How Does a Slowdown in Office Impact the Market?

LOS ANGELES—Momentum in the office market may be slowing down, according to the 1Q16 report from Newmark Grubb Knight Frank, which shows that office absorption was less than 400,000 square feet in Los Angeles at the beginning of the year. By comparison, the final quarter of 2015 had 1.1 million square feet in absorption, while a year-over-year comparison is more positive, with only 260,000 square feet absorbed in 1Q15. Despite a potential slowdown in absorption and vacancy rates that still float above the previous peak levels, rental rates have remained on a steady upswing. Rates increased $0.02 in 1Q16 to an average of $3.03, significantly higher than 1Q15's $2.75 rates and the $2.91 highs from the previous peak. Will Adams, an executive managing director in the Downtown Los Angeles office of NGKF talks about this dynamic and what to expect from the office market this year in this exclusive interview.

GlobeSt.com: Do you expect to see a slowdown in the office market this year?

Will Adams: Perhaps a slight slowdown as some companies may be affected by global economic issues and interest rate anxiety, however, those concerns have been around for some time and did not affect the leasing market last year. So, demand should remain robust throughout 2016 and any slowdown in what has been very rapid growth in rents and sale prices can be seen as movement toward more sustainable growth rates. We certainly don't expect negative demand or declining rental rates this year.

GlobeSt.com: It is interesting to see that rents are back at peak pre-recession levels, but vacancy rates haven't come down to the peak levels yet. What does that dynamic say about this market, and with higher vacancies, what is driving rents up?

Adams: Certain landlords have taken a strategic approach to owning large percentages of key submarkets which has allowed them to control pricing and help insulate them from more typical real estate market drivers, including vacancy rates. A prime example of a landlord taking this approach occurred this quarter when Douglas Emmett purchased 2.2 million square feet of Class A office space in four buildings along Wilshire Boulevard, where they already owned two Class A buildings. Douglas Emmett now owns 78 percent of Westwood's Class A inventory along Wilshire Boulevard, giving them enormous control over rates in that market.

Throughout the economic recovery, we've also been seeing the repositioning or redevelopment of many buildings into creative office space. Often times these were underperforming buildings or industrial buildings that ask top rates once they are transformed into a unique creative product. This conversion of Class B and Class C buildings to top-of-market creative space has not only added to the inventory, but has come online at asking rents exceeding institutional trophy building rates.

GlobeSt.com: The Westside seems to continue to lead the LA office market. Do you see that trend continuing, or do you think other emerging markets (Hollywood, DTLA) will catch up?

Adams: Yes, that trend will continue and Westside rents will lead the market, however, creative office space in Hollywood and the Arts District in Downtown LA are closing some of that gap, although the Arts District is still waiting for that monumental lease that really puts it on the map. With rail transportation reaching all the way to the ocean in in Santa Monica, the Westside markets will continue to be highly desirable and more accessible than ever.

GlobeSt.com: What are your biggest concerns for the market?

Adams: If there is a substantial slowdown in key sectors like technology, entertainment or healthcare that would greatly effect job growth. Venture investment in the Los Angeles region plays a large role in giving many of our high-growth companies the power to expand so if concerns over valuations or the broader economy slow the flow of venture money into the region, it could create a speed bump for our local office market. However, as long as we continue on a slow growth path, we should be good through the end of 2017.

LOS ANGELES—Momentum in the office market may be slowing down, according to the 1Q16 report from Newmark Grubb Knight Frank, which shows that office absorption was less than 400,000 square feet in Los Angeles at the beginning of the year. By comparison, the final quarter of 2015 had 1.1 million square feet in absorption, while a year-over-year comparison is more positive, with only 260,000 square feet absorbed in 1Q15. Despite a potential slowdown in absorption and vacancy rates that still float above the previous peak levels, rental rates have remained on a steady upswing. Rates increased $0.02 in 1Q16 to an average of $3.03, significantly higher than 1Q15's $2.75 rates and the $2.91 highs from the previous peak. Will Adams, an executive managing director in the Downtown Los Angeles office of NGKF talks about this dynamic and what to expect from the office market this year in this exclusive interview.

GlobeSt.com: Do you expect to see a slowdown in the office market this year?

Will Adams: Perhaps a slight slowdown as some companies may be affected by global economic issues and interest rate anxiety, however, those concerns have been around for some time and did not affect the leasing market last year. So, demand should remain robust throughout 2016 and any slowdown in what has been very rapid growth in rents and sale prices can be seen as movement toward more sustainable growth rates. We certainly don't expect negative demand or declining rental rates this year.

GlobeSt.com: It is interesting to see that rents are back at peak pre-recession levels, but vacancy rates haven't come down to the peak levels yet. What does that dynamic say about this market, and with higher vacancies, what is driving rents up?

Adams: Certain landlords have taken a strategic approach to owning large percentages of key submarkets which has allowed them to control pricing and help insulate them from more typical real estate market drivers, including vacancy rates. A prime example of a landlord taking this approach occurred this quarter when Douglas Emmett purchased 2.2 million square feet of Class A office space in four buildings along Wilshire Boulevard, where they already owned two Class A buildings. Douglas Emmett now owns 78 percent of Westwood's Class A inventory along Wilshire Boulevard, giving them enormous control over rates in that market.

Throughout the economic recovery, we've also been seeing the repositioning or redevelopment of many buildings into creative office space. Often times these were underperforming buildings or industrial buildings that ask top rates once they are transformed into a unique creative product. This conversion of Class B and Class C buildings to top-of-market creative space has not only added to the inventory, but has come online at asking rents exceeding institutional trophy building rates.

GlobeSt.com: The Westside seems to continue to lead the LA office market. Do you see that trend continuing, or do you think other emerging markets (Hollywood, DTLA) will catch up?

Adams: Yes, that trend will continue and Westside rents will lead the market, however, creative office space in Hollywood and the Arts District in Downtown LA are closing some of that gap, although the Arts District is still waiting for that monumental lease that really puts it on the map. With rail transportation reaching all the way to the ocean in in Santa Monica, the Westside markets will continue to be highly desirable and more accessible than ever.

GlobeSt.com: What are your biggest concerns for the market?

Adams: If there is a substantial slowdown in key sectors like technology, entertainment or healthcare that would greatly effect job growth. Venture investment in the Los Angeles region plays a large role in giving many of our high-growth companies the power to expand so if concerns over valuations or the broader economy slow the flow of venture money into the region, it could create a speed bump for our local office market. However, as long as we continue on a slow growth path, we should be good through the end of 2017.