To get a sense of how much Los Angeles' commercial real estate boom has sputtered out, try this.

Vacancy rates have doubled in some industrial strongholds, Class A office buildings are opening without a single tenant and high-profile marquee projects are being all but abandoned.

Consider SunCal Cos. plans for 10000 Santa Monica Blvd., a 45-story condo tower with a $400 million price tag.

When the Century City project was unveiled in February, it appeared to have an impeccable pedigree: The 600-foot glass tower was designed by French architect Jean Nouvel to appeal to European buyers. Signing up as an equity partner was storied investment bank Lehman Bros. Holdings Inc.

But that was before the financial markets collapsed and Lehman Bros. went bankrupt, forcing the Irvine developer to shelve the project.

"We are in an unprecedented time right now, when you see the instability in the financial markets. It is something like nobody has seen before," said Lew Horne, executive managing director of CB Richard Ellis Group Inc.'s greater Los Angeles region. "There is really no pattern or trend line to look at in terms of historical trend lines or other bear markets."

But it isn't just the big stuff and it's not only the financial crisis. With the economy soft, job losses piling up and international trade slowing, the real estate market is getting hit from all sides with nearly every county submarket affected, and midsize and small deals hit hard, too.

The average monthly asking rent for Class A office space across the county fell in the third quarter by six cents to $3.49 per square foot. The last time the county experienced a similar quarter-over-quarter decline was in 2001 amid the tech bust and Sept. 11.

And while the industrial market has remained relatively strong, it's not the hot market it was a year or so ago when booming international trade drove port-related businesses far and wide in search of warehouse space.

"So much of this is being by driven by investor psychology," said Richard Green, director of the Lusk Center for Real Estate at USC. "Because so much of this is being driven by fear, as well as real stuff going on, as long as people are scared and no lending is happening this is going to ripple through every sector of the economy."

Leasing collapse

The commercial real estate market got hit earlier this year when the capital markets froze in response to the continuing ripple effects of the subprime lending disaster, which ravaged the investment banking and insurance industries.

Now, the area is feeling the secondary effects of that disaster, with the county's office vacancy rate rising by nearly 1 point to 11.4 percent since midyear a deceptively low increase since only a fraction of all leases turn over in any given quarter.

More telling of the slowdown, perhaps, is the amount of space put back on the market, so-called negative net absorption. Year to date it has totaled 2.29 million square feet, with the give-back picking up steam as the year has progressed: 792,481 square feet hit the market in the third quarter alone, up from 689,363 square feet in the second.

For example, Pasadena-based IndyMac Bancorp was seized by the government in July and since then regulators have put 360,000 square feet of its office space on the Tri-Cities market. IndyMac is not the only financial services company likely to dump space. Brokers are worried about the defunct Countrywide Financial Corp., which had substantial west San Fernando Valley operations and was bought by Bank of America earlier this year.


The tumult has created an environment in which tenants are less willing to sign up for long-term deals or renewals, even though landlords are increasingly willing to make concessions. In short, many prospective tenants are staying on the sidelines.

In the Santa Clarita Valley, for example, Parker Properties and RREEF Alternative Investments just completed a 144,000-square-foot Class A office building that is well positioned near the Golden State (5) Freeway but it doesn't have a tenant.

"Because this market is so unprecedented, there is just a real air of caution in the air," said Horne, who sees signs that landlords are willing to make significant concessions to cut a deal. "I think landlords are more inclined to have those conversations than there were (even) a month or two ago."

The vacancy rate in the upscale Santa Monica office market rose 1 point since the second quarter to 11.2 percent; a year ago it was just 7 percent. That increase has driven down the average Class A asking price to $5.82 per square foot in the third quarter from $6.02 per square foot at midyear, still the priciest in the county.

Real estate investor Richard Ziman believes they will go even lower, with landlords being forced to offer large tenant improvement allowances and sometimes free rent to entice tenants.

"Six dollar rents were a reality for a nanosecond in time. The nano is gone," said Ziman, chairman of AVP Advisors LLC and the former chief executive of Arden Realty Inc., an office investor and landlord. "Those $6 rents are anywhere from $3.50 to $4.25 depending (on the circumstances)."

Industrial weakness

Los Angeles County's nearly 1 billion-square-foot industrial real estate market is one of the nation's biggest and strongest, but the downturn is taking a heavy toll on it, too.

The vacancy rate rose a full half-point since midyear to 2.3 percent, driven by 3.1 million square feet of space that was put back on the market. By contrast, the market absorbed 140,000 square feet in the second quarter.

Driving the poor results: Much of the market is dependent on the ports and international trade. That's especially true in the San Gabriel Valley, with its concentration of Asian businesses. There the vacancy rate was up nearly 1 point to 2.5 percent and the market gave back about 1.2 million square feet in the quarter accounting for more than one-third of the county's negative net absorption. It's only expected to get worse.

"Everybody is anticipating a reduction in consumer purchasing and sales and that will have a direct impact on warehousing," said Craig Meyer, the national head of real estate services firm Jones Lang LaSalle Inc.'s industrial brokerage unit.

The situation is so bad that many brokers, who have experienced a long commercial real estate boom, are wondering if they will even have a job. There are expectations among some that brokerages will merge; L.A.-based CB Richard Ellis, the nation's largest real estate services company, already has made cuts, though the company won't talk numbers.

"We are obviously trying to right-size our firm and we are focusing on finding efficiencies," said Horne, who added that the company has enacted a hiring freeze and canceled its 2009 World Conference because of the current economic climate. "We are focusing on making sure that we are getting the most out of our people and being as efficient as we can be."

Project and investments

Meanwhile, the marquee projects are getting the most attention.
SunCal isn't detailing the financial problems of its Century City project, but the company released a statement saying that the failure of Lehman Bros. made it impossible to proceed.

"We have been unable to obtain assurances of continued funding that would allow us to move forward with confidence at this point in time," the company said in the statement.

Construction at the Century City site never began, though the company had been doing prep work, and was working on an environmental impact report and a site plan. A spokesman said SunCal hopes to restart work as soon as possible.

Nearby, a planned 252-unit luxury condo development at 9900 Wilshire Blvd. on the site of a shuttered Robinsons-May department store is in flux. Candy & Candy, the London-based developer, needs to restructure a massive loan on the property and extricate itself from a partnership with equity partner Kaupthing Bank. The beleaguered bank was taken over this month by Iceland's government amid the world financial crisis.

Last week Candy & Candy said that it wanted to add a hotel to the project and reduce the number of condo units to make it easier to obtain financing.
"Banks aren't lending money," said Candy & Candy principal Nick Candy. "When it does come back, it will be completely different. Everyone thought they were a developer, everyone thought they could build. We will see a complete change in the financing industry."

A big trend now is debt assumption deals, in which buyers simply take on the debt of the previous owner in order to finance a transaction. These deals were once seen as onerous because they didn't allow the buyer to shop for a better loan package. But now with few options these deals have become in some cases the only way to complete a transaction.

"As it turns out now assumable debt is quite attractive because of the difficulties in the finance market," broker Darin Beebower told the Business Journal earlier this month, when he was interviewed about two county apartment buildings that sold for a combined $9.5 million in July using such financing.

But, of course, not all is bleak.

Related Cos. has been struggling to get a construction loan for its $3 billion Grand Avenue redevelopment project. But just last week it was disclosed that three South Korean insurance companies invested $100 million this month for an equity stake in the project, reflecting the international scale and reputation of Los Angeles' economy and real estate market.

Also moving forward is the $2.5 billion L.A. Live project next to Staples Center backed by Denver billionaire Philip Anschutz. In Hollywood the redevelopment boom is continuing with the giant mixed use Hollywood and Vine and W Hotel project.

Legendary Los Angeles investor Robert F. Maguire acknowledged the "serious downturn," but said that "diversity carries the region pretty well," adding that there are myriad investment opportunities.

"We think there are going to be some terrific opportunities," said Maguire, the founder and former chief executive of Maguire Properties Inc., an office developer and the biggest landlord in downtown Los Angeles. "The thing that is going to be difficult is the financing to facilitate sales. It's more expensive, more coverage is required and until that settles down, it is going to be tougher to get good sales."

There are a handful of sectors that commercial leasing brokers say should remain hardy during the downturn.

Creative office and entertainment-related leasing activity has remained solid in some higher-end markets like West Los Angeles and Hollywood.
Governmental leasing should also be a safe haven because Los Angeles has such a high concentration of government offices second only to Washington, D.C.

"Government-related business is usually pretty stable in good and bad times," said Jonathan Larsen, a tenant representative broker with Transwestern. "I think (brokers) will take a listing that attracts a government tenant."

But despite voicing a general confidence in Los Angeles' ability to rebound from the downturn, few of the industry insiders interviewed for this article were willing to venture a guess about when the market might improve.

"Reality has changed a lot in the last year," said Green of USC's Lusk Center.

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