REGIONAL REPORT: REAL ESTATE : Bloom Is Off Commercial Real Estate

Southern California’s once-booming commercial real estate market, which dramatically altered the region’s office skylines in the 1980s, is in the early stages of a bust that may last two years or more, property experts believe.

While not as severe as in other regions of the country, the downturn nonetheless could further depress the Southern California economy when it is already reeling from thousands of aerospace industry layoffs.

“We’re in the throes of a real estate recession . . . and a national recession would only make that worse,” said Andrew S. Kane, a real estate specialist in the Los Angeles office of the Arthur Andersen & Co. accounting firm.

While the office market is slumping in Orange and San Diego counties, it appears to be particularly bad in downtown Los Angeles, which faces the prospect of massive overbuilding. With some buildings in major financial difficulties, there is further trouble ahead for banks, savings and loans and other lenders that already have experienced large losses on building loans gone sour.

Older office buildings in downtown Los Angeles have vacancy rates as high as 80%, and some new buildings are not faring much better. In some markets, office rents have been falling for some time, a trend that is expected to continue as more office buildings open.

Fueled by easy credit from U.S. lenders and heavy foreign investment from nations such as Japan, Southern California went through an unprecedented office building boom in the mid- to late 1980s that gave dramatic new skylines to Long Beach, Westwood and Costa Mesa as well as the downtowns of Los Angeles and San Diego.

Though Japanese investment has tailed off and construction loans are no longer easy to obtain in Southern California, the region remains in the final stages of a building frenzy that is adding millions of square feet of unneeded office space. (A typical middle-class home has 1,000 to 2,000 square feet of space.)

The breakneck pace of office construction is not expected to last much beyond next year. Foreign investors no longer see greater Los Angeles as a superior investment opportunity, and banks, under pressure from regulators because of huge problems facing the savings and loan industry, have scaled back real estate lending.

“There’s no doubt that lots of deals are falling through now because the financing is not coming together,” said David A. Eisner, a real estate specialist for Price Waterhouse.

Difficulty obtaining financing has caused problems for the planned $650-million Watt City Center, a residential and commercial complex on the west side of the Harbor Freeway in downtown Los Angeles.

Developer Ray Watt said that he needs to find a major tenant for the office space before lenders will give him the money to begin construction. He said that he may also raise money by selling an equity interest to outside investors.

While demand has leveled off, office space in downtown Los Angeles is still rising at an unprecedented rate. “More office space is coming on line than at any time in the history of this city,” said John C. Cushman III, a well-known Los Angeles real estate broker.

Several major office buildings under construction in downtown Los Angeles are expected to increase office space there by more than one-fifth, pushing vacancy rates from 16% to as much as 25%.

“Downtown is pretty scary for a lot of people right now,” said David Ash, senior vice president of Eastdil Realty, a real estate investment firm. “It’s going to be difficult times ahead. The question is: Will they last two years, three years or four?”

The commercial office market in the San Fernando Valley, which is less overbuilt, appears to be the exception. The office vacancy rate there was 14% in the second quarter of 1990, down slightly from earlier this year.

Vacancy rates are a key indicator of regional economic health, generally mirroring employment levels in white-collar trades such as financial services, insurance and the law. A healthy vacancy rate is 7% to 10%, according to Sanford Goodkin, a real estate consultant in San Diego for the accounting firm KPMG Peat Marwick.

With falling housing prices and major layoffs in the aerospace industry, Wall Street investment firms are turning out bearish reports on the region’s commercial real estate scene. The office-market downturn also has spilled over into retail and industrial leasing, real estate experts say.

Several large financial institutions in California have disclosed large writeoffs, in part because commercial real estate loans have gone unpaid. Wells Fargo and Bank of America recently repossessed two office buildings in the Los Angeles area.

Much of the savings and loan industry’s current problem stems from office-building loans that went into default in states such as Texas and Arizona after their regional economies turned down. In recent weeks, two large California S&Ls;, CalFed and HomeFed, announced large losses partly because of commercial-loan problems in California.

Most property experts, though, continue to believe that Southern California probably will not experience a recession in commercial property as severe as those that hit major U.S. cities from New York and Boston to Phoenix.

Besides a diversified economy, Southern California has had Japanese buyers who have “put a floor under the market,” Goodkin said. Nearly a third of the office space in downtown Los Angeles is now owned by Japanese investors, according to Cushman.

A close look at regional markets shows that some are faring far better than others. Burbank and Glendale, for example, are benefitting from a migration of entertainment-connected firms from Century City, according to Salomon Bros., the New York investment banking firm.

Office vacancies around Los Angeles International Airport, though, have been high for years and are expected to get higher because of layoffs in the aerospace industry and cutbacks by the military, two major office tenants in that area. Office vacancies north of the airport are running as high as 34%, said commercial broker Bill Goodglick.

Sluggish office demand accompanied by the sharp increase in supply has accelerated an already stiff competition for office tenants, who are breaking their leases in droves in favor the new office digs.

Major new tenants are receiving lucrative incentives, such as 18 months of free office space, if they relocate to the new buildings. “There is a slash-and-burn philosophy among the major tenants in downtown Los Angeles,” said Todd Anderson, a vice president for the Faulkner Co., a commercial brokerage.

The accelerating tenant exodus has been particularly difficult for landlords of older office buildings, especially those built before the mid-1960s. Many of these buildings are a third or more empty, according to figures from Wilrock National, a brokerage firm.

One of the most prominent buildings in trouble is Giannini Place in downtown Los Angeles, built in 1922 by Bank of America founder A. P. Giannini. Bank of America recently repossessed the building, which is nearly 50% vacant. Bank officials could not be reached for comment.

Among the other troubled commercial developments that dot the Southern California landscape is Andrex Point, an office complex along the San Diego Freeway near Gardena that Wells Fargo recently repossessed.

A Wells Fargo spokeswoman confirmed that Andrex Point, built in 1988, has not been a financial success because rents have been “dropping significantly.” She added that the 12-story building, which is half empty, is the bank’s only problem office building in California.

Even in Los Angeles’ tony Westside, with its tougher building restrictions, the office market is surprisingly soft, real estate experts say. One office high-rise in Westwood known as Center West, owned by businessman Kambiz Hekmat, is only 25% occupied.

A 3-year-old structure on the fringe of downtown Los Angeles that has struggled since it opened is the WCT Building, owned by East Asian financier Ming Yu Tsai. Located at 1100 Wilshire on the west side of the Harbor Freeway, the 38-story office tower has only three tenants.

The San Fernando Valley is a somewhat different story. Seth Dudley, Valley branch manager for the commercial brokerage firm Julien J. Studley Inc., noted that the area benefits from lower office rents than the Westside and downtown.

Dudley said, however, that a severe office-space shortage may materialize in certain areas of the Valley in coming years partly because zoning changes and building moratoriums in some business centers have restricted development. Shortages are starting to develop in areas such as Encino, where 96% of all office space is occupied, he said.

Orange County more closely resembles downtown Los Angeles. A region with an economy the size of Norway’s, Orange County has 50 million square feet of office space, most of it built in the past five years.

About a fifth of that office space--the equivalent of all the space in New York’s twin-towered World Trade Center--stands vacant, while another 3 million square feet is now under construction. As in Los Angeles, rents have slid as landlords wave incredible deals at tenants.

The San Diego office market is likewise overbuilt, with a countywide vacancy rate hovering around 20%, and much higher in some suburban markets. “From a developer’s standpoint, the office market is as tough as I’ve ever seen it,” said Dennis Cruzan, a San Diego developer.

Times staff writers Chris Kraul in San Diego, Michael Flagg in Orange County and Patrice Apodaca in the San Fernando Valley contributed to this story.

OFFICE VACANCIES

The vacancy rates in selected California cities expressed in percentages, as of January, 1990. Los Angeles: 15.7% Orange County: 20.3% San Diego: 21.7% San Francisco: 15.3% San Jose: 15.1% Oakland / East Bay: 18.6% Sacramento: 16.3% Source: Moody’s Investors Service