Landlords, Tenants Playing ‘Chicken’
Who is going to blink first?
That’s the question players in the Los Angeles commercial real estate market are asking as the slowing economy leaves a lot of office landlords and tenants waiting to see which direction rents are headed before making commitments.
Many tenants are taking more time to shop for space as vacancies rise. The lackluster economy has made them skittish about expanding or making long-term financial decisions. Landlords, meanwhile, are for the most part not reducing rents, banking on the slowdown being short and hoping that strong real estate fundamentals could make rent cuts look like a bad idea within a few months.
That situation is a dramatic change from only a few months ago when rival tenants competed for space even as landlords bumped up rents.
“It’s kind of like a game of chicken,” said Nick Christensen, a broker at CB Richard Ellis. “Tenants are betting that rates are going down . . . in the next few months, and the landlords are betting that we have found the bottom.”
In addition to a lackluster economy, Los Angeles has faced some unique circumstances that have created more uncertainty. Threatened strikes by Hollywood writers and actors have stalled decisions among some entertainment clients. The dot-com bust has resulted in the sudden availability of more than 1 million square feet of space for sublease on the Westside of Los Angeles.
Companies, such as insurance firms, that were once looking for expansion space are now not so sure they will need as much room to grow in the years ahead, according to brokers.
Many companies are “concerned about what size they are going to be and what type of financial reversals they might face,” said Robert Chaves, who heads the Los Angeles office of real estate firm Staubach Co. “Optimism is at a low.”
Real estate statistics and trends do seem to be going in the tenants’ favor. During the first quarter of 2001, the vacancy rate for the combined Los Angeles and Orange county office markets rose to 11.9% from 11.1% at the end of last year, according to Delta Associates. The net amount of occupied office space fell by 900,000 square feet during the same period after years of expansion.
“Tenants have more choices now instead of just two or three,” said Rosey T. Miller, senior managing director, with real estate firm Julien J. Studley Inc.
Attorney Leslie Abel has seen the market move in his favor in the six months he has searched for 10,000 square feet of space on the Westside. On a recent excursion, Abel toured a former dot-com office littered with boxes of unopened computers in a building where monthly rents once exceeded $4 a square foot.
“The landlords have come back to us and said, ‘Make us an offer,’ ” said Abel, whose firm is now located in Century City. “I think there is going to be more softening.”
In Orange County, tenant broker Dave Willis says many of his clients are betting on lower rates in the years ahead by trying to avoid long-term leases. Instead, many are considering taking advantage of the growing pool of cheap sublease space available for two or three years. His clients’ most frequent question: “If I wait longer, will I save money?”
But landlords and many brokers are warning tenants not to wait too long. Despite the dot-com bust, most other tenants have shown no signs of giving back space in large quantities. In addition, the lack of major new construction in most areas will work in the landlords’ favor by limiting the number of new competitors.
Brokers said landlords will offer all sorts of concessions--from reduced parking rates to more remodeling money--before they cut rents, which would reduce the value of their property.
“In the [recession of the early] 1990s, it took years in some cases for landlords to meet the market and lower rates,” said broker Dave Toomey at Cresa Partners. “When you talk to landlords, they just say that everything is fine.”
That’s the case at Arden Realty, Inc., one of the largest owners of office space in Southern California.
“There are better opportunities for [tenants], but I’m not concerned,” said Arden’s leasing chief Robert C. Peddicord. “There is not a lot of space out there. We are still in single digits [vacancy rates].”
John Moe, who heads Los Angeles operations for property owner Divco West, sees no reason to reduce rents on his company’s two Century City office buildings. The towers, which combined total about a million square feet of space, are 96% occupied, and rents in the prestigious business district have continued to rise.
“We are doing pretty well in our projects,” Moe said. “I don’t think the tenants that are waiting [for lower rents] in Century City will benefit.”
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Market in Transition
Rising office vacancies in Los Angeles County have shifted the market in favor of tenants. *
Los Angeles County
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Absorption* Avg. asking leasing (in millions of rate, per square foot Vacancy rate square feet) (monthly basis) 1st qtr 2000 10.8% 2.1 $1.85 2nd qtr 2000 10.2 1.5 1.85 3rd qtr 2000 10.4 1.3 1.95 4th qtr 2000 10.3 1.3 2.03 1st qtr 2001 11.1 -0.6 2.07
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*Net change in the amount of occupied space
Source: CB Richard Ellis
