Success in Los Angeles’ Office Market Means Strategic, Proactive Repositioning

by Jeff Shaw

— By Sean Fulp, Vice Chair & Head of Office Capital Markets, U.S. Southwest, Colliers —

Office sales, leasing and development activity are at historic lows for Los Angeles County. With interest rates rapidly increasing, few active developments, and office vacancy and availability at an all-time high, the office market is in discovery mode. One of the major trends in development is creative, state-of-the-art studio/office campuses. These developments have broken ground in West Hollywood, Burbank, Santa Monica and Culver City. 

Developers in this space have the mindset of “if you build it, they will come.” Office sales activity is down more than 50 percent in the past year due to a high interest rate environment and a divide between buyer and seller pricing expectations. As loans become due, landlords will have decisions to make, and distress will occur in the market. 

Office availability is at an all-time high in Los Angeles at nearly 30 percent — likely the new norm going forward. Companies have figured out that employees like to have the flexibility of where and even when they work. With that said, companies are downsizing their office space by 25 percent to 50 percent and, in some cases, by 100 percent. Office owners must become strategic to win leasing deals and generate positive cash flow. Their options include placing additional capital into the building, adding amenity space, or converting a portion (or all) of the building to another use, such as hotel or multifamily. Office owners facing upcoming loan maturity dates will likely have to refinance or sell and, in some cases, give the keys back to the lenders, as interest rates have risen dramatically and property values are at an all-time low.

Activity and Impact

Ongoing developments, such as the Metro Purple Line and the Metro Regional Connector, have the potential to transform Los Angeles and create a positive impact on the community. The Purple Line is a transit system planned to span from Brentwood to Downtown and will stop in some of LA’s premier neighborhoods. The Regional Connector will prevent riders having to transfer trains between Azusa and Long Beach, and between East Los Angeles and Santa Monica. This will create ease of transit for riders and connect the city. If kept safe and clean, these projects could have an enormous impact on Los Angeles as freeway traffic would decline, office usage would improve, and retail sales would rise, thereby increasing the city’s tax revenue. The Purple Line has an anticipated completion date of 2027, and the Regional Connector is expected to deliver in late 2023.

When looking at Greater Los Angeles, two markets still have an influx of sales, leasing and development activity: Culver City and Century City. Culver City has completely transformed in the past decade, catalyzed by the influx of large tech and entertainment companies like Sony Pictures, ByteDance (TikTok) and Beats Electronics. Since 2010, nearly 2 million square feet of office space has been delivered. Class A office product has positive net absorption, a rarity in the current office environment. 

Century City has emerged as the most desirable submarket for many tenants due to its high-quality office product, various walkable amenities, and ease of access from the 405 and 10 freeways. The submarket is also surrounded by LA’s largest pocket of executive housing, with its neighbors being Beverly Hills, Santa Monica, Pacific Palisades and Brentwood. We have seen a recent flight to Century City from law firms and private equity companies, which will continue to occur.

Although Los Angeles’ office supply is much greater than the current demand, developers are still taking risks in building high-quality, attractive office product to draw large tenants from competing assets. In today’s market, office buildings that are dynamic and highly amenitized are winning leasing deals as impressive office space is a tactic for companies to bring employees back into the office. The largest active office developers in Los Angeles are Hines, Worthe Real Estate Group and Redcar Properties. Historically, Hudson Pacific Properties, Lincoln Property Company, Kilroy Realty Corporation and CIM Group would be on the list, however, all have temporarily halted office development.

Incentives & Demand

The options for tenants looking to relocate and expand their office space in the market are vast. Now more than ever, tenants can choose the buildings they want to occupy. The recent migration of tenants has been to Silicon Beach, Century City, Culver City and the South Bay. Many of the employees live in these markets, and the high-quality office product is already there. There are also options for tenants to buy office buildings and use the space for their business if acquiring the asset makes sense and aligns with their needs. 

When taking an investor’s perspective, buyers are acquiring near-stabilized office products at attractive cap rates, but they must be willing to take a risk on the office market. These investors believe in the rebound of office and look at acquiring these assets at price points they may not have been able to pre-pandemic, but they will need to acquire the asset all cash or avoid negative leverage. 

Tenants hold power in today’s environment. If you pair a surplus of office product with a rapid decline in tenant demand, the tenants will strategically pick and choose where they want to conduct business. We have seen this in markets like Downtown Los Angeles where there is a high volume of premier, Class A product with large tenants vacating and moving to different buildings (or markets) upon lease expiration. Their options are vast, and tenants can get great deals in today’s market. Landlords can no longer charge premium rents and provide minimal concessions for even the highest quality product, as they will likely lose leasing deals and inherently lose property value.

Though vacancy and rental rates differ from market to market, Greater Los Angeles has a vacancy rate of nearly 22 percent with an average asking rent of $3.78 per square foot, per month (full-service gross). One can look at each market individually and find similar results. For perspective, however, Century City has a 21 percent vacancy compared to Downtown, which has a 25 percent vacancy rate and a 30 percent availability rate.

Tenant improvement allowances across Los Angeles have drastically increased due to inflation, construction costs and labor shortages. Tenants demand higher allowances to build premier office space. Employers must build modern office space to draw employees back into the office. Landlords’ hands are also tied as they must pay larger allowances to attract tenants in a world of increased costs, albeit at higher rental rates. Higher tenant improvement allowances go hand in hand with offering attractive concessions like free rent and additional incentives, such as signage, parking and storage. All these items work together to structure an attractive deal for tenants.

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