The fourth quarter was a record setter in Los Angeles County for the commercial office market, but it wasn’t the kind anyone wanted to see.
A bit more than 1 million net square feet of office space was dumped onto the market during the last three months of 2008 more even than at the height of the dot-com bust and the most since Grubb & Ellis Co. started compiling local quarterly data in 1983.
The figure was sobering in another respect: It was the worst quarter of a terrible year. In all, a net of about 3.28 million square feet was vacated in all of 2008 also a record for one year.
“We haven’t seen numbers this big, even during the last recession,” said J.C. Casillas, associate vice president and client services manager at Grubb & Ellis Research Services.
By comparison, in the trough of the tech wreck in the second quarter of 2001, the county gave back about 955,000 square feet as scores of Web companies shuttered.
The countywide office vacancy rate hit 12.2 percent in the fourth quarter, nearly a point higher than in the third quarter and two and a half points more than a year earlier. While that’s not a record in the fourth quarter of 2002 vacancies hit 16.7 percent it’s still high. The damage spread to just about every corner of the county, although the Westside and downtown were hit hardest.
Experts cited a confluence of factors to explain the brutality of last quarter, but pointed mostly to rising unemployment, which in November hit 8.9 percent in L.A. County, the highest rate in 14 years. That has led to a corresponding rise in vacancies as more companies closed or contracted.
Meanwhile, the volatility of the economy has made many prospective tenants tepid when it comes to committing to long-term decisions about real estate. That has forced landlords to lower rents, often just to retain their tenants. Countywide, Class A asking rents fell 8 cents to $3.41 a square foot a month since the third quarter, and brokers and other industry professionals expect they’ll fall further as the year progresses.
“If you talk to landlords today, their mantra is all about tenant retention,” said David Doupe, West Coast team leader for the capital markets group at Jones Lang LaSalle Inc.
“Companies are saying to the landlords, ‘Look, I don’t want to make a decision right now, and if you force me to make a decision, I’m going to leave.'”
The freefall was led last quarter by the previously red-hot Westside market, which gave back about 538,000 square feet of space and saw its vacancy rate jump to 11.1 percent from 9.8 percent in the third quarter.
Much of the spike in vacancy came from media, entertainment and financial services companies, and was spearheaded by Yahoo Inc., which dumped about 100,000 square feet when it laid off staff at its Colorado Boulevard offices in Santa Monica. That kind of give-back contributed to a significant softening of asking rents, which fell by more than 25 cents to $4.53 per square foot.
Also faring poorly was the downtown submarket, which saw about 336,000 square feet pop back on the market. One-third of that damage could be chalked up to two national law firms Thelen Reid & Priest LLP and Heller Ehrman White & McAuliffe LLP that liquidated in the fall. That left a total of 125,000 square feet of prime real estate at Bank of America Plaza, 333 S. Hope St., vacant.
The San Fernando Valley saw its vacancy rate rise nearly a half-point to 13.6 percent for the quarter, capping off a year in which more than 633,000 square feet was vacated. The main culprits? Crippled financial services companies, such as Countrywide Financial, Washington Mutual and AIG, which occupied millions of square feet and are now abandoning offices.
Even the handful of bright spots generally came with caveats.
The South Bay submarket, for instance, absorbed about 114,000 square feet in the fourth quarter, but that was buoyed in large part by a 330,000-square-foot lease signed by Northrop Grumman Corp. for an El Segundo office tower previously occupied by Continental Airlines. Without that huge deal, the story would have been worse, and even with it the South Bay had a bad year. It saw about 355,000 square feet cumulatively open up.
One portion of the commercial real estate market, however, did escape last quarter relatively unscathed: L.A. County’s historically strong 1 billion-square-foot industrial market, one of the nation’s largest.
While the market is not nearly as strong as it was two years ago, when foreign trade was sky high and filled the region’s warehouses to the brim, it did pretty well. In fact, the countywide industrial vacancy rate fell one-tenth of a point to 2.2 percent as the market absorbed 621,000 square feet of space. Asking rents held the line at 57 cents per square foot a month.
To a certain extent, the industrial market may have simply settled after a horrible third quarter that saw 3.1 million square feet of space open up when trade at the ports of Los Angeles and Long Beach slowed dramatically.
The county remains the largest manufacturing center in the United States, and its ports are still the largest. As a result, the industrial market remains active. In September, Storm Properties Inc., a Torrance-based developer, sold a 16-building portfolio of industrial properties to TA Associates Realty of Boston for about $54 million. The 545,000-square-foot portfolio includes 10 local properties, including several at the Storm Business Park in Torrance.
Indeed, Los Angeles’ industrial vacancy rate puts it among the lowest in the country, beating out other regions such as Houston, Seattle and the San Francisco Bay Area, said Craig Meyer, the national head of real estate services firm Jones Lang LaSalle’s industrial brokerage unit.
Now, that does not mean more pain does not lie ahead. Traffic at the ports continues to decline in December year-over-year shipments were down 15 percent at the L.A. port but Meyer said the area’s industrial base will help it weather the economic storm better than other regions.
Of course, there is a flip side to the carnage for landlords: The thousands of office and industrial tenants who keep the L.A. economy running are looking at signing new leases at sharply lower rates. That will help keep them afloat during the tough times.
Some aren’t waiting for their leases to expire. Doupe of Jones Lang LaSalle said he’s seen many tenants halfway through leases that were signed when real estate prices were high “blend and extend.” That is they commit to a lease extension in exchange for the landlord knocking their rents down to current market rates.
“It’s definitely a market conducive to tenants right now,” said Lewis Horne, executive managing director for Southern California at CB Richard Ellis Group Inc.
Most agree that it’s unlikely the office market will rebound in 2009.
Paul Habibi, a professor of real estate at the UCLA Anderson School of Management, said he expects the unemployment rate will climb before it trends back down. That will likely be reflected in the office market.
“I think we’re poised to witness the next stage in increases in vacancy and drops in rental rates,” he said.
And while it’s hard to say whether this year will be worse than last, experts agreed that at least the market is braced for bad news, unlike 2008 when the abrupt financial collapse took it by surprise.
“The real good news about 2009,” Horne said, “is that we’ll be comparing it to 2008.”