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Downturn Continues in Region's Office Market

Real estate: Landlords are cutting rents to stimulate demand. Relief isn't expected until 2003.


The Los Angeles-area commercial office market continued to deteriorate during the first half of the year as the region remained stuck in a nearly two-year-long downturn, although demand for industrial property remained strong with the help of discounted leases.

In Orange County, office vacancy rates dipped slightly but only after landlords cut rents by up to 10% to stimulate demand.

Faced with a dearth of new demand, the Greater Los Angeles-area office market saw the second-quarter vacancy rate increase to 17.13% from 16.29% the previous quarter, according to newly released figures from Insigna/ESG, a real estate brokerage and services firm.

Although the region's commercial real estate market has held up well compared with other national markets, many real estate observers do not expect that Los Angeles-area landlords will see a significant and sustained turnaround until early next year, when job growth is expected to pick up.

"Things are starting to bottom out and we will bump along for the next six to eight months," said brokerage executive Clay W. Hammerstein at Insignia/ESG.

The Los Angeles-area commercial market is mirroring the national trend, and Los Angeles is doing better than the San Francisco Bay Area and other regions where the high-technology bust has created huge pools of vacant space and a sharp decline in rental rates.

"L.A. as a whole seems to have fared better than the rest of the Western region," said Andrew Wright, senior consultant with Reis Inc., a real estate research firm.

"Even though the vacancy rate has been creeping up, it [Los Angeles] seems not as quite hard hit [as other cities] and seems to be holding right on par with the U.S."

During the first half of this year, most of the activity in the Los Angeles and Orange County office markets consisted of firms faced with lease expirations or those that relocated to take advantage of cheaper locations. There were only a few deals involving significant corporate expansions that helped reduce the overall amount of vacant space on the market.

In Los Angeles, for example, aerospace company BAE Systems Controls leased about 150,000 square feet of space at the Wateridge project owned by Crown Realty & Development. But Irvine-based Crown, which owns about 2 million square feet of space in Los Angeles and Orange County, said demand across the region remains soft.

"Until we see some job creation I don't see much of a pickup in demand for the balance of this year," Crown President Robert Flaxman said.

One reason for higher vacancy rates is that many companies have empty cubicles and unused work spaces, real estate brokers said. Some of these companies do not need to expand as they rebuild their work forces or are taking less space to save money when they renew their leases.

Although the office market has seen vacancies surge, the demand for industrial space has remained strong enough to keep vacancies in check. In Los Angeles County, for example, the industrial vacancy rate at the end of the second quarter hit 4.6%, up less than a percentage point from the beginning of the year and below year-ago levels, according to Cushman & Wakefield.

Firms looking for distribution and warehousing space to service Southern California's huge population gobbled up 14.6 million square feet of industrial space in the Inland Empire alone, said Darla Longo, a broker at CB Richard Ellis. However, landlords have had to cut leasing rates by 10% or more from last year to keep up the pace of leasing, she said.

"Leasing was steady but not booming," Longo said of activity during the first half of the year. "We're busy compared to other people" in real estate.

In Orange County, the second-quarter office vacancy rate edged down to 20.30% from 20.70% in the first quarter as landlords cut rates and busy mortgage companies expanded, according to Steve Case, an executive at CB Richard Ellis in Orange County. It was the first time the quarterly vacancy rate had dropped in nearly two years.

Still, Orange County office landlords have had to cut leasing rates by as much as 10% and are eager to make other concessions, brokers said. "Even though there is more stability in the market, the landlords are being aggressive to get the deals done," Case said.

Despite the weak leasing market, commercial real estate sales remain brisk, with private and institutional investors showing a preference for apartments, industrial properties and small shopping centers anchored by supermarkets, said Michael Ross, head of investment sales for brokerage firm Colliers Seeley.

The property markets in the Los Angeles area and elsewhere have benefited from low interest rates, and the depressed stock markets have made real estate a good buy in the view of many investors.

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