Developers Showing Restraint This Time
Real estate experts have developed a standard response when asked whether Southern California developers, enjoying good times, will blow it again and produce a glut of new office buildings rivaling that of the 1980s.
“No. The market is more disciplined today,” goes the answer.
That verbal reflex appears to be right on target, at least for now.
Developers in Los Angeles, Orange County and the rest of the country are building new office space at a dramatically slower pace during the current commercial real estate rebound than they did in the highflying 1980s.
The 1.8 million square feet of new office space under construction in Los Angeles County is equal to just slightly more than 1% of the total existing inventory of 160 million square feet, according to figures from Grubb & Ellis Co.
In 1985, by comparison, 14.5 million square feet of new space was being built in the county at a time when the existing inventory totaled approximately 100 million square feet. Developers in Orange County that year were building 6.5 million square feet--nearly 20% of the then existing inventory.
The burst of building in Los Angeles and Orange counties was not unusual for the times.
“It is pretty much what happened throughout the country in the 1980s,” said Robert Bach, national director of market analysis for Grubb & Ellis. “During any given quarter in the 1980s, the amount of space under construction nationally equaled 10% or more of the existing inventory.”
Today, the rate of new construction nationally is 2.6% of existing inventory, compared with just more than 1% in L.A. County and approximately 1.7% in Orange County.
The pace at which new office space is being built is far more than just an esoteric statistic, said Gary Weiss, a senior managing director at Julien J. Studley Inc., a commercial real estate brokerage.
“New office development affects virtually everyone in business. Not just people in real estate, but lawyers, accountants, people in the entertainment business, people in high tech. You name it,” Weiss said. He explained that the pace of building ultimately determines how much rent businesses will pay for their office space because a glut of space will lower rents while a shortage will drive them up.
Today’s slower building pace might suggest that developers have grown wiser, but the commercial real estate industry has another expression that suggests otherwise: “Given the opportunity, developers will develop.”
Or, in the words of longtime Los Angeles developer Jerry Snyder: “When money is available, builders build, and each one thinks he is going to lease his building.”
Andy Fishburn, a senior vice president at El Segundo-based Kilroy Realty Corp., a real estate investment trust, said the “more disciplined market” everyone talks about today is the greater scrutiny to which lenders subject development projects.
“The game has changed now that most of the money is coming from Wall Street,” Fishburn said. “It used to be that a developer could borrow 80% of the value of the project, but the loan-to-value ratios are much more conservative now. The lenders are requiring developers to put up half of the money.”
This means that much of the millions of square feet of new Los Angeles Basin office construction being discussed remains little more than a daydream until developers obtain financing.
Bach, the Grubb & Ellis research chief, described the vast chasm between an “announced” or “planned” development and actual construction.
“At one time in 1992 or 1993, there was still a huge amount of space on the books as ‘planned’ in Orange County. None of it was built, but officially it was planned because it had been announced,” Bach said.
According to Howard Sadowsky, an executive vice president at Studley, the gap between announced projects and actual construction of office space is comparable to the distance between hopes and reality in Hollywood.
“There’s no question that people are working on office deals, just like people are working on movies. The question is which, if any, of the deals are going to become reality,” Sadowsky said.
Sadowsky’s Hollywood analogy is especially appropriate in connection with the Los Angeles office market because the entertainment industry is credited with creating much of the demand for new space in recent years. Burbank and Glendale, home to movie studios and other entertainment firms, register some of the lowest vacancy rates and command some of the highest rents in Southern California.
But Hollywood’s demand for new space is slowing down, according to recent reports. Jobs in the entertainment industry are growing at about 3%, compared with past years that often exceeded 5% and sometimes soared into double digits.
The film industry will add about 3,500 jobs in Southern California this year, compared with an annual average of about 13,600 from 1990 through 1997, according to Jack Kyser, chief economist for the Los Angeles Economic Development Corp. The entertainment industry’s slower growth rate is one of several factors suggesting that Southern California is wise to build office space at a slower pace than during the last boom.
“The demand for space today is nowhere near as great as it was in the 1980s,” Sadowsky said. “In the 1980s, law firms were coming into Los Angeles from all over the country, taking whole floors and then doubling and tripling their size.”
By contrast, mergers in banking and other industries today are reducing the demand for space in some markets, Sadowsky said, while at the same time businesses in general are getting by with less space for the same number of workers.
“Companies in general lay out space differently and put more people in the same amount of square footage than we used to. Technology has made us rethink the way we use space,” Sadowsky said.
Sadowsky, Fishburn and Weiss all cited downtown Los Angeles, where more than 6 million square feet of new space was built during the 1980s, as an extreme example of what can happen when the pace of construction far exceeds demand.
“There still is an incredible glut of space downtown. I don’t care what anyone says about how downtown is coming back,” Fishburn said. “Downtown still hasn’t recovered. It isn’t even close.”
Added Sadowsky: “In 1991 we had 7 million square feet of space on the market in downtown L.A. We still have over 5 1/2 million.” Weiss said the empty space hasn’t been filled because companies keep merging and “there’s not a lot of movement into downtown from other markets.”
According to Fishburn, developers have both the fresh memory of the early 1990s and ‘incredibly sophisticated” information systems today to steer them away from unjustified building.
“Aside from your gut, there is a solid backbone of information to rely on today,” he said. “A lot of that isn’t worth a damn, of course, if there is an economic crisis.”
But Fishburn and others interviewed for this article believe the current pace of development makes sense in light of expectations that the economy will remain steady.
Developer Snyder, for example, recently began construction on the second phase of the Water Garden, a 600,000-square-foot office development in Santa Monica, and said he plans to begin construction within two months on a previously announced 585,000-square-foot office project in Burbank.
“The underlying assumption in all of this [new construction] is an expanding economy” in which tenants are growing and requiring more space, Fishburn said. “If that big picture changes, it’s anybody’s guess what will happen to the market.”
Slowing ‘90s
Construction of new office space has slowed markedly from the pace set in the 1980s. Square footage under construction today is slightly more than 1% of the existing inventory, compared with about 14% of existing inventory during the peak building year of 1985. New office space under construction and completed, 1985-98, in millions of square feet:
Los Angeles County
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Year Under construction Completed 1985 14.5 5.6 1986 10.0 8.8 1987 10.6 8.4 1988 13.7 7.1 1989 11.7 7.7 1990 11.0 5.2 1991 3.1 6.7 1992 0.2 2.5 1993 0.1 0.0 1994 0.1 0.0 1995 0.1 0.1 1996 0.0 0.1 1997 0.5 0.3 1998 1.8 NA
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Orange County
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Year Under construction Completed 1985 6.5 4.0 1986 5.5 4.2 1987 5.0 4.0 1988 5.1 3.6 1989 2.7 3.2 1990 2.1 2.9 1991 0.1 0.1 1992 0.0 0.0 1993 0.2 0.0 1994 0.0 0.2 1995 0.0 0.0 1996 0.0 0.0 1997 0.5 0.0 1998 0.9 NA
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Source: Grubb & Ellis
