Office Market Looks Ominous, but Housing Expected to Shine

The naked city is more bare than before.

Office vacancy rates in downtown Los Angeles jumped 16% last year, according to a new market study, reflecting continuing softness in the local economy.

And this year isn’t looking much better.

“We are going to have a volatile ‘03,” said John Cushman, chairman of Cushman & Wakefield Inc., a New York commercial real estate brokerage with a large presence in Los Angeles. “It will be erratic.”

Downtown L.A.’s vacancy rate reached 19.6% at the end of 2002, up from 16.9% at the end of 2001, the report by Cushman & Wakefield found.

The increase in vacancies was brought on by businesses’ continued belt tightening and the opening of buildings that were planned during the economic boom of the late 1990s but are proving difficult to fill now.

“It’s highly likely that office markets will not be reinvigorated until we see some significant level of job creation,” said Stuart Gabriel, director of the Lusk Center for Real Estate at USC. “We have not seen the level of employment expected in an upswing.”

Indeed, Los Angeles County lost 17,500 jobs between November 2001 and November 2002, according to the latest statistics available from the state Employment Development Department.

Orange County fared the best among the region’s major markets; its vacancy rate was virtually unchanged last year at 17.5%, compared with 17.4% a year ago, the study found. Rents, however, have fallen 12.9% since the first quarter of 2001.

Los Angeles’ Westside fared the worst, with vacancies soaring by a third to 20% at year-end.

Overall, office vacancies in Los Angeles County rose to 18.8% in 2002 from 16.8% in 2001. More sublease space and 2.2 million square feet of new office space were behind the increase, the report said. About 1.6 million square feet of that still is vacant.

The Cushman study tracks buildings of 25,000 square feet or larger, which represents the bulk of the office market. The statistics do not include medical, government or owner-occupied buildings.

In response to the declining market, rents in all areas of the county fell over the course of the year, and landlords became more generous with concessions such as space improvements and parking fees. The average rent is $2.24 per square foot per month.

The president of Arden Realty, Southern California’s largest office landlord, downplayed the effect of new buildings on L.A. vacancy rates. Victor Coleman said the construction pipeline is nearly empty, and the market should tighten fairly quickly from here on out.

“Our anticipation is six months of holding our own and trying to tread water, and then six months of improved leasing activity,” said Coleman, who heads the Los Angeles-based real estate investment trust.

Still, Coleman acknowledged that many Southern California business executives are experiencing “decision paralysis” because the economy hasn’t settled down enough for them to know what kind of growth plans to make.

Lower interest rates on mortgages on their buildings helped ease the pain of declining rental revenue for landlords. But they again were hit with rising operating expenses in 2002 as insurance companies increased premiums, security costs skyrocketed and utility costs temporarily spiked.

The Southland’s falling occupancy rates mirrored those across the country. U.S. downtown office vacancies rose to their highest level in six years even as landlords said they see signs the market is improving, according to the Cushman report.

About 14.8% of all office space in the U.S. was unoccupied at the end of December, noted Maria Sicola, senior managing director of research at Cushman. The last time vacancies were this high was at the end of 1996, when the rate also was 14.8%.

Sublease space -- a key measure of the health of the market -- may indicate that demand is improving, Sicola and some landlords said.

The amount of excess space offered by tenants for sublease fell nationwide to 40 million square feet, the second straight drop, and a decrease from a peak of 43 million square feet in mid-2002.

The pace of leasing nationwide accelerated in the quarter, with 20 million square feet of space leased, up from 18 million in the previous quarter, according to the study.

Bloomberg News was used in compiling to this report.