Downtown L.A. Still a Deal
Businesses bemoaning the rising cost of office space in Southern California take note: Things could be worse. You could be renting space in San Francisco.
Or New York.
Or Washington.
Or any number of places where office rental rates keep climbing while the supply of available space dwindles.
“Downtown L.A. is still one of the best bargains, compared with all of the major cities,” said Howard Sadowsky, an executive vice president in Los Angeles with Julien J. Studley Inc., a New York-based commercial real estate brokerage.
Despite a real estate recovery that has been pushing Los Angeles office rents steadily higher over the last several years, a just-completed Studley study shows downtown Los Angeles office owners are unable to demand the kind of rents that landlords get in comparable urban markets.
Premium office space in downtown L.A. rents for about $27 per square foot per year, according to the Studley study, compared with $46 in midtown New York, $40 in Washington and $39.50 in San Francisco.
Surveys by Studley and other brokerages show that cheaper downtown office space is available in other parts of the country, but not usually in cities that compare in size and status with L.A.
“Downtown L.A. is one of the few bargains in the whole country. There aren’t many places where there is a lot of Class A space left,” said Robert Bach, national director of market analysis for Grubb & Ellis Co.
Downtown L.A.’s distinction as a discount market, however, is a classic good-news-bad-news scenario. Whether the news is good or bad depends on whether you’re a landlord or a tenant.
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The good news for office tenants is that they can rent top-quality space for relatively low rates.
The bad news is that downtown L.A. is lagging the rest of the region and the country, with lower rents and nearly 20% of its office space vacant, despite a protracted economic recovery and a real estate rebound that is several years old.
Contrasting downtown with Westside Los Angeles markets strikingly illustrates that lag.
“It’s like a tale of two cities,” Sadowsky said. Class A rents run nearly $8 per square foot per year higher in West Los Angeles than in downtown L.A. Westside rents average about $34.80, according to the Studley study, but some of the most expensive buildings, such as 100 Wilshire in Santa Monica and 1999 Avenue of the Stars in Century City, command rates of up to $40 per square foot.
Still, even the Westside rents can look budget-priced compared with rates in San Francisco and New York. And on the Westside there are still empty offices for rent.
“In San Francisco you can’t find an inch of space,” the Studley executive said. “Whenever some space does come on the market, there’s a bidding war for it.”
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Of course, the decision on where to rent space is not just a dollars-and-cents issue, or rents in comparable-quality buildings would probably be a lot more uniform throughout Southern California, said broker Stan Gerlach of CB Richard Ellis.
Some companies insist on being in West Los Angeles or the also-expensive Burbank Media District and wouldn’t consider a downtown L.A. building no matter how grand its granite, Gerlach pointed out.
On the other hand, Gerlach added, “We are starting to see some companies take a look at downtown” because of its lower rates. For example, he said, the insurance brokerages Johnson & Higgins and Marsh & McLennan chose to remain downtown when they consolidated recently.
“They had some space in West Los Angeles too, but they knew it would be a lot easier to sublease the West L.A. space than the downtown space,” Gerlach said.
Even as it lags the rest of the region and the country, downtown L.A. is an improving market, according to Sadowsky and other brokers. The steady rise in rental rates throughout Southern California and the rest of the country might suggest that rents are headed ever skyward, but Sadowsky said new construction could eventually save the day for rent-hike-weary tenants.
When new space is built, Sadowsky explained, it tends to keep a lid on rates because the new space brings supply and demand more into balance.
Relatively little new space has been built in U.S. downtowns in recent years, Sadowsky said, thanks to the overbuilding of the past and to the growth of suburban markets that compete for tenants. Now, however, “Some cities are actually starting to think of building new downtown space,” he said.
Whether that will happen in downtown L.A. is one of the big questions to be answered in the coming years.
Sadowsky pointed out that the typical tenants in downtown L.A. buildings are title companies, brokerages, law firms and banks, none of which are growing at the rates of the entertainment and high-tech companies moving into Westside and suburban markets.
In addition, bank mergers have hindered downtown’s comeback by dumping hundreds of thousands of square feet of space on the market.
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Bach, the Grubb & Ellis research chief, offers yet another perspective.
“One school of thought is that downtown markets will perpetually trail the suburban markets because people prefer to be in the suburbs, and with unemployment at historic lows around the country, people can work where they choose,” Bach said.
And with more office space being built in the suburbs, he said, the question is whether some downtown markets will ever recover their former glory.
“Ten years ago, downtowns were charging the highest rents and building palaces, but now it’s the suburban buildings,” Bach said. The thinking among some real estate experts, he said, is that the continuing growth of suburban markets “could put the kibosh on some downtowns.”
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Not all central business districts are expected to decline, according to this scenario. Such downtowns as Chicago, San Francisco, Boston and others with superior mass transit and plenty of nearby housing for workers and executives are expected to thrive, Bach said.
But L.A. isn’t considered a member of that group because it lacks both a well-developed mass transit system and the requisite housing.
Bach pointed out that another school of thought believes just the opposite: That L.A. and other downtowns have many assets working in their favor and will surely recover strongly.
“That’s why you’re seeing downtown buildings change hands,” he said. “The new owners believe rents are going to go up.”
According to Sadowsky, it could happen in the blink of a proverbial eye.
“In downtown New York two years ago, they couldn’t give the space away. They were talking about converting office buildings into housing,” he recalled. “Today, they are fighting for space there. It changed that dramatically in that short a time because businesses suddenly needed the space.”
Rental Squeeze
Downtown Los Angeles rental rates remain a bargain compared with those in most other major cities, despite a local real estate recovery that has boosted rents throughout the region. A recent study by Julien J. Studley Inc. also indicates that as rents increase and a market tilts in favor of landlords, office tenants can expect to pay higher rates for their share of operating expenses and property taxes. Another effect of a tightening market is that landlords are willing to spend less on “tenant improvements,” the amounts they will commit to customizing space for tenants.
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Tenant Effective improvement rental rate* allowance** As of As of As of As of Area 6/97 6/98 6/97 6/98 Midtown New York $40.00 $46.00 $62.00 $55.00 Washington 37.00 40.00 45.00 40.00 San Francisco 38.60 39.50 25.00 10.00 West Los Angeles 30.00 34.80 40.00 34.00 Downtown Chicago 26.00 28.50 45.00 40.00 Downtown Los Angeles 25.00 27.00 50.00 45.00 Downtown Houston 22.00 23.50 15.00 15.00
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Operating Propety Class A vacancy expenses*** taxes**** rate***** As of As of As of As of As of As of Area 6/97 6/98 6/97 6/98 6/97 6/98 Midtown New York $7.00 $7.50 $9.10 $9.50 5.8% 4.0% Washington 8.00 8.00 5.00 5.00 8.9 6.5 San Francisco 8.95 9.40 2.95 3.00 5.8 6.0 West Los Angeles 6.30 6.42 2.38 2.75 13.4 9.8 Downtown Chicago 6.60 6.75 7.25 7.75 10.0 7.8 Downtown Los Angeles 8.75 9.00 1.75 1.75 21.0 19.0 Downtown Houston 5.10 5.30 2.25 2.25 9.0 7.0
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* Per rentable square foot for Class A high-rise office space, including free rent, average for 10-year lease, consummated deals
** Per usable square foot for Class A high-rise office space, average for new leases only
*** Per rentable square foot for Class A high-rise office buildings, including everything except property taxes
**** Per rentable square foot for Class A high-rise office buildings
***** For all Class A buildings
Source: Julien J. Studley Inc.
