A dip in first-quarter vacancy rates bolsters the theory that's been driving downtown office investment for several months that the influx of residential development will eventually spur occupancy in office, retail and other sectors.

The office vacancy rate fell to 17.8 percent in the January-March period from 19.1 percent in the previous three months and 19.8 percent in the year-ago first quarter, according to Grubb & Ellis Co. Net absorption totaled 108,918 square feet.

Acquisitions still dominated transaction activity, as several buildings changed hands. Several more are on the block.

"There is still tremendous investor interest in downtown from office building investors, developers and residential re-developers," says Chris Runyen, vice president with Grubb & Ellis. "When residential infill occurs, retail and entertainment amenities follow. They also serve the office buildings, making them more desirable."

In one of the largest transactions, Maguire Properties Inc. picked up CommonWealth Partners' 10-building portfolio of office buildings for $1.51 billion. The deal includes 5 million square feet of office space, most notably the 1-million-square-foot 777 S. Figueroa St.

In addition, Cargill Inc. sold the 678,500-square-foot MCI Center at 700 Flower St. to Jamison Properties Inc. for about $160 million. And Hines US Office Value-Added Fund bought Union Bank Plaza, at 445 S. Figueroa St., from Walton St. Capital for around $140 million.

There were several smaller deals, too, and other buildings are expected to move shortly. Real estate investment firm Layton-Belling & Associates Inc. has entered a binding agreement to purchase the 32-story SBC Tower at 1150 S. Olive St. for $130 million from New Pacific Realty Corp. and Canyon-Johnson Urban Fund. And the 82-year-old Millennium Biltmore hotel is on the block. The package includes the hotel, the Biltmore Court office space within the hotel and the 24-story Biltmore Tower.

'Cashing in'
Scot McBeath, founder of Scot McBeath Realty, said the pace of acquisitions "is being driven by current owners cashing in while the market is at a possible peak. They're selling to investors who believe that they have the local market expertise to make money despite relatively high acquisition costs."

He expects rising interest rates to chill the investment boom, especially if new owners are unable to quickly resell at a profit or compete against buildings bought cheaply long ago.

Asking rates for Class-A buildings have remained steady at $2.62 per square foot over the past two quarters, but rose from $2.56 in the first quarter of 2004 and $2.29 in the first quarter of 2003.

But with more office buildings slated for residential conversion and no new office developments planned, investors are betting that the market will tighten further.

"New landlords have higher expectations from tenants based on higher purchase prices that are now required to acquire buildings in this market," Runyen said.

One positive sign: "Most net absorption growth isn't from a few large deals, but collective expansion of existing tenants and some new deals," said John Eichler, senior director for Cushman & Wakefield.

During the first quarter, the law firm Sonnenschein Nath & Rosenthal LLP signed a $31 million at 601 S. Figueroa St. The $31 million deal ups Sonnenschein's square footage in the building to 82,500 feet from 64,000.

At 865 S. Figueroa St., eStyle expanded its headquarters to 30,000 square feet from 1,500 square feet in a $3.5 million, 5-year deal, and Quinn Emanuel Urquhart Oliver & Hedges LLP expanded to 41,251 square feet at unreported terms. In the same building, new tenant Hennigan Bennett & Dorman took 41,458 square feet, also at undisclosed terms.

A flurry of other transactions was prompted by deal-making landlords. "City National Bank Plaza (formerly Arco Plaza) continues to be the most aggressive Class-A building in the marketplace," said Clay Hammerstein, executive vice president for CB Richard Ellis Inc., referring to the building owned by Thomas Properties Group Inc. "They are encouraging tenants to consider their options well before their leases expire, which is creating velocity in the marketplace."

Banks were busy. Manufacturer's Bank renewed for 69,206 square feet at 515 S. Figueroa St. At 777 S. Figueroa St., the Bank of Tokyo-Mitsubishi renewed for 34,000 square feet in a 10-year, $15-million contract.

Hong Kong Shanghai Banking Corp. took about 21,000 square feet in a 10-year, $5-milllion deal at 660 S. Figueroa St., while subsidiary HSBC Business Credit USA Inc. sublet 26,858 square feet at 1000 Wilshire Blvd. to Banque Americasia. Terms for the 3-year deal weren't disclosed.

Boston Consulting Group changed floors for 26,658 square feet at 355 S. Grand Ave. And Los Angeles Center Studios reported long-term leases totaling 31,000 square feet with six entertainment firms.

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