Office Vacancy Rises As New Product Comes Online

Are we building too much office product in Los Angeles? Office vacancy increased by 10 basis points to 11.4% in the second quarter, and according to the 2Q17 market report from NAI Capital, new deliveries of office product were behind the bump. The report shows that 705,454 square feet of product delivered in the second quarter, including the 73-story Wilshire Grand in Downtown Los Angeles, and points to the new construction as the cause of the increase in vacancy. Joseph Faulkner, an executive managing director at the firm, however, says that there isn't enough new construction to affect vacancy, but instead the increased rate is the result of firm's right sizing. The trend is also causing an increasing in sublease space as well. To find out more about the increase in office vacancy and how the Los Angeles office market is changing, we sat down with Faulkner for an exclusive interview.

GlobeSt.com: What is driving office vacancy rates up in Los Angeles?

Joseph Faulkner: It is not an oversupply. Vacancy is rising more from the ongoing process of firms reducing their size while keeping the same amount of people. They do this using creative office strategies and downsizing offices for individuals.

GlobeSt.com: Are developers overbuilding?

Faulkner: There is not a lot of office building construction. The C3 project just came on line in Fox Hills with a fair amount of preleasing. Hollywood keeps putting space on the market one small building at a time. And of course, the 400,000 square feet of office space in the Wilshire Grand Downtown hit the market about 25% leased.

GlobeSt.com: How will this new supply and increasing vacancy rate affect rents?

Faulkner: There are quarter-to-quarter changes in vacancies but overall supply and demand are in pretty good balance. Increasing vacancy should mean a corresponding drop in rents although the effect has a delay. Good office buildings are still very much in demand and with all the available capital; there is no shortage of buyers. Prices are still going up not just in the tech markets but also across the board. After tenants shrink down as far as they can go, the rents are still rising. Tenants may be facing an affordability issue. Many landlords will renew early for a strong tenant and we are recommending this strategy where it is feasible.

GlobeSt.com: Is the vacancy increasing for a certain class of office product, or across the board?

Faulkner: Traditional high rises are having a tough time attracting tenants who want creative space. Although they seem to work in Seattle and San Francisco, Los Angeles still is lagging. Areas Downtown like Bunker Hill and Woodland Hills have significant vacancy.   Creative space can be delivered in a traditional high-rise envelope but there is tenant resistance.

GlobeSt.com: Where is demand remaining strong, and what submarkets are suffering?

Faulkner: Demand remains strongest in the Westside and Hollywood. Firms that have ties to entertainment and technology still gravitate to these areas but sky-high rents have forced consideration to non-traditional areas. Downtown remains pretty neutral even with significant space soon arriving in the Arts District. Glendale is finally healthy and so is Pasadena. El Segundo has seen tremendous growth but is still lacking in large bulk users.

Are we building too much office product in Los Angeles? Office vacancy increased by 10 basis points to 11.4% in the second quarter, and according to the 2Q17 market report from NAI Capital, new deliveries of office product were behind the bump. The report shows that 705,454 square feet of product delivered in the second quarter, including the 73-story Wilshire Grand in Downtown Los Angeles, and points to the new construction as the cause of the increase in vacancy. Joseph Faulkner, an executive managing director at the firm, however, says that there isn't enough new construction to affect vacancy, but instead the increased rate is the result of firm's right sizing. The trend is also causing an increasing in sublease space as well. To find out more about the increase in office vacancy and how the Los Angeles office market is changing, we sat down with Faulkner for an exclusive interview.

GlobeSt.com: What is driving office vacancy rates up in Los Angeles?

Joseph Faulkner: It is not an oversupply. Vacancy is rising more from the ongoing process of firms reducing their size while keeping the same amount of people. They do this using creative office strategies and downsizing offices for individuals.

GlobeSt.com: Are developers overbuilding?

Faulkner: There is not a lot of office building construction. The C3 project just came on line in Fox Hills with a fair amount of preleasing. Hollywood keeps putting space on the market one small building at a time. And of course, the 400,000 square feet of office space in the Wilshire Grand Downtown hit the market about 25% leased.

GlobeSt.com: How will this new supply and increasing vacancy rate affect rents?

Faulkner: There are quarter-to-quarter changes in vacancies but overall supply and demand are in pretty good balance. Increasing vacancy should mean a corresponding drop in rents although the effect has a delay. Good office buildings are still very much in demand and with all the available capital; there is no shortage of buyers. Prices are still going up not just in the tech markets but also across the board. After tenants shrink down as far as they can go, the rents are still rising. Tenants may be facing an affordability issue. Many landlords will renew early for a strong tenant and we are recommending this strategy where it is feasible.

GlobeSt.com: Is the vacancy increasing for a certain class of office product, or across the board?

Faulkner: Traditional high rises are having a tough time attracting tenants who want creative space. Although they seem to work in Seattle and San Francisco, Los Angeles still is lagging. Areas Downtown like Bunker Hill and Woodland Hills have significant vacancy.   Creative space can be delivered in a traditional high-rise envelope but there is tenant resistance.

GlobeSt.com: Where is demand remaining strong, and what submarkets are suffering?

Faulkner: Demand remains strongest in the Westside and Hollywood. Firms that have ties to entertainment and technology still gravitate to these areas but sky-high rents have forced consideration to non-traditional areas. Downtown remains pretty neutral even with significant space soon arriving in the Arts District. Glendale is finally healthy and so is Pasadena. El Segundo has seen tremendous growth but is still lacking in large bulk users.