Southern California office landlords faced more bad news in the second quarter as occupancy and rents in their buildings fell again.
The persistently soft market has created opportunities for tenant businesses to sign some of the cheapest leases available in several years. The pace of deals has picked up a bit, brokers said, but many companies are still carefully husbanding their finances and avoiding long-term rental commitments.
Commercial real estate is a lagging indicator of the economy, and the drop in California employment that started in 2007 has helped shrink the amount of space businesses need to house their employees.
“Vacancy will go up nominally through the end of the year,” said Joe Vargas of real estate brokerage Cushman & Wakefield. “I certainly think the worst is behind us, but we are going to continue to see job losses.”
Overall vacancy in Los Angeles, Orange, San Bernardino and Riverside counties rose to nearly 20% from 17% a year earlier, while average asking rents dropped to $2.37 a square foot per month from $2.52, according to the brokerage.
The weakest market was the Inland Empire, where vacancy surpassed 25% in the second quarter. Orange County was also weak, with 22% of its office space unleased. Both areas suffer from oversupply, Vargas said, because during the last decade’s real estate boom, developers gambled that growth in the region would continue to raise demand.
Over-building was less of an issue in densely populated Los Angeles County, where it’s more difficult to get large developments approved. Though no new office towers have gone up in downtown Los Angeles since an unprecedented building binge ended in the early 1990s, the financial district office market has yet to fully recover.
In the years after the growth spurt that made the skyline taller and more crowded, some of downtown’s largest corporations, such as Atlantic Richfield Co. and First Interstate Bancorp, closed or were acquired, dumping millions of square feet back on the market. More recently, law firms and other white-collar service firms cut their payrolls as the shrinking economy bit into their practices.
“Downtown has had to absorb a continuing stream of office space since 1992,” said broker Stephen Bay of CB Richard Ellis.
Downtown L.A. vacancy hit 17% in the second quarter, up from 16% a year earlier. The average asking rent slid to $2.83 from $2.97, a smaller drop than most markets experienced. That’s because the bulk of downtown’s best buildings are owned by a small group of landlords such as MPG Office Trust and Brookfield Properties that are holding the line on pricing, Bay said.
“If that ownership was diversified you would see downtown Los Angeles rates move like they have everywhere else,” he said.
On the Westside, the region’s largest and most expensive office market, average asking rent fell to $3.34 from $3.73 a year earlier. And many Westside landlords will accept substantially less rent than they ask for, brokers said, especially to keep a valued tenant from moving to another building when the tenant’s lease expires.
“In today’s market, it’s almost as if asking rates have lost their relevancy,” said Neil Resnick, a broker at Grubb & Ellis. “Landlords don’t want to lose quality tenants.”
Tenants who can demonstrate that they are in solid financial shape can expect kid-glove treatment from landlords and lock in lease terms that might be considered a great bargain within a few years if the economy continues to recover, he said.
Still, Resnick said, many tenants are being cautious, signing short-term lease renewals and avoiding commitments to larger accommodations as they wait to see whether better times really are on the way.
“Uncertainty breeds indecision,” Resnick said.
Another reason for empty office space is that entertainment firms and others are cutting back on frills and comfort, fitting more employees into less space if they can, he said. The grandiose entry rooms and wide corridors common to showbiz ventures of the past are going away as companies try to make the most practical use possible of their space.
Movie company Imax Corp. is looking for new digs, Resnick said, and plans to work with an architect to make sure its offices are as efficient as possible.
“Entertainment firms are looking less for ‘statement’ space and more for the functional circulation from reception to the boardroom,” he said.
Among the hurdles to the office market recovery is the abundance of space that companies have rented but aren’t using. That space must be reabsorbed before companies start renting more and bringing down vacancy rates.
Some tenants who are confident about their financial positions are signing leases of five to seven years now because they think the office market is at or near the bottom, Vargas said, but empty space and bargains should be available for months to come.
“I don’t anticipate real job growth until the end of 2011 or 2012,” Vargas said. “It doesn’t appear that we are going to have a quick recovery.”