Is DTLA’s Office Market Heading for a Correction?

In the last five years, nearly 60% of the office product in Downtown Los Angeles has traded hands to new ownership. As a result, office rents have increased to prices that are often competitive with West Los Angeles. That may be changing. With new product and renovated product coming to market this year—and a vacancy rate that continues to hover in the high double digits—Downtown Los Angeles’ office market may be heading for a correction. We sat down with George Crawford, a senior associate at Charles Dunn Co., to talk about the office market in Downtown Los Angeles and what tenants can expect in the next year.

GlobeSt.com: Given that roughly 60% of the office space in DTLA has new landlords, can you provide some more perspective on what and where?

George Crawford: DTLA’s core office market is considered to be the Financial District and Bunker Hill, which contains roughly 32 million square feet of office space. Of that, approximately 19.45 million square feet has traded in the last 5 years, though not all to landlords looking for a rent growth repositioning play. Of DTLA’s 10 most expensive office buildings, six were sold during this time period. The top two buildings on the list: Pacmutual and CalEdison (previously One Bunker Hill), are the most expensive in the core market, but were nowhere near the top of that list just five years ago; they were Class B office buildings providing functional office space to traditional office tenants. Tenants who have been in either of these buildings since before their repositioning are bound to experience sticker shock at the new rental rates, which have increased as much as 57%. These two buildings are the extreme examples in the neighborhood, but are indicative of the market trends. By the way, the 10 least expensive office buildings have experienced a flurry of activity from office tenants still searching for value. Four of them are now better than 94% leased.

GlobeSt.com: What can DTLA office tenants expect to see with rents over the next 18 months or so?

Crawford: Rent growth has leveled off recently. In late 2017, overall asking rents in the area did not grow at all. Generally, the outlook is positive for office tenants and one main driver for that is the scheduled delivery of a substantial amount of new and converted office space coming on line in DTLA, as well as in the adjacent Arts District and Historic areas. This will provide tenants with more vacant space nearby, and possibly cause the leasing market to further soften.

GlobeSt.com: Can you expand on those numbers for new deliveries?

Crawford: New office space deliveries have perhaps been an overlooked dynamic until recently due to incomplete information in office market reports, as many have tracked new construction but failed to track building conversions. The Downtown LA Business Improvement District has included both conversions and new construction in its data, which states 2.9 million square feet of office space is under construction in the greater DTLA office market. This will eventually be added to the existing vacancy of more than 5.3 million square feet available in the core market. Zooming out, in the City of Los Angeles as a whole, roughly 7.4 million square feet of new office space is coming online during the same period, by mid-2020. This is equivalent of building a whole new submarket nearly the size of Century City.  The question that no one really has the answer to at this point is what tenants will fill all of this vacant space?

GlobeSt.com: Given this influx of new construction, is this a tenant’s market now? How are you advising your clients whose leases are expiring soon?

Crawford: No. It is too early to make any broad declarations, but the market is in a period of transition where rental rates seemed to have leveled off, possibly even dipped a bit. The term “tenant’s market” is such a dramatic idea, because it implies a sort of desperation by landlords to attract tenants, which is not the case. Once the new deliveries are available, then landlords will become more competitive by necessity. So, for office tenants whose leases are expiring in 2020 and beyond, this is food for thought.