The drive to satisfy voracious housing demand in Los Angeles County continued to spill into the office market in the first quarter, as condo conversions and new residential projects gobbled up land and drove prices higher for commercial investors.
Despite relatively flat asking rents, buyers are paying more for office buildings gambling that an uneven market will eventually tighten.
Falling first-quarter vacancies lent support to this view, especially in areas such as Hollywood where the vacancy rate has fallen sharply in the past year to 8.3 percent from 21.9 percent, as well as in downtown Los Angeles and the Westside, where improvements have been more modest.
Across L.A. County, office vacancies fell to 14 percent in the first quarter from 14.8 percent in the previous three months and 16.1 percent in the year-ago quarter, according to Grubb & Ellis Co.
"The recovery on the occupier side for office space has been lumpy it really varies from place to place," said Lew Horne, executive managing director for Greater Los Angeles at commercial brokerage CB Richard Ellis Group Inc.
Despite tightening vacancies, countywide asking rents have remained largely unchanged at $2.45 a square foot for Class-A space, unchanged from the fourth quarter and up 3 cents from the year-ago first quarter.
Where those numbers might be headed is up for debate. Uncertainty looms over factors that may slow the economy principally interest rates, the cost of oil, the weak dollar and the massive trade deficit.
"There's a tug-of-war going on," said Stuart Gabriel, director of USC's Lusk Center for Real Estate, citing recent data that suggests a slowing economy. "That might dampen inflationary expectations and put less pressure on long-term interest rates."
It could also prolong the availability of cheap capital that has fed into higher purchase prices for office properties.
The largest office purchases revolved around high-rise properties downtown. Real estate investment trust Maguire Properties Inc. won a $1.51 billion bidding war for a 3 million-square-foot portfolio sold by Commonwealth Partners LLC, including the 53-story tower at 777 S. Figueroa St., a 1 million-square-foot building that is one of the downtown skyline's most prominent features.
In other large downtown deals, New Pacific Realty and Canyon-Johnson Urban Fund sold SBC Tower (formerly the Transamerica complex) and a smaller building to Irvine-based pension fund advisor LBA Realty Fund Inc. for $125 million. Also sold were MCI Center on Flower Street ($160 million) and Union Bank Plaza ($144 million).
"The story downtown is strong sales activity, and the primary driver has been renewal activity. So the long-term view of downtown is extremely positive," Horne said.
Elsewhere, residential demand had a palpable effect on falling vacancies in several submarkets. "In West L.A. and Tri-Cities especially, there is an insatiable appetite for residential conversion," Horne said.
On the Westside, office vacancies fell to 13.5 percent from 14.6 percent, pushing tenants into the neighboring Miracle Mile/Park Mile submarket.
Vacancies fell slightly in the Tri-Cities submarkets of Burbank, Glendale and Pasadena, to 10.5 percent.
But it was Hollywood, where residential, retail and office development has been booming, that the largest mixed-use deals took place.
SSR Realty Advisors Inc. purchased the Sunset + Vine complex from Bond Cos. and Canyon Johnson Realty Advisors for $165 million. The project has 300 apartment units atop 87,000 square feet of ground-floor retail at 1555 Vine St. in Hollywood.
In addition, the Nederlander family inked a deal with Clarett Hollywood LLC to develop a $300 million residential and retail project surrounding the Art Deco Pantages Theater.
Competition from residential purchasers seeking to do conversions has driven up the price of office properties, particularly downtown and in Hollywood.
"It's been the same story for several quarters, the challenge now is the lack of inventory," Horne said. "We've seen land prices go from $50 a square foot downtown to nearly $500 a square foot, so if there's any chance of converting to residential, investors can take two or three times the value back of that property."
The question is whether the market will tighten enough for landlords to ratchet up rents. The answer depends partly on the residential real estate market, and it also depends on other outside events, such as the merger between Sony Corp. and Metro-Goldwyn-Mayer Inc., which closed last week.
"The Sony-MGM merger is putting 250,000 to 300,000 square feet on the market in Century City, and another 150,000 square feet in Santa Monica," said Alan Aufhamer, a senior vice president with CB Richard Ellis. "So just when landlords think things are tightening to the point they can raise prices, something else comes on line. I think rents will be tempered by this new product. I don't see rental rates going up for a while."
J.C. Casillas, L.A. research director for Grubb & Ellis, noted several conversions of office space into medical use could be a sign that investors are looking to get in at an early stage in an area before it takes off.
Telo Medical Center LLC purchased two office buildings in Torrance totaling 80,000 square feet for $10 million in the first quarter.
"Investors are looking to be at the forefront," Casillas said. "Residential stuff has already been priced at a certain level, so it's no longer at the forefront, besides in downtown."
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