Office Rents May Rise Sharply as Supply Shrinks

For tenants around L.A., the office party may soon be over.

Commercial rents in Los Angeles County are expected to rise dramatically in coming months after mostly languishing for a decade, according to a report set to be released today by brokerage Cushman & Wakefield.

Landlords should soon be in a position to boost rates as an expanding local economy increases demand for office space and a dearth of new construction keeps the supply limited. The cost of leasing space should start to edge up in the second half of this year -- and then jump sharply, landlords and brokers predict.

“In two years, rents are going to be a lot higher than they are today,” said Steve Marcussen of Cushman & Wakefield, who represents tenants in rent negotiations.

Overall, vacancy in the county’s office buildings fell to 14.8% in the fourth quarter of 2004 from 17.4% a year earlier.

Although landlords asked for an average of $2.06 per square foot per month, about the same as a year ago, prices in some markets are already creeping up. The Westside, Wilshire Center, Pasadena and the San Fernando Valley all reported slight gains.

Rents are only marginally higher than they were in the mid-1990s, and they’re still about 20% below what they were in the midst of the dot-com bubble of 2001. But concessions that landlords offer as incentives to tenants -- such as periods of free rent and subsidized building improvements -- are drying up. And that is typically a precursor to rent hikes.

Cushman & Wakefield expects rents to rise 7% annually over the next three years.

Arden Realty Inc., the largest office landlord in the county with 11.3 million square feet of space, expects to keep rents relatively flat for the next six months and then elevate prices in the second half of the year, when vacancy rates are expected to fall closer to 10%.

“We’re almost to that point where we will see some decent movement” in rents, said Robert Peddicord, Arden’s executive vice president of leasing and property operations. “We really like where we are right now.”

A market with a 10% vacancy rate is considered to be in balance and historically has been a signal to developers to put new building projects in the pipeline. Even though vacancy has fallen below that rate in several premium office towers around L.A., very little construction is underway, and most of the new space already has committed tenants.

It probably will be quite some time before the region sees the kind of speculative building boom that changed the Los Angeles skyline in the 1980s and early ‘90s. Building costs have climbed so much in recent years that rents would have to jump about 40% to justify a spate of new construction, Marcussen said.

To be sure, some markets remain soft. The vacancy rate around Los Angeles International Airport rose to 32% in the fourth quarter from 30% a year earlier. In El Segundo, 23.7% of office space was still empty.

Those markets should eventually be lifted by the rising tide on the Westside, said Chris Houge of Madison Partners, a Los Angeles brokerage. Westside vacancy fell again last quarter to 13.3% from 17.3% a year earlier. As that market tightens and rents rise within the next six months to a year, more tenants will opt for the South Bay as an alternative, Houge figures.

In downtown L.A., fourth-quarter vacancy stood at 16.9%, down from 18.9% a year earlier.

With the economy improving, many tenants plan to expand their businesses, brokers said. A recent national survey of office users by Merrill Lynch & Co. found that 47% expected to require more office space in 2005. That was up from 37% in June.

Another factor that may lead to higher rents is the growing consolidation of ownership. Most top-quality buildings are owned by a small number of real estate investment trusts, investment fund managers and wealthy individuals. That tight circle of control should give landlords more of an opportunity to increase prices as the market improves.

“I’m not saying they are going to collude,” Marcussen said, “but they’re all going to go to Building Owners & Managers Assn. meetings together.”