Downtown Office Market Struggles
The long-awaited recovery of downtown L.A.’s office market must wait a while longer, despite a plentiful supply of inexpensive space, plush buildings and a development boom that many have been counting on to help attract tenants.
Downtown registered a net loss of more than 80,000 square feet in the third quarter that ended Sept. 30, according to a report by real estate brokerage Cushman Realty Corp.
Not all of those who track real estate agree with that statistic. Cushman & Wakefield says downtown posted a net gain of about 80,000 square feet of office space occupied during the quarter, and Grubb & Ellis lists a net gain of about 96,000 square feet.
But whether it lost ground or made minor gains during the quarter, downtown--with several million square feet of vacant space--still lags far behind other Los Angeles County markets when it comes to putting tenants in buildings.
Nearly 25% of the office space downtown was empty at the end of the third quarter, according to the Cushman Realty report, compared with less than 7% in West Los Angeles and approximately 13% in the San Fernando Valley.
The surfeit of offices for rent downtown is primarily the result of corporate mergers and downsizings that continue to dump large blocks of space on the market as businesses reduce their staffs or leave the region. For example, BP Amoco’s acquisition earlier this year of Atlantic Richfield Co. added several hundred thousand square feet to downtown’s inventory.
Downtown also struggles with an image problem among many potential technology and entertainment industry tenants, who view it as dull and lifeless in contrast to the Westside. In other cases, executives who live on the Westside prefer to set up shop closer to home.
Real estate brokers, developers and downtown boosters hoped for a speedier recovery of the office market, which has been in the doldrums since the early 1990s. Many still predict that tenants will be attracted by inexpensive space and major new developments--including Staples Center, Disney Concert Hall, the Cathedral of Our Lady of the Angels and apartment projects.
“I’m very upbeat and very optimistic about downtown,” said Cushman Realty broker Steve Marcussen. “We are making progress. It’s just that we keep getting hit.”
Colliers Seeley broker Mark Shaffer said he, too, remains positive, noting that new leases for 200,000 square feet of office space were signed during the third quarter.
Among the few “new-economy” tenants who have moved to the neighborhood is Full Moon Interactive. The designer of Internet strategies for Fortune 500 companies grabbed 30,000 square feet at 911 Wilshire Blvd. this summer. Chief Executive Fred Walti said he needed to expand from 7,000 square feet in Hollywood and couldn’t find suitable, affordable space anywhere but downtown.
As Walti describes it, there was a little kicking and screaming involved in the decision to move to a part of the city he perceived as dull and uninviting.
“I was a skeptic,” Walti said. My wife [Full Moon office manager Karen Rutherford] and Ryan Schnell [his broker] literally dragged me to see this space.”
Full Moon managers spent six months looking for suitable quarters they could afford, visiting dozens of buildings throughout the Westside, the San Fernando Valley and other markets. When they found space they liked, it was too expensive; when they found space that was affordable, it wasn’t any place they or their workers wanted to be.
Downtown is “a great financial deal” and “equally inconvenient for everyone” in the company, Walti said. Full Moon pays about $1.55 per square foot per month in a seven-year sublease that includes furniture, thus saving the company even more. The only financial downside, he said, is the cost of parking, which somewhat reduces the rent savings.
“Downtown has been a treat,” Walti said. “There is a lot of activity here.”
Brokerages say their numbers tracking the market differ because of the different methods they use to calculate what’s known in broker jargon as net absorption--the gain or loss in occupied space. Some brokerages consider space to be empty as long as it is available for a new tenant to rent, even if an existing tenant with plans to move out is still occupying it. Others consider the space to be filled as long as it is physically occupied, even if the tenant has announced plans to move out.
Whatever the numbers say, brokers agree that downtown is making progress little-by-little, with small firms like Full Moon moving in, and that it’s also making headway in the sense that fewer businesses are moving out.
“We’re seeing [tenants] coming into the market who are looking to take advantage of the price differential,” said broker Onno Zwaneveld of Julien J. Studley Inc. He believes those tenants will eventually include larger businesses.
“We’ve staunched the flow of companies moving out,” said broker John Eichler of Cushman & Wakefield, explaining that a number of businesses in recent years have elected to renew leases downtown after considering higher-priced space in other markets. He said Westside rents--where premium space now tops $4 a foot--have risen so much in recent years that tenants are bound to head downtown for relief.
Downtown has yet to benefit from rising Westside rents, Eichler said, because businesses have turned first to other, formerly soft markets such as El Segundo and the LAX Airport area. Now those areas are filling up.
Also, many Westside tenants are still enjoying below-market rents in leases they signed years ago that won’t come up for renewal for several years. At renewal time, Eichler said, those tenants will face much higher rents and will be more likely to look east.
For now, downtown has a higher percentage of empty space than most of its competitors. Cushman & Wakefield and Colliers Seeley both calculate the overall vacancy lower than Cushman Realty, at approximately 20%. CoStar Group Inc., a real estate research service, puts it at 19%.
Marcussen believes downtown will continue to whittle away at the oversupply and that the amount of empty space will decline over the next few quarters, assuming no more corporate consolidations occur.
“Eventually, people are going to leave the Westside because there isn’t going to be any space left for them,” Marcussen said. “It just hasn’t happened yet.”
