Though Wall Street investors are showing some enthusiasm about the direction of the economy, shell-shocked business owners in Southern California are still more inclined to shrink than grow their companies.
Problems at white-collar firms are bleeding the region's enormous office rental industry. Almost 51 million square feet of office space in Los Angeles County, Orange County and the Inland Empire is now empty -- more than 17% of the total.
The exodus from office buildings that started in late 2007 accelerated during the third quarter as the anemic business climate took its toll on the real estate rental industry, according to the Cushman & Wakefield real estate brokerage.
"These vacancies are a direct reflection on unemployment," said Joe Vargas, an executive vice president at Cushman & Wakefield. "Companies continue to reduce their workforce, or they are not hiring."
Troubled business owners facing expiring leases often choose to downsize these days and take less office space, even though rents are falling, he said.
Real estate rentals are a lagging indicator of the economy, so the shrinking-space trend is expected to persist well into next year even if the nation's financial outlook continues to improve.
Industry observers were divided in their assessments about whether tenants at least showed signs of interest in renting new office space.
"There was a dramatic drop-off in leasing velocity last quarter," said John McAniff, managing director of brokerage Jones Lang LaSalle. "Apparently the rebound on Wall Street did not translate to a rebound in tenant commitments. That tells me there is a lot of uncertainty out there."
Office landlord Jeff Worthe of M. David Paul & Associates, which caters to the entertainment industry in Burbank and Santa Monica, was more optimistic.
"People are thinking about getting back to their business plans and not being on defense," Worthe said. "We're seeing people ready to make commitments."
Last month, his property company arranged the early renewal of a lease with Lions Gate Entertainment Corp. at the MTV Building in Santa Monica.
The $40-million deal represented a reduction in rent but gave the landlord peace of mind to know the entertainment company wouldn't be vacating its 125,000 square feet any time soon.
"We were better off not to face the prospects of them talking to other people" about leasing elsewhere, Worthe said.
Indeed, competition is plentiful. Office vacancy in Santa Monica was 15.4% last quarter, up markedly from 10% a year earlier.
Early lease extensions such as Lions Gate's are a sign of the times, experts say, as tenants decide to take advantage of lower rents in exchange for agreeing to stick around longer.
Broker Gary Weiss of Madison Partners, who specializes in representing tenants, said he's seeing more business owners figuratively "kicking the tires" and considering moves. He predicts the office market will stay soft -- in favor of tenants -- well into the first quarter of next year, but perhaps not much longer.
"A lot of us on the Westside believe we have seen the bottom, and now is the time to cut deals," Weiss said.
The more pessimistic McAniff, who compares the weak market with the depths of the last big real estate down cycle in the mid 1990s, also described the moment as an opportunity for tenants.
"You only see the bottom of the market in your rearview mirror," he said. "If you are confident about your business plan, you should go ahead and execute."
Cushman & Wakefield's Vargas predicts Southern California will remain a tenant's market through mid-2010 and perhaps longer if employment doesn't start picking up.
"This is certainly the worst downturn we've seen," Vargas said. "We're not going to see real improvement until job growth occurs."