By Tucker Hughes
In 2017, Los Angeles’s office market experienced a reduced level of net absorption and rental growth relative to 2016. Why then does it seem that so many owners of office space throughout Los Angeles remain optimistic about the future? The answer might surprise you. The market’s success over the most recent years has been driven in large part by specific industries–most notably technology, entertainment, and consumer product companies–expanding into premium creative office product in targeted areas of market. This distortion has allowed most property owners to be beneficiaries of apparent strong demand across the full market, despite many areas having been quite static. Most tenants simply aren’t being told the full story and it’s in the collective interest of property owners to spin the media coverage of the market accordingly.
Perhaps even more interesting is that the vast majority of new development caters to the needs of the above referenced growth industries, who prefer a converted bottling plant, car factory, or pen manufacturing building to the traditional corporate high-rise tower. So if rental growth is slowing and net absorption is down relative to last year, and prior strong growth and leasing activity have been driven by the select segment of the economy that wants these types of buildings, what’s the likelihood that we see landlords, specifically those who think they own the best product in town, are unable to lease their latest development project? It’s certainly a possibility, but the more likely answer would be price reductions that would cause other types of businesses to become more interested in their product. If this were to occur it would put further downward pressure of traditional rental rates, even in markets with high vacancy rates in the high-rise environment, such as Downtown, the LAX area and urban Long Beach.
The foregoing considered, we ended 2017 with a 10.4% vacancy rate for office product county-wide, an average rental rate of $2.99 on a gross basis, and nearly six million square feet of new office buildings under construction. Ironically, Playa Vista and the closely adjacent submarkets are up to a 17% vacancy rate despite an average asking rate of $4.35 per square foot while North Hollywood has a vacancy rate of 5.5% and average asking rates of $2.62 per square foot. This is all driven by new development focused on the creative users discussed above. Landlords have cause to be concerned, although they rarely admit so publically. On the flip side, tenants who understand this dynamic can leverage it into more economically attractive leases for themselves.
Switching gears to touch on the industrial segment of the Los Angeles market, we continue to see extremely low vacancy rates and steady rental growth. Due to the supply-constrained nature of Los Angeles, especially relative to the Inland Empire, it’s unlikely that we can truly see enough local building to re-level the market. Any correction is much more likely to be a demand-driven issue, which could be fueled by macro-economic factors or a specific technology such as self-driving and/or wide spread use of a more advanced electronic trucking capabilities that would make the proximity to the ports and consumers less critical to users of space.
The Inland Empire, which in contrast to Los Angeles, has a significant amount of buildable land for industrial product, is the growth area of the Los Angeles logistics and manufacturing economies. Despite being farther east and characterized by very different rental rates and vacancy levels, the Inland Empire has the ability to profoundly influence rental rates in Los Angeles over time. While many view the supply-constrained nature of Los Angeles as a permanent safety net for rents, if dramatic overbuilding occurs in the Inland Empire, the price disparity between the two relatively close markets could be so extreme that we see more tenants opting to make the move.
Tucker Hughes is managing director at Hughes Marino, an award-winning commercial real estate firm with offices in San Diego, Orange County, Los Angeles, San Francisco, Silicon Valley and Seattle. As head of Hughes Marino’s Orange County and Los Angeles offices, Tucker specializes in tenant representation and building purchases throughout Southern California. Tucker makes frequent media appearances to speak on the future of commercial real estate, and is also a regular columnist for Entrepreneur.com. Contact Tucker at 1-844-NO-CONFLICT or firstname.lastname@example.org.