates even further.

During the July-September period, vacant office space in just about every L.A. County submarket was snapped up, pushing the average vacancy rate to about 15 percent, according to Grubb & Ellis Co.

And while landlords are still offering steep concessions to lure prospective tenants, asking rates countywide for Class-A office space are stabilizing and in some markets rents are beginning to climb.

"Some big holes still exist," said Jim Kruse, senior managing director of CB Richard Ellis Inc., "but the outlook and condition of the market is that the cake is starting to rise."

Exuberance over the cultural renaissance downtown, from the opening of Walt Disney Concert Hall to the vast number of new apartment and condominiums being built or renovated, has been reflected in the prices being paid for office properties.

In one of the highest-price per-square-foot deals for a downtown office building since the early '90s, Trizec Properties Inc. paid $435 million for 333 S. Hope Street, formerly known as BP Plaza.

The nearly fully leased building, a trophy address that traditionally has commanded above-market rents, could be hamstrung in raising rates much further until large vacancies in other downtown office buildings are filled.

Downtown landlords have been grumbling about the difficulty of negotiating higher rents because they say Thomas Properties Group Inc. has been signing below-market deals to fill more than a half-million vacant square feet in City National Bank Plaza, formerly Arco Plaza.

In the third quarter alone, Thomas Properties was able to steal law firms Jones Day and Fulbright & Jaworski LLP from buildings owned by Maguire Properties Inc. and Manulife Financial Corp., respectively.

And now, the Los Angeles Unified School District has notified Maguire it may not renew its 260,000 square feet at KPMG tower. LAUSD is kicking the tires of nearly a dozen other downtown office buildings.

Despite the competitive market, landlords believing businesses place a premium on downtown raised average asking rents in the third quarter to $2.63 a foot, nearing levels previously seen only on the Westside.

Landlords say the key to a sustainable downtown market is City National Bank Plaza. If Thomas Properties leases it up, the rest of the market could jell. That might happen should Overture Services Inc. move into 300,000 square feet from its Pasadena headquarters. But the company is also considering building a new headquarters in Burbank.

Kruse said the moves show leasing terms are still favorable to tenants. "It has stopped raining on the landlords but I would still prefer to be a tenant," he said. "They are still taking advantage of the perceived spongy market, but the choices are starting to tighten up a little bit."

On the Westside, investors continue to pay top dollar for office properties despite the threat of a looming glut of space coming to the market.

Equity Office Properties Trust, in partnership with pension fund giant TIAA-CREF, paid $434.6 million for the 1.1 million-square-foot Colorado Center in Santa Monica.

With blue-chip tenants such as Viacom Inc.'s Home Box Office and software maker Symantec Corp., EOP might continue to push rents and raise the value of the development.

However, Santa Monica already with the highest office rates in the county had a mediocre showing during the third quarter, with rents falling 8 cents to $3.04 a foot, according to Grubb & Ellis.

And pressure on rents throughout the Westside is only likely to increase with the 790,000-square-foot 2000 Avenue of the Stars opening in less than 18 months.

Also, Sony Corp. may possibly sublease roughly 400,000 square feet in MGM tower if its acquisition of Metro-Goldwyn-Mayer Inc. goes through. "There's potentially a lot of space coming on the market on the Westside," said Studley Executive Vice President Mark Sullivan. "And it's unclear what effect that could have on the market."

Still, the Westside had its bright spots. Third quarter vacancy rates in the Hollywood/West Hollywood market plunged to 11.5 percent from 20.8 percent in the second quarter and from 19.7 percent a year ago, according to Grubb & Ellis.

Most of that comes from a 140,000-square-foot lease inked by the Interpublic Group of Companies SA for offices in the Pacific Design Center on the corner of Melrose Avenue and San Vicente Boulevard, and a number of large office buildings taken off the market that are slated for conversion into condominiums.

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