Deliveries Raise Vacancy As Rents Stabilize

The Los Angeles County office market recorded 465,800 square feet of net absorption and 434,000 square feet of deliveries as the total vacancy rate fell to 15.4%. All submarkets except Central Los Angeles (-190,900) led positive gains in the county. Much of the positive movement stemmed from the West Los Angeles submarket totaling 294,000 square feet. Rental rate growth heated as rates increased by $0.07 to $3.31 PSF FSG. Six of seven Los Angeles County submarkets saw rates increase or experience no change. Construction activity remains concentrated in Downtown and West Los Angeles, accounting for 71% of construction in the county. Los Angeles County non-farm unemployment in May 2018 held steady at 4.4%, a 0.9% decrease year-over-year. Over the past 12 months, Los Angeles County gained 15,700 non-farm jobs for an increase of 1.5%.

The Hollywood/Wilshire Corridor market saw mixed results to close out the first half of 2018. Vacancy climbed 130 basis points from the previous quarter, while absorption posted negative demand for the second time in four quarters, recording negative 190,000 square feet. Rents dropped again this quarter, sliding by $0.01. A historical perspective shows some cooling.

The Downtown Los Angeles office market recorded positive absorption for the fourth straight quarter as vacancy stayed below 20%. At a macro level, Downtown Los Angeles’ current vacancy hasn’t changed from the five-year historical average of 19.3%. Leasing volume recorded 605,600 square feet due primarily to major relocations from West Los Angeles by Arup (Financial District) and Spotify (Arts District). Asking rents in the CBD have continued growing by 3.6% year-over-year. In the face of rising build-out costs and high asking rents in creative conversion space, landlords in the CBD have kept rates high, choosing to compete for tenants with larger concession packages, like abatement and higher tenant improvement allowances.

Vacancy in the West Los Angeles market rose by 10 basis points, as the delivery of a few partially vacant buildings negated absorption gains in Century City and Westwood. Rents continued their torrid ascent, rising by $0.11 to $4.74 PSF FSG, boosting year-over-year growth back over 6%. Leasing activity matched last quarter’s 1,417,400 square feet, recording 1,413,900 square feet of velocity.  

The San Fernando Valley and Ventura County office market recorded positive net absorption at 121,000 square feet as vacancy declined by 40 basis points in the second quarter. Asking rental rates recorded $2.40 PSF FSG, a 5.7% year-over-year increase. 

South Bay market rental rates exhibited growth for the 18th time in 19 quarters. Vacancy dropped from 16.2% to 15.8% on the strength of move-ins in LAX/Los Angeles/Westchester, Downtown Long Beach and El Segundo/Beach Cities. Leasing activity almost doubled last quarter’s total, recording 840,300 square feet. The NFL’s lease at the Kroenke Group’s stadium development site in Inglewood accounted for nearly a quarter of that total. Investment activity rebounded from last quarter’s total volume of $77.9 million to $310.6 million.

The San Gabriel Valley office market recorded 231,500 square feet of leasing activity, marking at least 100,000 square feet of velocity for five out of the past five quarters. Vacancy dropped by 50 basis points to 14.5% due to positive demand of 56,100 square feet. Among the major move-ins was United Healthcare moving into 17,600 square feet in Irwindale. The overall asking rent rose by $0.01 to $2.26 PSF FSG.

The Tri-Cities market saw slightly positive demand for the first time in three quarters. Gains in Burbank and Pasadena were canceled out by Nestle’s exit from Glendale. After decreasing last quarter, rents saw no movement in the second quarter. Investment activity was concentrated in Pasadena and Glendale. Glendale saw its 16th Class A property trade in the last three years, while one of Pasadena’s trophy assets traded and will be brought up to market rent levels. For investors, sizable discount to replacement cost and rents below peak levels are helping to fuel activity, along with a varied tenant base for the market.

The Orange County market saw positive movement during the second quarter as leasing activity increased by 38% compared to last quarter. Investment activity was concentrated in Aliso Viejo as multiple buildings traded hands including the Summit Office Campus marking the highest priced transaction in Orange County this year.

The total vacancy rate for the Inland Empire office market increased 10 basis points from 12.5% last quarter to 12.6%. The increase in vacancy stems from the Riverside submarket, which recorded an increase of 110 basis points. The second quarter closed with negative absorption recording down 21,200 square feet. Leasing activity recorded 273,100 square feet, which falls within the three-year average. The weighted average asking rental rate increased during first quarter to $1.79 PSF FSG. As a historical perspective, one year ago the asking rental rate recorded at $1.72 PSF FSG.

Key Takeaways:

  • The Greater Los Angeles Basin office market posted minimal positive demand of 530,900 square feet. 
  • Given positive absorption, office market vacancy fell by 10 basis points from last quarter to 14.8%. Historically, vacancy rose by 20 basis points from 14.6% year-over-year.
  • Asking rental rate growth jumped compared to previous quarters, increasing at a trailing four-quarter average of 1.6% to end at 3.11 per square foot (PSF) full service gross (FSG). This is a 6.7% gain over last year.
  • New construction totaling 5.3 million square feet is underway in the Los Angeles Basin office market, half of which will deliver in 2018. 
  • The Los Angeles Basin unemployment rate fall, ending at 3.9%. Job growth slowed to 1.7% as the economy stabilizes at virtually full employment.

Outlook:

There is currently 825,800 square feet of office product under construction in the Hollywood/Wilshire Corridor market, along with 191,600 square feet of additional proposed product scheduled to break ground in 2018. The majority of deliveries will take place in 2020 with the arrival of Hudson Pacific’s EPIC building and Kilroy’s Academy project. 

The West Los Angeles market will add more than 1.34 million square feet in the next two years. San Fernando Valley and Ventura County office market trends are expected to move at a slow rate with only two new projects under construction on the horizon. Given these conditions,the market will remain supply-constrained and absorption is expected to remain flat to slightly positive.  

About 135,200 square feet of product remains under construction in South Bay and is expected to deliver by the end of the year. In Orange County, there are 17 blocks of space greater than 100,000 square feet available for lease. Market fundamentals will remain strong as newly built inventory delivers to the market during 2018, giving tenants the opportunity to explore new space options. As tenants seek opportunities to right size and new construction delivers to the market, absorption gains are expected to be limited in coming quarters.