By Tucker Hughes

The fundamentals underlying the commercial real estate market throughout Los Angeles County considerably improved over the course of 2015. Office space absorption for the year was 2.91 million square feet, vacancy rates fell to 11%, and the average time for an available space to lease dropped by more than two months. These factors, in addition to increasingly positive landlord sentiment, have generated modest increases in rental rates. The average rental rate county-wide increased from $2.56 per square foot per month to $2.67 per square foot on an “all-in” basis, with much more substantial appreciation being felt in submarkets such as Santa Monica, Century City, and Downtown.

Landlords are quick to tout the above metrics as justification for even further rental rate increases. What is rarely mentioned is that the market is actually slowing. Consider that net absorption of office space in 2014 was 3.95 million square feet, an amount that is 36% higher than was reported last year in 2015. Another leading indicator is furniture sales. Steelcase, one of the world’s largest manufacturers of office furniture, recently stated that their executives had some concern over short-term demand for their products. Their data suggest that some of North America’s largest users of space have reduced or eliminated further expansion plans. There is no question that rents should be going up rather than down at this stage in the economic cycle, however, it appears that many landlords’ expectations don’t line up appropriately with recent market trends.

New developments are underway in many areas of Los Angeles. These real estate developers, along with other owners who are making a multitude of value-add acquisitions, are making big bets on the longevity of this real estate cycle. Even if they execute on their respective strategies perfectly, there is little chance of success if the market turns against them. Billions of dollars of capital on the line and external factors that are ostensibly beyond even the most powerful real estate conglomerates’ control create an eerie situation for everyone involved.

Once referencing an accelerating demand for additional space from established companies, landlords had an almost irrefutable argument in favor of increasing rents in previous years. That is beginning to change as the most recent market data no longer support crazy, double-digital annual rent growth. Should rents still be increasing? Yes, however, the current rate of appreciation is likely overly optimistic, especially in Class A office markets.

This coming year promises to be an interesting one between shifts in interest rates, foreign markets, global conflict, and more, all of which have the potential to severely impact how landlords seek to maximize their positions in the market, and thus the optionality and rent that tenants pay for their space. The relative illiquidity and almost complete lack of transparency in commercial real estate basically guarantees that most spectators won’t be able to draw parallels between actual performance of an asset and the perception of either success or failure. Be cautious of hyperbolic claims from landlords. Many are far too bullish on the market and others refuse to admit (at least publicly) that their basis for continued appreciation may be built on shaky ground.