New paradigms in tenant demand and workplace trends have dramatically altered Los Angeles’ office market in the past three years. Internet, creative and entertainment (ICE) tenants have primarily pushed demand and new trends in adaptive reuse, while finance, insurance and real estate (FIRE) end users — along with their law firm counterparts — have contracted. This is often due to lower spatial requirements per employee, coupled with the rising trend of collaborative space. The segments of LA with repurposed and renovated office properties are white hot. This is especially true in Santa Monica’s Silicon Beach area where rents average $50 but can get as high as $70 per square foot. This new coastal, high-rent district benefits its surrounding areas, as well as the city’s CBD and Downtown, where tenants are seeking lower-cost space. Despite an overall market vacancy of about 18 percent, Downtown rents are holding steady due to a concentration of Class-A owners holding firm or even slightly escalating rates.
Considering the real estate fundamentals — relatively high vacancy and 9.5 percent unemployment — there may be a disconnect in the investment market. Los Angeles office investment is generally still a bargain compared to other global gateway markets, however. The area’s ties to the Pacific Rim also make it an attractive market for Asian investors.
Silicon Beach has experienced an astounding 14 percent rent growth in the past two years. This is supported by the atypical, ICE end user. The open, light, bright, airy offices with abundant collaborative space are the ones attracting the highest rates in the city. Even though some tenants have vacated the area in search of more cost-friendly environments, tenants are waiting around the block to gobble up newly vacant space as soon as it hits the market and, in some cases, even before.
Unfortunately, the problem with many ICE users (as opposed to traditional FIRE tenants) is their smaller footprints. Blockbuster leases for Los Angeles office space are increasingly rare. There are a few exceptions, however. Riot Games recently inked a 15-year lease for 284,000 square feet at Playa Vista, a mixed-use development south of Silicon Beach, and Amazon has leased a total of 115,000 square feet at the Water Garden development on the Westside, also near Silicon Beach. Areas like El Segundo, Century City and Downtown benefit from the cost-conscious tenants who have migrated from the Westside and Silicon Beach. Developers like Lincoln Property Co. have taken advantage of this, and are turning former Class B and C properties into creative office space.
Brookfield Office Properties now controls 43 percent of the Downtown submarket after its acquisition of MPG Office Trust. This includes a total of 8.8 million square feet. Commonwealth Partners has increased its ownership position in Downtown as well. The company recently acquired City National Plaza’s two towers for $885 million. It also acquired 1888 Century Park East in Century City for $605 per square foot.
Downtown also illuminates the Asian investor’s increasing influence. Korean conglomerate Hanjin is developing Wilshire Grand Tower, a $1-billion, mixed-use development with 400,000 square feet of office space that is scheduled for completion in 2016. Singapore’s Overseas Union Enterprise also acquired U.S. Bank Tower, the tallest building in the Western U.S., for $363 million last summer — a prime example of value-add bargain shopping in Los Angeles.
Los Angeles’ office market seems to have either incredible potential or a gigantic disconnect. This paradigm is playing out in the city’s Central Business District as well. While owners like Brookfield and Commonwealth hold steady on rates, the submarket has 161 floors of fully vacant, Class A space and 300 floors of fully vacant, Class B and C space. On its own, U.S. Bank Tower is 60 percent vacant and presents significant leasing risk for its new owners.
As the economy moves forward and continues to improve, Downtown LA is poised to benefit from the Silicon Beach overflow, improving overall demographics and population growth. A repeat of the 2000-2001 tech bubble, though, would be a blow to lofty Silicon Beach rents and valuations, with the impact proving to be a negative trickle-down effect.
— By Arty Maharajh, Vice President, Research, Cassidy Turley. This article originally appeared in the January 2014 issue of Western Real Estate Business magazine.