Office Market Slump Weighing on Arden
As Southern California’s commercial property market continues to sink, the real estate company with perhaps the most to lose is the region’s biggest owner of office space: Arden Realty Inc.
All of the Los Angeles company’s nearly 18 million square feet of office space is in Southern California, which many mistakenly had believed would avoid the worst of the slowdown that has hit commercial real estate nationwide.
Instead, Arden and its rivals have watched the region’s occupancy and leasing rates deteriorate for more than two years, with no end in sight.
To the dismay of investors, Arden, a publicly traded real estate investment trust, reduced its earnings and operating targets in the first half of the year, and the company’s property and leasing managers will remain under tremendous pressure in coming months to keep occupancy rates from sliding further.
“It’s being tested right now,” said real estate securities analyst David Shulman at Lehman Bros. “The company had the wind at its back for a long time, and now they have the wind in front of them. Now we will find out how good they are.”
Arden remains financially strong and continues to churn out profit, generating $17.4 million in net income during the second quarter. But company executives, like their peers at other property companies, have been surprised by the depth and duration of the real estate slump. Net income was $28 million in the second quarter of 2001.
Hope for a market turnaround evaporated by midyear as the vacancy rate at Arden’s buildings hit approximately 10%--about double year-earlier levels--and the company leased only 75,000 square feet of space in June, far below expectations.
“We have not seen the level of business expansion and job growth required to drive significant office demand,” founder and Chairman Richard S. Ziman said during a recent conference call with investment analysts. “At this time, we see little short-term relief from these market pressures.”
Arden’s lackluster performance has forced many Wall Street analysts to reduce their expectations for the company and the region’s office market. “We thought Southern California would be holding up better,” Shulman said.
On Monday, Arden shares rose 16 cents to $24.60 on the New York Stock Exchange.
During the real estate bust of the early 1990s, Ziman and Chief Operating Officer Victor Coleman formed Arden by amassing a huge portfolio of office buildings at bargain prices. That portfolio, which consists of about 130 mostly suburban office buildings that are leased primarily to smaller professional firms, generated impressive year-over-year gains as the Southern California economy expanded during the booming second half of the 1990s.
But strategies that served Arden well during boom times have not insulated it from the market’s downturn.
Arden minimized its exposure to large corporate tenants that tie up huge blocks of space by leasing to many small businesses--which have proved especially vulnerable in the sluggish economy.
Arden is retaining far fewer tenants than it has in the past, and the leases it is signing are for spaces that are about 40% smaller than the company’s historical average. The company still is able to raise rents when most leases expire, but the increases are only about half as much as they were last year.
“You’ve got smaller, regional tenants that are [not as] well- capitalized” as larger firms, said Jim Bracken, an office real estate industry analyst at Green Street Advisors in Newport Beach. “It’s a problem as the market weakens.”
The company also has suffered from its large presence in the Westside and the South Bay, markets that have fallen sharply since the dot-com boom of the late 1990s. At Howard Hughes Center in Westchester, the company has failed to find tenants to fill 6100 Center Drive, a recently completed 12-story high-rise, despite cutting rents by about 15%.
“The activity is not that great,” said Robert Peddicord, senior vice president of leasing at Arden. “West L.A. was hit fairly hard by the downturn.”
Peddicord said the company has intensified its focus on stabilizing occupancy and retaining tenants, often contacting them far in advance of their leases’ expiration. In addition, it is working to shorten the time necessary to complete the often-lengthy leasing process. In one extreme case, Arden completed a lease for 1,000 square feet in about two hours.
“You can’t go out and create demand,” Peddicord said. “You have to focus on areas where you can make a difference.”
Despite rising vacancy rates, Arden is committed to keeping a sizable presence in key markets. The company recently agreed to purchase the 433,000-square-foot Gateway Towers complex in Torrance for about $66 million. Such acquisitions are part of a strategy to ensure that the company is prepared for the long term when the office market rebounds.
“We are not panicking,” Peddicord said. “We are maintaining and continuing to grow and learn about ourselves and how we operate. We are here for the long term.”
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Under Pressure
Shares of Arden Realty rallied sharply in 2000 and held up well in 2001 amid a broad advance in REIT stocks. But the stock has slumped recently on worries about rising vacancy rates in Southern California’s office market.
Arden Realty shares, monthly closes and latest:
Sept. 1997: $31.38
Nov. 1999: $19.25
Monday: $24.60, up 16 cents
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Arden Realty at a Glance
Headquarters: West Los Angeles
Senior officers:
Chairman and CEO: Richard S. Ziman
President and COO: Victor J. Coleman
Business interests: Office leasing, property and asset management, property development, and energy management under consulting division. Largest office building landlord in Southern California.
Properties: 130 with about 18 million square feet
Premier property: Howard Hughes Center in Westchester
Total assets (June 30, 2002):
$2.7 billion
Second-quarter revenue: $103.1 million
Recent acquisition: Gateway Towers in Torrance for about $66 million
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Sources: Bloomberg News, company reports
