DTLA Dethrones Class-A Office

LOS ANGELES—In Downtown Los Angeles, class-A office product isn't the most expensive anymore, according to George Crawford, an associate at Charles Dunn Co., who says that class-B and class-C product is emerging as the most expensive and the most sought-after assets in Downtown Los Angeles. As a result, there is some pricing confusion in the market. Class-A is typically the standard by which other office classes set pricing. Now, Crawford says that determining values from class-A to class-C can be a challenge, and there are many buildings that are being reclassified thanks to adaptive reuse conversions and value-add plays, which is driven largely by creative office. To find out more about this emerging trend, how Crawford and other professionals determine value and how developers fit into the equation, we sat down with Crawford for an exclusive interview. Here is what he tells us:

GlobeSt.com: Can you provide an overview of the amount of buildings that have been reclassified in Downtown Los Angeles over the past two years?

George Crawford: Reclassification is a subjective concept. It is primarily characterized by the building owner's vision and investment into building upgrades, which will attract a certain “creative” tenant mix, who will pay higher rents. Over the past 24 months, a handful of Financial District office buildings totaling roughly 9% of the square footage in the submarket have been reclassified as class-A, and rents have increased as a result. In the Arts District, industrial to creative office conversions have also been a significant part of this creative trend for the greater downtown area.

GlobeSt.com: What is the difference in rental rates for creative office versus traditional office in Downtown LA and how do you see that changing over the next 12 months?

Crawford: Growth in rental rates for creative office in the Financial District is far beyond that of traditional office. Since Q4 2013, asking rates for repositioned office buildings have grown by approximately 33%. Compare that to 7% growth in Financial District class-A office, and you can understand why repositioning older office buildings is so attractive. As rents rise in creative office, traditional class-B properties will also see rental increases over the next 12 months as expiring leases push demand for traditional class-B space.

GlobeSt.com: As we all know, office property value is very dependent on tenancy. How do investors perceive value when it comes to creative versus traditional office tenants?

Crawford: Generally speaking, traditional class-A trophy buildings value functionality, while creative office investors focus on enhancing the work environment. It is a sign of a cultural change in the workplace as a whole. Creative tenants value comfort and the esthetic of retro features such as exposed brick and ceilings, open space, visibility, and building amenities that blur the lines between work and play.  For this, creative tenants will pay rents consistent with class-A trophy high rises.  In fact, now we are seeing trophy building owners incorporate some of these features to attract more creative tenants. Buyers also see added value in converted buildings, because they won't need to demolish traditional space and rebuild it to the demands of today's creative tenants.

GlobeSt.com: What challenges do developers face when seeking to renovate and reposition a property in Downtown?

Crawford:Each building presents its own set of challenges.  Generally, creative tenants tend to be more dense occupants—more employees per square foot—so parking requirements can become an issue, especially in older buildings and industrial conversions where zoning regulations set limits on land use. The process for obtaining conditional use permits from the city, in many cases, can be long and expensive. Also, historic buildings will face challenges when upgrading old building systems like elevators, HVAC and fire/life safety or remodeling structural components like stairwells, exits and corridors.

GlobeSt.com: Is there still opportunity to add value for creative office conversions in this market?

Crawford:With plenty of vacancy to fill, Downtown LA is still maturing as an office market, however it offers plenty of potential. Much of the ongoing creative office redevelopment is speculative, and with a 17% market vacancy and fierce competition between landlords, expect some time for the market to absorb that space.  The key to absorption will be attracting tenants from other nearby submarkets. More and more, high profile tech companies like Apple and Google are considering Downtown as an alternate to Silicon Beach. The retail sector is booming, residential development is among the highest in the county, and enhancements to public transportation will make Downtown easier to travel. All of the elements of a vibrant office market are falling into place nicely, which provides more opportunity for redevelopment. We have seen a tremendous amount of residential development in Central City West (just west of the 110 freeway), and office tenants are starting to look at alternatives there to avoid the congestion of the Central Business District, while still being within a quick walk to the amenities of the Downtown core.