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Tenants rule commercial real estate arena

Office vacancies reached their highest level in 15 years in the third quarter, forcing reluctant landlords to lower rents as the market appeared to be bottoming out.

October 17, 2010|By Roger Vincent, Los Angeles Times

Commercial building vacancies climbed and rents went down — again — in the third quarter as Southern California's white-collar companies reduced the size of their offices.

Overall vacancy was nearly 20%, up significantly from 17.5% in the third quarter a year earlier, according to statistics compiled by real estate brokerage Cushman & Wakefield. The average asking rent was $2.35 a square foot a month, 13 cents less than in the July-September quarter of 2009.

"Vacancies are at their highest in 15 years," said Joe Vargas, the brokerage's Southern California area manager. "It's clearly a tenants' market and will remain a great opportunity for them for the next nine to 12 months."

The market is still catching up to staff cutbacks and office closures provoked by the recession that drove unemployment up across the Southland. As long as companies are reluctant to hire new workers, the office market will remain weak and challenging for landlords, real estate brokers said.

Landlords have lowered their rents to some of the lowest levels in memory, offering tenants a bit of financial breathing room and the opportunity to lock in favorable rates for years to come.

Although demand for office space has been weak for more than a year, few leases beyond urgent renewals were signed for several months because many landlords were reluctant to lower rents in the hope that the economy would soon bounce back. And even when rents did come down, tenants were reluctant to make commitments because they were uncertain about their own business prospects or believed that the rental market had further to fall.

The logjam started to break up in the third quarter, brokers said, as landlords grew more realistic about what they could charge and tenants grew more optimistic about their futures. Rents are expected to dip a bit more, but appear to be bottoming out.

"The market has kind of flattened," said Mark Sullivan, regional manager of real estate brokerage Studley. "Landlords have taken a full dose of medicine and we have kind of reached a balance here allowing transactions to happen."

The biggest lease of the quarter was Southern California Gas Co.'s 15-year commitment to keep more than 1,300 employees in 350,000 square feet in Gas Company Tower in downtown Los Angeles. Had the utility moved its headquarters to another building the consequences could have been devastating for landlord MPG Office Trust, which has been struggling with heavy debt and the weak rental market.

The downtown L.A. office market has been nearly flat for years. A building boom in the late 1980s and early 1990s left an abundance of space that was never absorbed, even during the flush years of the mid-2000s when rents were flying upward in Century City and Santa Monica. Downtown vacancy was nearly 18% in the third quarter, up from 16% in the year-earlier quarter.

"Downtown never profited from the spike that the Westside got during the boom," Sullivan said. "The Westside is a bit more manic-depressive than downtown."

Overall vacancy on the Westside is 16.6%, up two percentage points from the same period a year earlier. Asking rents are $3.27 a square foot, down 39 cents from the third quarter of 2009.

Asking rents tend to be significantly higher than what tenants actually pay, though, after calculating all the incentives landlords offer to get tenants to sign long-term leases, Cushman's Vargas said. "Free rent, free parking, moving allowances — we are seeing the whole gamut of concessions to move."

Tenants have become more aggressive just in the last month or so, said Whitley Collins, senior managing director of brokerage Jones Lang LaSalle.

"Even six months ago people thought we could maybe be headed for another significant [economic] drop," Collins said. "People are feeling that if we are not at the bottom now, the bottom is near and it's not going to be much worse."

Office occupancy will continue to fall, he predicted, because many companies that downsized during the recession are still renting more space than they need. When it comes time to renew their leases, they will take less room.

"We are going to see the consequences of that shadow space in the fourth quarter and into next year," he said.

The market is no longer getting worse for landlords, he said, but it won't be getting better soon either.

"In a year," he said, "we will feel like we are in the same place."

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