Southern California office market is hammered by recession

Layoffs, tight credit and other fallout from the troubled economy have battered Southern California’s office market, leading to vacancy rates as high as 30% in some areas.

The pain is expected to continue for months, if not years, with vacancies rising even as the economy shows modest signs of recovery, according to industry observers tracking activity in the first quarter.

“We have a rough road ahead of us,” said Joe Vargas, senior managing director of real estate brokerage Cushman & Wakefield. “It’s going to be a very challenging market for the remainder of the year.”

Desperate landlords in the Inland Empire have begun offering such perks as a year of free rent to attract tenants. In West Los Angeles, owners are steeply discounting the monthly cost of an office -- cutting rates that, ironically, grew so high during the boom years that many companies were forced to move out and find cheaper digs.

Vacancy in Los Angeles County reached 14.3% in the first quarter, up from 11.2% a year earlier, according to a report released last week by Cushman & Wakefield. In Orange County, where demand has been dwindling for more than a year, vacancy ticked up to nearly 18% from 15%.


Among the hardest-hit markets are the Inland Empire, Irvine and north Los Angeles County, all of which have been wracked by the losses of tenants in the troubled industries of mortgage and finance. Vacancies in all three areas have surpassed 20%, a sign of a very weak market. In Ontario and the area around Los Angeles International Airport, vacancy tops 30%.

The Westside of L.A. County, the largest office market in the Southland, remains among the most expensive for renters in the U.S. but is experiencing convulsions. The first quarter of 2009 saw the largest jump in empty space since the first quarter of 2001, when the burst of the dot-com bubble was in full swing, according to brokerage Grubb & Ellis Co.

Job losses, closures and moves out of the area caused a rapid emptying of offices on the Westside, and as a result many tenants are trying to sublease their unused space to others, brokers said. This has caused downward pressure on rents.

The area was among the hardest-hit in the region because its tenant base of technology and entertainment companies has been significantly affected by the recession. At the same time, the small- to mid-size white-collar companies that form the bedrock of the Westside’s office market are pulling back, sensitive because of their size to costs such as rent. “Rents come out of their pockets,” said broker Hunt Barnett of Madison Partners, who represents such firms in negotiations with landlords.

In the face of uncertainty brought on by the recession, owners of small companies want to keep their options open, Barnett said -- and landlords do too.

As a result, the few deals that are being made are frequently for short-term leases -- at rates well off recent peaks.

Westside rents reached $4 to $6 per square foot per month around 2007 but have fallen to about $2.25 to $5, Barnett said.

Many Westside landlords are not offering free rent or other incentives, Barnett said, because they prefer to cut rent on short-term deals and gamble they will be able to raise rates again in a year or two, when the economy recovers.

“It’s about whether you can weather the next two or three years,” said landlord Bert Dezzutti of Brookfield Properties.

Downtown Los Angeles, the region’s second-largest office market, has been more stable in recent years and remains that way, observers say.

“Downtown didn’t run up rents like the Westside, Burbank and Pasadena did,” said John McAniff, managing director of real estate brokerage Jones Lang LaSalle.

The central business district has been transformed since the dark days of high vacancy in the early 1990s and the decade that followed, he said, as institutions such as banks and energy companies left the market and were gradually replaced by large service firms in such fields as law, engineering and architecture.

With no large office buildings completed since 1992, there’s not much extra room, McAniff said. “We have seen a floor here and a floor there, but not three and four blocks available for long term.”

It’s been a different story in the Inland Empire, where overall vacancy rates top 25%. Some landlords there are offering tenants as much as a year of free rent if they will sign a lease, Cushman & Wakefield’s Vargas said. Landlords will also grant generous allowances that tenants can use to fund improvements to their offices or even allow a new tenant to assume an old tenant’s lease, a rarity in the real estate business.

Along with the area around John Wayne Airport in Orange County, the Inland Empire saw some speculative office construction in recent years. With hundreds of thousands of square feet of new office space and a dwindling tenant base as businesses contract or shut down, buildings are standing empty and there is little movement in the market. Construction is grinding to a halt in most of the region.

The few office buildings that do get built these days usually have tenants already signed. In Cerritos, for example, Transpacific Development Co. is completing a five-story office building that will be mostly occupied next month by law firm Atkinson, Andelson, Loya, Ruud & Romo, said Tom Irish, president of Transpacific.

“We had been looking for a tenant for a while that would be the anchor for the new building,” Irish said. “We wouldn’t start without one.”