Creative Inventory Continues to Boost Downtown

The Downtown Los Angeles office market recorded positive absorption for the fifth straight quarter as vacancy dipped below 19%. At a macro level, Downtown Los Angeles’ current vacancy hasn’t changed appreciably from the five-year historical average of 19.3%. Leasing volume recorded 590,500 square feet due primarily to new deals by Honey, Arizona State and accounting firm BDO. Asking rents in the CBD have continued growing by 2.5% 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. Tenants in non-creative/tech industries continue to dominate the tenant base in the market. On a positive note, much of the streamlining by these larger tenants has been completed. As the market saw during this quarter, much of the speculative space coming on line both in the CBD and the Arts District will be left to out-of-market interest to fill.

Direct vacancy for the quarter dropped 40 basis points to 18.4%, while sublease vacancy increased to 0.6%. Year over year, overall vacancy has dropped by 150 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 590,500 square feet. Demand of 155,000 square feet outpaced the average of 145,700 SF over the last four quarters. Downtown Los Angeles continued to draw interest from tenants looking to relocate or even expand. Honey, the online coupon aggregator, expanded by more than 80,000 square feet by leaving the CBD for 130,000 square feet at 963 E. 4th Street in the Arts District. Arizona State University signed an 80,000-square-foot deal at the Herald Tribune building to house their communication and design schools. With City National Bank pushing the second phase of their occupancy at 350 S. Grand Avenue to the fourth quarter, Bunker Hill demand contracted into negative territory for the quarter. Move-ins by Farfetch (24,800 square feet), Lendlease (17,500 square feet) and Netmarble (14,000 square feet) in the Financial District helped push demand to 140,500 square feet.

The overall average asking rate for direct space increased year-over-year by 2.5%. The Financial District led all submarkets in average asking rate at $41.48 PSF FSG, while rents in Greater Downtown/Arts District continued climbing to $42.23 (40.58 PSF FSG last quarter) on the strength of new creative properties in the Arts District and other areas like the Historic Core. New construction projects consist of new or adaptive reuse space and remain concentrated in the Greater Downtown/Arts District submarket. One 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-to-mid 2019. Despite delays, interest in the Arts District has continued to be robust as Honey agreed to relocate from two separate locations in South Park to Hudson Pacific’s 4th And Traction creative project. Investment activity in Downtown Los Angeles fell silent this quarter, with no properties trading. The landscape won’t be quiet for long, as Rising Realty Partners and Lionstone Investments brought the CalEdison building to market. The joint venture bought the property in 2015 for $92 million ($323 PSF).

Key Takeaways:

  • Demand continued to be positive in Downtown Los Angeles as move-ins in the Financial District and Greater Downtown/Arts District negated give-backs in Bunker Hill, recording 155,000 square feet of absorption.

  • Vacancy corresponded with a 50-basis-point drop to 18.8%.

  • The overall asking rental rate rose to $41.17 per square foot (PSF) full service gross (FSG), a change of 2.5% year-over-year. 

  • The Greater Downtown/Arts District and Financial District accounted for the lion’s share of leasing volume for the quarter, recording 68% of all activity.

  • The current construction pipeline held steady with a single project scheduled to deliver in 2018: the Title Insurance building in Greater Downtown/Arts District. 

Outlook:

Downtown L.A. vacancy is expected to contract slightly as positive demand counters new construction deliveries. Interest from out-of-market tenants persists, especially in the media and technology industries, has helped legitimize Downtown Los Angeles as a competitor to markets such as Hollywood and Silicon Beach. The signings of Honey and Arizona State 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 trim vacancy. Concern over leasing speculative office deliveries has been largely mitigated by out-of-market relocations to Downtown Los Angeles, as well as by the growing legitimacy of creative inventory in so-called “fringe” submarkets. Higher build-out costs and competition from creative conversion space will continue exerting upward pressure on rents.

Future construction will provide an abundance of high-quality creative space to the market, as Downtown Los Angeles accounts for 42% of all new construction in Los Angeles County.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. In Downtown Los Angeles, the question of whether to hold or sell an asset will weigh on landlord’s minds as some large footprints either downsize or leave outright.