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Rental Rates Experience Rapid Growth in Los Angeles Despite Stable Fundamentals

By Tucker Hughes

It’s safe to say that Los Angeles County’s office market is in an extended period of stability. Very few of the key indicators have experienced much change in the last quarter, year, or even three years. For example, between the first and second quarter the vacancy rate held constant at 10.5%, just as the availability rate held firm at 14.2%. Note the difference between these two metrics is that the availability rate tracks space that is being marketed for lease, but is not yet empty.

The amount of new space under construction only fluctuated slightly with a reduction of the pipeline from 6,256,000 to 5,831,000 square feet. This reduction was driven by new deliveries, which also remained static relative to the first quarter, exceeding the number of construction projects getting started.

Comparing all of the above indicators even back to 2015, and we don’t see that material of a change. What has changed though are the average rental rates. In the last three years we have seen the average all-in rental rate grow from $2.61 to $3.02 per square foot, representing a nearly 8% annual growth rate.

Conversely, if you look at the year-to-date net absorption, a figure that tracks the total amount of space leased relative to the total amount of space that becomes vacant either due to a tenant vacating or new construction being delivered, it is negative to the tune of 738,000 SF. In 2017, the market experienced a total of 1,517,000 SF of positive absorption. In the context of a market that is in excess of 415 million SF, this change is not material, but small changes over time make a big difference.

The industrial market has now experienced two consecutive quarters of material negative absorption. The first quarter of this year was negative 1,558,000 SF and the second quarter was even higher at negative 1,666,000 SF. Despite the massive industrial market, almost a billion square feet in size, this has pushed the vacancy rate from 2.4% to 2.7% between the first and second quarter. For some perspective, the vacancy rate was 3.0% three years ago. The availability rate also changed, but not as dramatically, moving from 4.3% to 4.4%.

The above would lead one to think that rental rates would be decreasing, but they are in fact continuing to experience rapid growth, even more so than the office rental rates. Between the first and second quarter alone, we saw the average triple net rental rates increase from $0.94 per square foot to $0.99 per square foot. This is up from $0.78 per square foot three years ago, representing an almost 13% annual growth rate.

In light of the increasing vacancy rate, why aren’t rental rates decreasing? First, the vast majority of the increased vacancy is being driven by new deliveries to the market. In the first and second quarter there were 1,923,000 SF and 1,547,000 SF of new construction completed, respectively. All of this feeds into the vacancy rate. Second, new construction, which represents a disproportionate amount of the available space, is often priced at a much higher rental rate, which has dramatically pulled up the average reported rental rate.

These small changes, on both the office and industrial side of the spectrum, can lead to big changes with time. How quickly will we begin to see the impact on the rental rates though? Only time will tell. Stay tuned next quarter for updates on the market.

Tucker Hughes is managing director at Hughes Marino, an award-winning commercial real estate firm with offices across the nation. As head of Hughes Marino’s Orange County and Los Angeles offices, Tucker specializes in tenant representation and building purchases throughout Southern California and beyond. 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 1-844-662-6635 or tucker@hughesmarino.com.

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