Could downtown L.A.'s office boom be in for a premature end?
That's what some commercial brokers are arguing, despite vibrant building sales and a recent uptick in occupancy rates. They say a looming glut of prime office space coming onto the market in the next two years can only push rents lower.
That's in sharp contrast to recent reports from Cushman & Wakefield Inc., and to a milder extent other brokers who paint a rosy picture of a downtown Los Angeles market on the rebound. Cushman, which caters mainly to landlords, has boldly predicted a 7 percent increase in downtown rents by year's end.
But looking at downtown's 27 Class-A office towers those that can command higher rents and typically attract corporate tenants a different picture begins to emerge. Those buildings contain 21.2 million square feet of space and are currently advertising space of 4.6 million feet a 21.5 percent vacancy rate, according to data from tenant representative firm Studley.
That's far higher than the 17.8 percent first-quarter vacancy rate for downtown that was published by Grubb & Ellis Co.
Grubb & Ellis, like many other brokerages, looks at a larger segment of downtown office buildings, including lower-quality properties that are increasingly being taken off the market for conversion to residential use.
Grubb officials believe the downtown market remains strong and will improve.
"Overall, in downtown, rents will go up and vacancies will decrease," said JC Casillas, research analyst for Grubb & Ellis. "That is what we're looking at."
Even though those properties have been re-made into apartments and condominiums, few new tenants have entered the market.
In fact, Studley found that downtown office tenants today have a smaller presence, and by extension a leaner workforce, than five years ago.
The cumulative net absorption in downtown Los Angeles the difference between the amount of office space leased and the amount put back on the market, has actually declined since 2000, Studley reported.
That's because downtown is still feeling the aftershocks of having numerous corporations either move out of the market or get acquired during the early-to-mid 1990s.
And until new companies move into downtown and fill that void, the situation isn't likely to get better.
"Downtown won't change until we get tenants moving into downtown from outside of downtown," said Stephen Bay, an executive vice president at CB Richard Ellis Inc. "Until that happens, we're basically stuck in a game of musical chairs where tenants hop from one building to another."
Attracting new companies downtown so far hasn't gone smoothly.
Last month, city officials were rejected in their attempt to lure the administrative headquarters for the state's new stem cell research initiative to a downtown site.
Yahoo Inc. subsidiary Overture looked closely last year at relocating its operations from Pasadena to downtown's City National Plaza, only to choose instead a build-to-suit campus near Bob Hope Airport in Burbank.
Meanwhile, large chucks of office space are coming back on the market. The Los Angeles Unified School District has finalized plans to leave the 260,000 square feet it occupies in KPMG Plaza, owned by Maguire Properties Inc.
Sources with knowledge of the district's negotiations say school officials are close to signing a lease at 1055 W. Seventh St. While the School District is remaining downtown, it's dropping the amount of space it will take to about 120,000 square feet.
Bank of the West won't likely renew the lease it has for 220,000 square feet it takes at the Figueroa at Wilshire a building owned by Hines at 601 S. Figueroa St. Hines is marketing the building for sale through Secured Capital Corp. with a $400 million price tag.
The space is currently subleased to tenants who will have to renegotiate directly with the landlord for possible renewals. Brokers expect many of those tenants to move elsewhere.
Complicating landlords' positions is the nearly 1 million square feet of vacant space at City National Plaza, owned by Thomas Properties Group Inc.
Thomas bought the twin obelisks at a bargain price because the buildings' anchor tenant, Atlantic Richfield Co., had abandoned its space after being acquired by British Petroleum Co. PLC.
To fill the largely vacant buildings, Thomas is giving tenants below-market deals that many other landlords can't match. At times, Thomas has given tenants a year or two of free rent to lure them out of leases at other buildings.
The strategy is paying off for Thomas, which has inked long-term deals for about half its space with law firms and financial institutions. With a large amount of space yet to lease, Thomas is likely to continue to take tenants away from other downtown office landlords.
Maguire, the largest office building owner in downtown, is also grappling with its loss of law firm Jones Day, which is leaving the 160,000 square feet it takes at the Gas Co. tower for new digs in City National Plaza.
In its first quarter 2005 earnings announcement last week, Maguire said that even though it had signed 400,000 square feet worth of tenant space, it had to discount space being re-leased by 32.8 percent (38.5 percent if only cash payments are considered).
Banc of America Securities analysts attributed much of the discounting, called "roll-downs," to 150,000 square feet previously occupied by Wells Fargo & Co. that's sitting vacant in Maguire's Wells Fargo Center on Bunker Hill.
BofA analysts Ross Nussbaum and John P. Kim wrote in a report last week they are concerned about the company's leasing results and expected similar roll-downs for the Wells Fargo space and the Jones Day space.
But they also believe Maguire, which has more than 15 percent of its leases expiring in the next two years, stands to increase its rents to market rates as many of those tenants renew.
"Disappointing lease results may be one-time," they wrote. "We believe (Maguire's) remaining expiring leases will roll positively to the market."
More attractive for whom?
Still, downtown boosters point to leases signed in the last two years by City National Corp. at former Arco Plaza and U.S. Bancorp taking naming rights and a large block of space in the former Library Tower.
City National Bank sold its headquarters location near the Jewelry District, and therefore isn't considered as absorption by some brokers because the company was already located downtown.
As for the US Bank, the lease was a consolidation of operations spread out throughout the Los Angeles region because of multiple mergers. Mark Sullivan, an executive vice president at Studley, said the deal was a rare gain for downtown.
"It was a great win for downtown," he said. "I'm a huge advocate for downtown but we don't have wins like that every year."
Boosters also point out that as the downtown living environment continues to improve, the office submarket may become more attractive to companies that previously wouldn't have considered moving their operations downtown.
As more older office buildings are converted to residential uses and filled with middle-to-upper income tenants, more attractions shops, restaurants, movie theaters and the like will open downtown, the thinking goes.
But CBRE broker Bay said the revitalization of downtown won't likely have an impact on the office market. He said no matter how nice downtown becomes, with vast amounts of vacant office space available, rents will continue to stay low as landlords fight each other for tenants.
"Landlords are saying, 'Look at all these non-commercial things going on and think about how that will affect the commercial market,'" Bay said. "But supply and demand don't support that statement."
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