Out-Of-Market Relocations Boost Downtown LA

Direct vacancy for the quarter was 18.8%, while sublease vacancy recorded at 0.5%. Bunker Hill saw the largest drop in vacancy from 13% to 10.8% as City National Bank started to move into its namesake building at 350 S. Grand Avenue. Year over year, overall vacancy has dropped by 70 basis points as demand has managed to mitigate construction deliveries and corporate relocations. Many larger tenants in the market have already streamlined their footprints, further minimizing the effect of rightsizing on vacancy. Leasing activity in the Downtown L.A. market for the quarter recorded 605,600 square feet. Demand of 95,600 square feet marks the first time in four quarters absorption slipped below 100,000 square feet. The trend of relocating to Downtown Los Angeles found two new participants this quarter. Arup left Playa Vista and leased 66,000 square feet at Wilshire Grand. Spotify agreed to relocate from West Hollywood to the Arts District and will occupy 110,000 square feet in the At Mateo complex. City National Bank occupied the first phase (120,000 square feet) of its 240,000 square foot space at the renamed CityNational@2Cal with options to take more in the future. Insurer Marsh & McLennan completed its move to 68,000 square feet at 633. W. 5th Street, moving from 777 S. Figueroa Street. South Park recorded the largest hit, as Transamerica gave back its entire 160,000-square-foot space.

The overall average asking rate for direct space increased year-over-year by 3.6%. The Financial District led all submarkets in average asking rate at $41.28 PSF FSG, while Greater Downtown/Arts District also recorded $40.58 PSF FSG on the strength of new creative properties in the Arts District and other fringe markets. New construction projects consist of new or adaptive reuse space and remain concentrated in the Greater Downtown/Arts District submarket. Two out of six projects currently under construction are due to deliver by the end of 2018. The delivery date for Shorenstein’s Ford Factory has continually been pushed back since it broke ground and now has a target of early 2019. Despite delays, interest in the Arts District has continued to be robust as Spotify agreed to relocate to At Mateo and RowDTLA continues to pull tenants from across a variety of industries. Investment activity in Downtown Los Angeles fell silent this quarter, with no properties trading fully. The Ratkovich Company sold its share of 700 S. Flower Street to one of its original partners in the building, National Real Estate Advisors. The building, which had experienced some delays in build-out and leasing efforts, was 66% leased at the time of sale.

Key Takeaways:

  • Demand continued to be positive in Downtown Los Angeles, although less than last quarter. Move-ins in the Financial District and Bunker Hill negated give-backs in South Park to the tune of 95,600 square feet of absorption.

  • Vacancy corresponded with a 30-basis-point drop to 19.3%.

  • The overall asking rental rate rose to $40.74 per square foot (PSF) full service gross (FSG), a change of 3.6% year-over-year.

  • The Financial District accounted for the lion’s share of leasing volume for the quarter, recording 59% of all activity.

  • The current construction pipeline held steady with two projects scheduled to deliver in 2018:, the Title Insurance building in the Historic Core and the Maxwell in the Arts District. 

Outlook:

Downtown L.A. vacancy is expected to stay relatively flat despite positive demand due to new construction deliveries. However, as mentioned previously in this report, if interest from out-of-market tenants persists, especially in the media and technology industries, Downtown Los Angeles may be able to claim itself as a competitor to markets such as Hollywood and Silicon Beach. The signings of Arup and Spotify this quarter arguably happened not only due to pricing, but also due to the quality of space and an ever-increasing slate of amenities in the market. This combination of factors should lead to continued momentum for Downtown Los Angeles.

Vacancy levels will stabilize or drop in the short term with the majority of construction due to hit in 2019. Recent strong leasing activity will also push vacancy down. New construction deliveries could temper demand from future out-of-market relocations to Downtown Los Angeles, but the emergence of the Arts District as a tenant destination could mitigate demand concerns. Higher build-out costs and competition from creative conversion space have will exert upward pressure on rents. Future construction will provide an abundance of high-quality creative space to the market, as Downtown Los Angeles accounts for 40% of all new construction in Los Angeles County. Its effect on vacancy will depend on delivery timing and preleasing activity. While interest rates continue their ascent and capitalization rates slowly inch up, the investment environment has become more prudent as of late. Nevertheless, Los Angeles County remains a favorable investment environment for foreign and domestic capital.