Thrown by a New Rental Market
Martial arts master Jin Yong Kwon isn’t knocked off balance easily. But even he was floored when he started shopping for a new space for his tae kwon do studio.
Storefronts were so scarce in his Corona del Mar neighborhood that he resorted to knocking on doors for leads on possible vacancies. He’s now paying 25% more per square foot for a studio half the size of his old one, where he lost his lease last summer. The ceiling in his new place is low, parking is scarce and students and their parents are starting to complain.
“When I first saw this place, I felt claustrophobic,” said Kwon, running a sinewy bare foot over the dark green carpeting, “but it was all we could find.”
Apartment dwellers and first-time home buyers aren’t the only ones getting scorched by the sizzling Southern California real estate market. Small-business owners too are feeling the heat from rising rents and a shortage of prime space in some areas. Whether it’s retail frontage in Corona del Mar, office space in Hollywood or industrial buildings in the South Bay, many entrepreneurs are experiencing sticker shock as they renew leases originally signed years ago when the economy was still in recession.
Many are chalking it up to the price of doing business, banking on increased sales and continued pep in the economy to offset rising rents. Others are scrambling for cheaper locations or retreating to home offices. Some have found themselves forced out by building owners eager to rent to bigger, more upscale tenants now that the good times are back. Still others are looking to purchase their own facilities and rid themselves of landlords and rent hikes once and for all.
One thing is certain: Small-business owners are eyeing their lease expiration dates with a trepidation not felt in years.
“They’re suddenly looking up and realizing that the whole landscape has changed,” said Jerry Neitlich, founder of Irvine-based IN/House Corporate Real Estate Advisors, which represents small-business tenants in lease negotiations. “Those that haven’t planned for it are panicking a bit.”
A number of factors are fueling the Southland’s recent run-up in commercial leasing rates--including rising costs for new construction and landlords eager to make up for lost time--it essentially comes down to supply and demand. Vacancy in the Los Angeles County office market, for example, has fallen steadily in recent years as the economy has improved, from an 18.5% countywide vacancy rate in 1995 to 12.2% in the second quarter of this year, according to figures from brokerage giant CB Richard Ellis. Leasing rates have responded accordingly, rising to an average of $1.78 per square foot per month from $1.51 over the same period, an 18% boost.
These increases aren’t limited to office space. Asking rents for retail space in central coastal Orange County where Kwon was hunting for space have jumped nearly 8% over the last year alone to an average of $1.97 a square foot, according to CB Richard Ellis. Likewise, industrial vacancy rates in the South Bay are at an all-time low of around 4%, which has pushed rents up an average of 30% since the third quarter of 1998, according to Grubb & Ellis Co.
Although these increases appear hefty compared to the minimal rate of inflation, experts say they’re magnified simply because so many tenants are coming off bargain leases struck when the economy was in the doldrums.
“Landlords got beaten up in the early 1990s while tenants had a field day from all the overbuilding,” says Jim Duke, a retail broker with CB Richard Ellis in Anaheim. “Now it’s the landlords’ turn.”
To be sure, some property owners still can’t give away space in older buildings in tough parts of the region. And overbuilding has kept a lid on prices even in some desirable areas. Office rates in Glendale, for example, haven’t budged in more than a year, thanks to a glut of new projects. Still, some small tenants in up-and-coming areas are finding that the price of entry has gone way up since they last inked a lease.
Elio Gomez, owner of a Hollywood-based broadcasting school for Spanish speakers, expected his bargain rent of $1.20 a square foot to increase when his three-year deal expired in May. But he never dreamed he’d be hit with a whopping 67% rise to $2 a square foot. Gomez, now on a month-to-month lease, has bought a building in Montebello, where he will move his International College in time for a Nov. 1 opening.
“Everybody wants to be famous. That’s why we located in Hollywood in the first place,” Gomez said. “But these landlords are looking for big tenants and big money now.”
Indeed, real estate watchers say new investors in hot areas such as Hollywood are wasting little time in trying to maximize the return on their purchases. For many, that means courting large users and big-name tenants, even if that means displacing small fry who have been on the premises for years.
Hollywood lawyer Howard Beckler is relocating his offices from 6922 Hollywood Blvd. after 31 years because his new landlord refused to negotiate another long-term lease. The building’s owner, the CIM Group, declined to comment on its plans for the 12-story Class A building. But local observers say they’re currently in negotiations with a large entertainment conglomerate.
Although some small businesses grumble that they stuck it out in the bad times only to be squeezed out now, when a boom appears imminent, others say rising rents are a blessing for an area trying to shake off its seedy past.
“We don’t need any more T-shirt shops down here,” said Terry Jorgensen, president of the Bank of Hollywood. “We need quality businesses and quality buyers to support them.”
Beckler already has found new office space in Hollywood, albeit at nearly double the price of his current place, and he’s upbeat about the changes brewing in the area.
Lawyer Gene Kramer, meanwhile, has taken a different approach to rising rents in Century City, his business address since 1973. The private practitioner recently set up shop at his home in Westwood, a cheaper alternative to Century City, where average asking rents in prime office buildings are hovering near $3 a square foot.
“I’ve been practicing long enough that my existing clients don’t care where I’m located,” Kramer said. “But this arrangement wouldn’t work for everyone. . . . Clients tend to view the surroundings as symptomatic of the attorney’s prowess. So the guy in the storefront isn’t going to have the same recognition as the guy on the 25th floor with the view of Los Angeles.”
Of course, what’s most attractive is in the eye of the beholder. To a casual observer, the squat tan building Maxtrol Corp. has been leasing in an industrial swath of Santa Ana is nothing remarkable. But to Uri Ranon, it’s a gem.
The president of Maxtrol, a company that makes electronic controls and automation systems, was recently informed by the landlord that his lease won’t be renewed. Now Ranon is scrambling to find a 4,000- to 5,000-square-foot building and get his business moved before his old lease expires Nov. 30.
Ranon currently is paying 59 cents a square foot for a building he describes as “beautiful” by virtue of its ample lighting, abundant electrical outlets and air conditioning. He recently looked at a brand-new facility in Lake Forest whose asking rent was nearly double what he’s currently paying. Not to mention the thousands of dollars he would probably have to spend to customize the space in a hot market in which free rent and landlord-paid improvements are evaporating.
Wherever he ends up, Ranon vows to pore over the rental documents to make sure he gets an option to stay on when the lease term ends.
“I’ve been renting places for 20 years and never had this problem,” Ranon says. “I just never anticipated something like this.”
Neitlich says even experienced businessmen like Ranon make the mistake of signing the “standard” leasing document, whose terms invariably favor the landlord. He says tenants should always be thinking about their next lease when they sign the current one, making sure to get a renewal option with the terms spelled out. Those thinking about relocating in this tight market should start scouting the market at least a year in advance, he says.
“You’ve got to have a plan . . , and you’ve got to have alternatives,” Neitlich said. “Otherwise you’re just going to have to swallow whatever terms the landlord gives you.”
Jesse Pena and his family decided that they’d had enough of landlords when they recently purchased the Long Beach building that houses their El Rey Bakery. Even though they were being charged a reasonable rent for the Pacific Avenue location, they know how quickly things can change.
“We’re getting in at the right time,” Pena said. “Rents are still low, but they’re going to start rising because this area is getting better.”
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Sticker Shock
Area small-business owners who signed relatively low-cost leases during the recession are finding it’s a landlord’s market now. A sampling of average lease rate increases in selected markets in Los Angeles and Orange counties over the last year:
Los Angeles County Office Space
(Asking price in dollars per square foot per month)
*--*
Submarket 2nd Qtr. ’98 2nd Qtr. ’99 % Change Downtown L.A. $1.51 $1.74 15.2% South Bay 1.46 1.68 15.1 Hollywood 1.37 1.57 14.6 San Gabriel Valley 1.42 1.56 9.9 San Fernando Valley 1.67 1.81 8.4 West Los Angeles 2.35 2.48 5.5 Glendale 1.96 1.96 0.0
*--*
Orange County Retail Space
(Asking price in dollars per square foot per month)
*--*
Submarket 2nd Qtr. ’98 2nd Qtr. ’99 % Change Central Coast $1.83 $1.97 +7.65% South County 1.53 1.63 +6.54 Central County 1.36 1.41 +3.68 North County 1.40 1.41 +0.71 West County 1.42 1.37 --3.52
*--*
Los Angeles County Industrial Space
(Asking price in dollars per square foot per month)
*--*
Submarket 3rd Qtr. ’98 3rd Qtr. ’99 % Change South Bay $0.40 $0.52 +30.0% San Gabriel Valley 0.38 0.47 +23.7 Central L.A. 0.41 0.47 +14.6 North Los Angeles 0.51 0.54 +5.9 Mid-Cities 0.42 0.44 +4.8
*--*
Sources: CB Richard Ellis, Grubb & Ellis
