Are Office Rents Sliding in Pasadena?

PASADENA, CA—The Pasadena office market seems to be losing momentum. There has been ample multifamily and retail development in the market lately, but the office vacancy rate has climbed to 13% with the vacation of two major office users. Rene Soto, a principal at in Lee & Associates newly opened Pasadena office, and Chris Larimore, president of the Lee & Associates Pasadena office say that this could mean declining rental rates in the market. We sat down with Larimore and Soto to find out more and see how serious this issue is. Here, they give us an insiders look at the office market in Pasadena.

GlobeSt.com: Give me a snapshot of the Pasadena office market.

Rene Soto: The Pasadena office market is currently 13% vacant, but I think, when taking that into consideration, you also have to factor in the indirect vacancy. You have a bank vacating the market and leaving over 100,000 square feet, or you have the latest federal regulation that basically pushed Le Cordon Blue out of the market, which was a huge hit for Pasadena, leaving 180,000 square feet on the market. Between those two deals, you have 300,000 square feet on the market. So, the net absorption in the next year is going to be essential to justify the current asking rental rates of class-A buildings in Pasadena.

GlobeSt.com: Do you think there will be enough absorption to justify rents?

Soto: It will be based on the engineering and technology sector as well as medical office, which is really driving the market right now. What you have is a surplus of direct office space and shortage of medical space. There is lots of development right now in Pasadena, but it is more of a retail and multifamily development play than office development. You still have a migration of tenants that are moving into adjacent markets that are going west to Glendale or going east to the San Gabriel Valley market in search of lower rental rates.

Chris Larimore: A lot of office owners in Pasadena right now are at a cross roads with regards to what they are going to do with their rates. A lot of these owners bought these properties that are leveraged, so they need to get rental rates to justify the acquisition. That is why we are seeing an increase in the asking rates, but we are seeing that 13% vacancy rate impacting a lot of those owners. Some owners are keeping their rental rates high to justify their pro forma by giving other concessions, like rental abatement or a higher construction allowance.

GlobeSt.com:  If there are investors who need to justify their pro forma with these rental rates, are they in a potentially precarious situation?

Soto: No, because you still have a lot of companies that need to be in Pasadena. I don't think it will be disastrous. I think it will be somewhere in the middle. The current asking rates are plus $3 a foot for a class-A building in Pasadena, but I see that may be declining to $2.75 to $2.80 to stabilize the rents and stabilize the tenant rosters. It will be a slow absorption over the next few years. We aren't going to have a lot of people losing their buildings. Landlords are going to have to face the fact that they are either going to have a vacant building or they are going to have to lower their rental rates. The landlords that realize that are going to be the ones to do the deals.

How does this issue affect office investment in the Pasadena market?

Larimore: There are limited opportunities in Pasadena. I think there is a strong demand to buy office product in Pasadena, but we really don't see the availability of opportunities. There is a lot of capital that is trying to get into the market, but there is a lack of product for them to invest in, but there is a feeling among the investment community that Pasadena is a great place to allocate capital. The problem is that a lot of owners right now are not selling.

Soto: That is why net absorption is going to be so critical in the next year, because that is really going to tell the tale of what will happen at this cross roads.

GlobeSt.com: Are investors still looking for opportunities despite the potentially declining rental rates?

Larimore: I don't think a lot of them understand or know that the vacancy rates are where they are at right now. I don't think that they fully understand the indirect vacancy. Remember, people are seeing a lot of development going on in Pasadena. It has a young vibe and people want to be here. Investors think that translates to: 'let's buy office buildings.' I don't think that they fully understand what is going on in the market right now.

GlobeSt.com: Do you recommend that investors still look at opportunities in the market when they are available?

Soto: Pasadena is still a good market to be in; it is a matter of getting in now and the value of the asset. Pasadena is a good long-term play for office, and it is a good place to put your money. I would still encourage people to buy in Pasadena. The problem is that we don't have product available for them to purchase. Anything that might be available to purchase is overleverage, so if you are going to get into the market, you are going to pay a premium.

PASADENA, CA—The Pasadena office market seems to be losing momentum. There has been ample multifamily and retail development in the market lately, but the office vacancy rate has climbed to 13% with the vacation of two major office users. Rene Soto, a principal at in Lee & Associates newly opened Pasadena office, and Chris Larimore, president of the Lee & Associates Pasadena office say that this could mean declining rental rates in the market. We sat down with Larimore and Soto to find out more and see how serious this issue is. Here, they give us an insiders look at the office market in Pasadena.

GlobeSt.com: Give me a snapshot of the Pasadena office market.

Rene Soto: The Pasadena office market is currently 13% vacant, but I think, when taking that into consideration, you also have to factor in the indirect vacancy. You have a bank vacating the market and leaving over 100,000 square feet, or you have the latest federal regulation that basically pushed Le Cordon Blue out of the market, which was a huge hit for Pasadena, leaving 180,000 square feet on the market. Between those two deals, you have 300,000 square feet on the market. So, the net absorption in the next year is going to be essential to justify the current asking rental rates of class-A buildings in Pasadena.

GlobeSt.com: Do you think there will be enough absorption to justify rents?

Soto: It will be based on the engineering and technology sector as well as medical office, which is really driving the market right now. What you have is a surplus of direct office space and shortage of medical space. There is lots of development right now in Pasadena, but it is more of a retail and multifamily development play than office development. You still have a migration of tenants that are moving into adjacent markets that are going west to Glendale or going east to the San Gabriel Valley market in search of lower rental rates.

Chris Larimore: A lot of office owners in Pasadena right now are at a cross roads with regards to what they are going to do with their rates. A lot of these owners bought these properties that are leveraged, so they need to get rental rates to justify the acquisition. That is why we are seeing an increase in the asking rates, but we are seeing that 13% vacancy rate impacting a lot of those owners. Some owners are keeping their rental rates high to justify their pro forma by giving other concessions, like rental abatement or a higher construction allowance.

GlobeSt.com:  If there are investors who need to justify their pro forma with these rental rates, are they in a potentially precarious situation?

Soto: No, because you still have a lot of companies that need to be in Pasadena. I don't think it will be disastrous. I think it will be somewhere in the middle. The current asking rates are plus $3 a foot for a class-A building in Pasadena, but I see that may be declining to $2.75 to $2.80 to stabilize the rents and stabilize the tenant rosters. It will be a slow absorption over the next few years. We aren't going to have a lot of people losing their buildings. Landlords are going to have to face the fact that they are either going to have a vacant building or they are going to have to lower their rental rates. The landlords that realize that are going to be the ones to do the deals.

How does this issue affect office investment in the Pasadena market?

Larimore: There are limited opportunities in Pasadena. I think there is a strong demand to buy office product in Pasadena, but we really don't see the availability of opportunities. There is a lot of capital that is trying to get into the market, but there is a lack of product for them to invest in, but there is a feeling among the investment community that Pasadena is a great place to allocate capital. The problem is that a lot of owners right now are not selling.

Soto: That is why net absorption is going to be so critical in the next year, because that is really going to tell the tale of what will happen at this cross roads.

GlobeSt.com: Are investors still looking for opportunities despite the potentially declining rental rates?

Larimore: I don't think a lot of them understand or know that the vacancy rates are where they are at right now. I don't think that they fully understand the indirect vacancy. Remember, people are seeing a lot of development going on in Pasadena. It has a young vibe and people want to be here. Investors think that translates to: 'let's buy office buildings.' I don't think that they fully understand what is going on in the market right now.

GlobeSt.com: Do you recommend that investors still look at opportunities in the market when they are available?

Soto: Pasadena is still a good market to be in; it is a matter of getting in now and the value of the asset. Pasadena is a good long-term play for office, and it is a good place to put your money. I would still encourage people to buy in Pasadena. The problem is that we don't have product available for them to purchase. Anything that might be available to purchase is overleverage, so if you are going to get into the market, you are going to pay a premium.