South Bay Momentum Continues Into Third Quarter

South Bay market rental rates exhibited growth for the 19th time in 20 quarters. Vacancy dropped from 15.8% to 15.7% on the strength of move-ins in LAX/Los Angeles/Westchester, Long Beach Airport/Lakewood and 190th Street Corridor. About 45,200 square feet of product remains under construction and is expected to deliver by the end of the year. Leasing activity closed almost to last quarter’s total, recording 706,400 square feet. Investment activity dropped from last quarter’s total volume of $310.6 million to $106.4 million. Future demand, high-quality space and discounted rental rates compared to West Los Angeles will continue to attract a variety of media, technology, defense and consumer product tenants.

 

The overall vacancy rate for the South Bay market increased by 10 basis points. Deliveries of vacant speculative space tempered Class B gains. Vacancy was down 570 basis points since the same period four years ago, proof of the success the South Bay market has seen during the current cycle. Healthy demand in LAX/Los Angeles/Westchester and 190th Street Corridor drove vacancy rates down in those markets. Absorption for the South Bay recorded positive for the quarter at 128,200 square feet. Coworking and executive suite tenants continued to occupy square footage in the South Bay market, with WeWork agreeing to lease nearly 1000,000 square feet at Starwood Capital’s PCT complex. In the same building, Premier Office Centers renewed their current footprint of 18,200 square feet. Among the major move-ins for the quarter were transportation startup Tesloop subleasing 33,300 square feet at 12955 S. Chadron Avenue in Hawthorne, as well as bioscience firm KitePharma expanding by 28,000 square feet on the Utah Campus in El Segundo.

 

Class A rents increased by $0.10, followed by increases of $0.09 and $0.05 for Class C and Class B, respectively. Five of the six South Bay submarkets experienced year-over-year rent growth exceeding 5%, highlighted by El Segundo/Beach Cities increasing by 10.3%. NSB Associates’ 80,000-square-foot Ascend Campus delivered this quarter, with several major companies looking at the property as a potential landing spot. Hackman Capital’s purchase of Northrup Grumman’s facility at 888 Douglas Street stands as the only major potential office project in the South Bay. Investment activity for properties over 25,000 square feet logged $106.4 million in volume across three transactions. After purchasing a former Raytheon site at 2030 E. Maple Avenue for $15.2 million in 2015, a joint venture of Steelwave and Goldman Sachs sold the renovated creative project to Atlas Capital for $39 million ($383 PSF). Named INSITE, the property was vacant at time of sale. In Downtown Long Beach, the Salvation Army sold 180 E. Ocean Boulevard to Thrifty Oil Company for $35.3 million ($164 PSF). Salvation Army, which occupied nearly three quarters of the building, will move out over the next two years.

 

Key Takeaways:

  • Leasing activity continued to exhibit momentum in 2018, recording 706,400 square feet owing mainly to the El Segundo/Beach Cities submarket.

  • Average asking rents for the overall market continued to rise, scaling to $2.66 per square foot (PSF) full service gross (FSG) from $2.58 last quarter.

  • Class B vacancy benefited the most from modest demand this quarter, registering a 60-basis-point drop.

  • NSB Associates Ascend Campus delivered 80,000 square feet to the market, leaving 55,200 square feet remains under construction, all of which is slated to deliver by the end of 2018.

  • Sales activity continued to be robust with $106.4 million in transaction volume for the quarter. The trade of 2030 E. Maple Avenue in El Segundo from SteelWave to Atlas Capital was the highlight for the quarter.

Outlook:

The outlook for the South Bay market remains positive. Vacancy should decrease through late 2018, as a lessened construction pipeline and robust leasing activity in 2018 will counter subpar leasing velocity in 2017. Similar to West Los Angeles in the past couple of years, the South Bay has managed to defy rental rate expectations, routinely posting year-over-year growth in the 6%-8% range. The attractiveness of the market, both in terms of office inventory and quality of life, should continue leading to rising rates and declining vacancies. Heightened investor interest and activity will be seen across the whole market. In addition to core investment properties, value-add and creative conversion projects will remain part of the investment environment.

 

 Sustained velocity and some slowing in the construction pipeline will tighten South Bay market in the near future. In the near term, demand will lessen due to decreased leasing velocity in late 2017 and the first quarter of 2018. However, in what amounts to somewhat of a reversal of trends, shifting federal policies have also led to increased demand for defense/aerospace industry-specific build outs. After a period of measured rental growth in late 2016 and early 2017, South Bay rents have exceeded 5% growth in the last few quarters. This is expected to continue throughout 2018, particularly in secondary markets.

 

Construction will lag behind the boom the market saw in the past few years. However, all current projects, which account for 1% of all construction activity in the county, are due to deliver in the fourth quarter. The South Bay market has seen rising costs for industrial sites and obsolescent office inventory. The subsequent returns for those early into the market will continue to draw interest from investors, both local and institutional, in areas not traditionally known for office product.