Office Has Strongest Absorption Since 2005

LOS ANGELES—The Los Angeles office market has had seen its strongest quarterly net absorption since 2005, according to the 2Q15 office report from PM Realty Group. The market had 1.6 million square feet of office absorption during the quarter, mainly in the class-A market. Additionally, direct vacancy rates decreased by 140 basis points to 14.8% and class-A rental rates increased year-over-year by 4.1% to $2.85 per square foot and class-B rental rates climbed 3.5% to $2.31 per square foot.

“The absorption we're experiencing in Southern California is now broad-based—both tenant-type and submarkets,” Mark Mattis of PMRG tells GlobeSt.com. “When the economic recovery began a few years ago, occupancy gains were primarily derived from tech, social media and entertainment tenants in tech sectors, like Santa Monica, Playa Vista and Burbank. With space availability significantly constrained in those areas, tenants were forced to seek nearby, secondary locations. Miracle Mile/Mid Wilshire, the San Fernando Valley and especially the South Bay, primarily El Segundo, have all benefited significantly. In addition, Los Angeles created over 474,400 jobs since its trough in 2010 and it surpassed its 2007 pre-recession peak of 4.3 million jobs. The absorption has now moved well beyond creative projects as traditional drop-ceiling office buildings are leasing up steadily as well.” As Mattis mentions, job growth helped drive the surge. Year-over-year, Los Angeles gained 100,500 jobs, with the education and health, services and trade and transportation and utilities sectors reporting the highest job gains.

The quarter saw some significant leases, including Lewis Brisbois Bisgaard & Smith's 215,000 square foot lease renewal at the US Bank Tower and AECOM's 112,525-square-foot lease at One California Plaza. The challenge in the market has really been renovating and turning over investment spaces, because of the demand for creative office, the renovation costs tend to be higher. “The inflated cost of construction coupled with Title 24, has increased the capital demands for landlords to complete new deals and renewals,” says Mattis. “A new build out of raw space five years ago would cost about $50 to $55 per square foot. Today with creative demands, high construction pricing and Title 24, the same build out is closer to $75 to $80 per square foot. When rental rates are above $40 per square foot, these deals can pencil out, but at $30 per square foot, not so much. In addition, local municipalities are overwhelmed by the number of requested permits for tenant improvement work. My recommendation to the corporate service brokers is to get your tours set up 9-12 months ahead of time if the prospect is considering a significant build-out.”

Even with a rise in these costs, speculative construction picked up during the quarter. In 2015, approximately 1.8 million square feet of office space will come online—a dramatic increase from the 467,000 square feet in 2014. Mattis expects that tenant demand will continue to increase across L.A. submarkets. “Even though some of the professional services are reducing their per person footprint, they are increasing their net space in a growing economy,” he says. “In previous commercial real estate downturns you had obvious signs of trouble ahead: CMBS Debt, dotcom balance sheets, S&L crisis and over building. Today, there are some concerns on the horizon, like eventual interest rate increase, European currency and State of California issues, but they are not combined with over-building, yet.”