By Tucker Hughes
The Los Angeles office market has been characterized by relatively fluid and trivial back and forth swings in vacancy and the second quarter of 2019 was no exception. Since 2017, we have seen quarter-by-quarter vacancy go up five times, down three times, and remain steady to a tenth of a percent once. Meanwhile, over the same period, the average gross asking rent countywide has gone from $2.91 per square foot in 2017, to $3.03 per square foot in 2018, to $3.19 per square foot as of the end of the second quarter of 2019. Why have we seen rental growth at nearly 5% per year when the supply of available office space, at least in terms of vacancy, has remained flat?
While there is definitely organic rental growth occurring in the market, the biggest reason we are seeing such material growth is due to the steady supply of new construction being delivered to the area. These new buildings are almost always priced at a premium to the market due to the high cost to construct and developers requiring a minimum threshold of returns to take the risk of building. For perspective, since 2017 there has been over 5.5 million square feet of new inventory put onto the market. In the context of a 419 million square foot market, this may not seem like a significant amount, but relative to the amount of vacant space, which was around 41 million as of the end of the second quarter, this can have a significant impact on the average asking rent even though the average for all space, including those that are occupied with pre-determined rental schedules, is much lower.
Even though quarter-to-quarter we may see fluctuations, overall, the market has been moving in an upward direction. We have seen just five quarters of negative absorption since the beginning of 2015 compared to 13 positive quarters. Off-setting the specific amounts in each quarter, net absorption over that period is nearly 9.5 million square feet.
The industrial real estate market in Los Angeles looks similar from a trends standpoint. Since 2017, we have seen vacancy go up three quarters, down four quarters, and remain flat to a tenth of a percent twice. Over the same period, we have seen the average triple net asking rate go from $0.84 per square foot in 2017, to $0.90 per square foot in 2018, to $1.07 per square foot as of the end of the second quarter of 2019. This amounts to nearly 13% annualized compounded rent growth. The difference in the industrial market is that vacancy rates are literally as low as we see vacancy ever get in large markets. Vacancy has not gone above 2.5% for the last 15 quarters straight and currently is hovering at 2.3%. Since 2017, there has been an average of 5.4 million square feet of space delivered each quarter, or a total of 59.6 million square feet of new space, the vast majority of which has been absorbed. This is occurring as the amount of buildable industrial land becomes increasingly scarce, which is the perfect receipt for very rapid rental growth.
It will be interesting to see how rental rates behave once we begin to see more moderate swings in vacancy versus the relatively flat status of the prior years. Ultimately, the leasing market’s supply and demand balance will drive the market in the long run.
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 firstname.lastname@example.org.