HIGH AND DRY : Downtown Struggles to Recover From 1980s Building Boom That Went Bust
In a darkened sales office 28 floors above Downtown Los Angeles, the corner walls slide away at the touch of a button and sunlight pours in through huge windows. Below, the site of Los Angeles Center comes into view.
But instead of the shimmering skyscrapers envisioned a few years ago, Los Angeles Center remains a collection of parking lots surrounding an outdated office building. The outlook for office development is so bleak that the project’s backers now want to build a much less lucrative sports and entertainment complex instead.
“We were lucky we didn’t build that first building,” said Los Angeles Center’s director of marketing, John Semcken, whose offices overlook the project site. “It would be sitting there empty.”
While Southern California’s commercial real estate market shows signs of renewed vigor, the region’s most prominent business district, Downtown Los Angeles, remains stuck in a deep slump, forcing landlords to slash rents and developers to abandon their grand plans in favor of more modest, less traditional development.
After a dramatic building boom in the late 1980s and early 1990s, Downtown property values have plunged by nearly two-thirds, and almost a quarter of all office space lies vacant. Some buildings in the heart of the financial district are completely empty and huge new skyscrapers have been thrown into foreclosure.
Despite the widely held belief that Downtown has bottomed out and bargain rents will attract new tenants, the recovery will be painfully slow and uneven, say brokers and property owners. Looking beyond the current glut, real estate observers say Downtown Los Angeles and its peers nationwide will be plagued by numerous problems, ranging from the growth of rival suburban business centers to telecommuting and corporate downsizing.
“All things seem to be going the wrong way for Downtown Los Angeles,” said real estate analyst Jonathan Litt at Salomon Bros.
The plunge in Downtown’s fortunes has also punctured a great many civic and corporate egos inflated during the booming 1980s, when foreign investors from Tokyo to Toronto poured billions of dollars into Los Angeles real estate. Now, in a humbling turn of events, office buildings in once-sleepy Glendale command rents almost twice that of most Downtown skyscrapers.
“It was supposed to become the capital of the Pacific Rim. It didn’t,” said W. Brett White, regional manager for CB Commercial, a real estate brokerage.
Much of the financial pain and turmoil Downtown is hidden by an impressive display of marbled and mirrored skyscrapers that pushed the skyline to new and colorful heights. Developers built almost enough new space--about 8 million square feet between 1988 and 1992--to fill Century City. Figueroa Street alone added six high-rises.
The problem was that this new space--the result of a severe bout of overbuilding that swept the nation--would have taken nearly a decade to fill under normal circumstances. And things turned out to be far from normal in the early 1990s as recession and corporate restructuring decimated Downtown’s traditional tenants--the banks, the law and accounting firms and the major corporations that paid top dollar for space.
Longtime Downtown denizens, such as Bank of America and Security Pacific, merged and slashed their staffs and office space. Other blue-chip tenants, including IBM and AT&T;, have dumped large amounts of space on the market in the wake of painful reorganizations.
In a survey of a dozen major urban centers last year, Downtown Los Angeles had the dubious distinction of being the only market where landlords of prime office space lost money on their rents, according to Julien J. Studley Inc., a commercial real estate firm. For leases signed last year, the average rent--after landlord concessions--was less than $12 per square foot, about 40% of what it was in 1990.
Although many other downtown and suburban office markets have bounced back, Downtown Los Angeles has lagged because of the extent of the overbuilding and the depth and length of the regional recession.
“This is one of the worst markets in the country,” said Stephen Bay, manager of Studley’s Downtown office.
In a sign of future problems for landlords, accounting and consulting firm KPMG Peat Marwick this month began eliminating the permanent offices of about 100 consultants in its Downtown office. Instead, the managers will have to reserve an office when needed. Otherwise, they will work from client offices and home via telephone, computer and fax machine.
As a result, the firm has reduced its office by 1 1/2 floors, and “we are confident that we can accommodate [future] growth without adding space like we would have in the past,” said KPMG’s area operations director Bob Goldstein.
The nose-dive in rents and the glutted market has been a disaster for building owners and investors. The backers of Los Angeles Center, who paid $200 million for the Unocal headquarters site, have written off much of their investment, Semcken said. “Today it’s worth only tens of millions of dollars,” Semcken said.
Japanese investors have also seen the value of their Downtown properties shrivel. Okitami Komada, the former president of Mitsui Fudosan USA, estimates that the company’s 52-story Sanwa Bank Plaza is worth less today than the estimated $270 million invested in the 5-year-old building--even though it’s almost fully occupied.
“It’s a sad story,” he said of Downtown real estate values.
Lower-than-expected rents and a vacancy rate above 30% forced the lenders of Two California Plaza to foreclose on the 52-story skyscraper on Bunker Hill this spring. Completed in 1992 for an estimated $300 million, the tower is now valued at only about $100 million, according to property records.
“It’s an absolutely premier building,” said Studley’s Bay. But “the developers were never able to get the kind of return that was needed. They essentially decided it didn’t make economic sense” and walked away.
Downtown landlords have raided each other’s tenants with all manner of incentives. Bert E. Dezzutti, the leasing manager at 550 S. Hope, a 28-floor high-rise adjoining the Central Library, recently signed up the Canadian Consulate by offering lower rent than it currently pays in a Bunker Hill skyscraper, say local brokers familiar with the deal.
Despite leasing about 80% of his building, Dezzutti continues prospecting for clients as well as keeping a close eye on his current tenants for signs of defections, mergers or restructurings that could result in more empty floors. “This is the most challenging time in my career,” said Dezzutti, 34.
The pressure to fill space has resulted in a bonanza for tenants, particularly budget-minded government agencies once virtually ignored by major developers.
The cash-strapped Los Angeles Unified School District, for example, found space this year in the posh Well Fargo Center for 900 employees formerly housed in a quake-damaged building next to the Santa Monica Freeway. The district, which is subletting the space formerly occupied by IBM, expects to save $18 million over the seven-year lease, compared to fixing and operating its own building.
Now some district employees, who encountered homeless people asleep in their old building’s restrooms, are almost embarrassed about their glitzy new surroundings. “Our old building did not have a concierge,” said business services director R.W. Dunevant.
But even low rents are preferred to huge chunks of empty space that could drag the market even lower. “The key is to keep them full until the market gets stabilized,” said Robert Maguire of Maguire Thomas Partners, the largest owner of Downtown office space.
The battle for tenants has spilled into the historic district, where building owners along Spring Street and Broadway find themselves competing with big-money developers seeking to fill space in more desirable parts of Downtown.
“It’s extraordinarily hard for someone like us to compete,” said Antonia Hernandez, head of the Mexican American Legal Defense and Education Fund, a Latino advocacy group that spent $6 million to renovate an Art Deco building on Spring Street for government and nonprofit tenants. The building, which houses the group’s headquarters, still has three floors to fill.
“They are giving space away--I can’t [afford to] give space away,” Hernandez said of developers with deep pockets.
On Broadway, developer Ira Yellin had to radically change his renovation plans for two vintage buildings that surround Grand Central Market. Instead of offices, Yellin has converted the buildings into 121 apartments, with monthly rents ranging from $406 for low-income residents to $2,400 for a penthouse suite. Since opening in May, 55 apartments have been rented, primarily those available under an affordable housing program.
“Clearly, when the [prime] buildings are chopping their rents . . . it makes it almost impossible to go into a historic building,” said Yellin. “There is just no economic reason to do it.”
Yellin is not the only Downtown landlord who has recast his plans. The World Trade Center, a 10-floor, block-long complex on Bunker Hill, filled up 30,000 square feet of an indoor concourse with classrooms for UCLA Extension.
The “students have generated life in the building and activity in the concourse,” said Terry Tornek, executive vice president for building owner Haseko California. “People have come for courses here that had never been to the building before. It’s been a plus.”
On 7th Street, the Canadian investors who bought the land under the former Robinson’s department store have abandoned plans to build a major new development. Instead, they are working to lease the landmark structure to the operators of the Price Club for use as a discount warehouse store.
“It’s not great from my owner’s point of view,” said John Gordon, a real estate investment adviser who is trying to sign up the Price Club. “But it’s not a disaster.”
In the shambles of the Downtown real estate market, many brokers and landlords can still glimpse the seeds of a turnaround. Insurance firms have been lured Downtown by low rents, new restaurants and museums have opened, and the renovation and expansion of the Convention Center and Central Library have attracted throngs of visitors. A growing web of commuter trains, trolleys and subways focused on Downtown will enhance access.
For business partners Mickey Sills and Richard Howard, Downtown has provided an affordable, distinctive home for their new casual apparel company, P.J.'s Salvage Co. With his dog, Grady, in pursuit, Sills shows off the firm’s offices, which include a small warehouse, a sewing room for samples and a kitchen, all on the top two floors of an aging Spring Street office building.
There is no central air-conditioning and crime is a major worry, but the monthly rent is only about $1,800 for 5,000 square feet, and the Apparel Mart, where most of the firm’s customers maintain showrooms, is 1 1/2 blocks away.
“I love it here,” Sills said. “I love havoc.”
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Landlords at a Loss
Although the Downtown Los Angeles market may have bottomed out, rents in first-class buildings were so low last year that landlords were unable to cover their operating costs. Downtown was the only market out of a dozen surveyed--including West Los Angeles--where landlords lost money. Average landlord income per square foot:*
Midtown New York: $15.55
Washington, D.C.: $15.09
San Francisco: $9.85
West Los Angeles: $9.69
Downtown New York: $7.28
Downtown Los Angeles: -$0.26
* Total rent after operating costs, concessions, commissions and taxes. Debt payments not included.
Source: Julian J. Studley Inc.