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Office Market Goes Soft

By Ed Moosbrugger

September 17 -- What a huge difference a year has made in the Downtown Santa Monica office leasing market. A year ago there were hardly any vacancies and rents had jumped to dizzying heights.

Now, after more than 100,000 square feet of vacant space has recently been thrown on the market, vacancy rates are up and rents have dropped.

“The market is definitely shifting into a tenant’s market again,” said Randy Starr, a principal in Tenzer-Starr Commercial Brokerage.

Brokers attribute the shift to an uncertain economy and resistance to high rental rates by some tenants whose leases have come up for renewal.

“Boy has the market changed,” said Eric S. Broida of Broida Commercial Brokerage Group. “A ton of space is hitting the market. Current tenants are scaling back. A lot are subleasing.”

Still, Downtown landlords are enjoying some of the highest rents in the Los Angeles region.
“Santa Monica is still one of the most expensive, if not the most expensive, submarkets in Los Angeles,” Starr said.

That may be a problem.

Vincent C. Muselli of Muselli Commercial Realtors expressed concern that “landlords are going to price themselves out of the market and we will lose more tenants.”

Indeed, even when the market was at its peak last year, some brokers had expressed concern that rental rates had moved too high and might cause some tenants to leave.

Although the market has weakened, it’s not yet worrisome, said John Warfel, a principal of Metropolitan Pacific Commercial Real Estate Services.

“It always feels worse when you are coming off a very strong market,” he said.

“A couple of weeks ago I would have said it had softened a lot,” Warfel, a member of the Bayside Board, said at the end of July. “In the last week or two activity has picked up.”

It’s difficult to get a handle on exactly how much vacancy rates have risen and how much rental rates have come down.

Starr said vacancies have risen to about 12 percent, counting sublease space, while Muselli put the vacancy rate at about 5 percent. Warfel said he isn’t sure what the rate is, but that vacancies are up.

As for rents, Starr said they are down 15 to 20 percent when concessions, such as free rent, are taken into account. Muselli said rates are down about 5 percent.

Warfel reported a softening of rates for sublease space.

Typical rental rates range between $3 and $4.95 a square foot a month, Warfel said. Rents go as high as $6, according to Starr.

Starr expects rents to stay steady over the next year, while Muselli expects a flat market with perhaps an increase in vacancies.

Tenants are very cautious and concerned, with some not renewing leases and others downsizing, according to Muselli.

Warfel doesn’t yet have a sense of how the market will unfold over the next year. People are waiting to see where the economy is headed. “I’m not worried yet,” said Warfel, who is keeping a close eye on how much the economy will suffer.

Broida thinks the market could be soft over the next year or two.

“It’s a great time for tenants to start looking for space,” he said.

Although the Downtown office market is going through a bumpy period, it still has some big things going for it.

One reason Downtown rental rates are high is because the area is a “sweet spot” for the entertainment and Internet industries, Starr said.

He called Downtown a “mini Silicon Valley” with such major tenants as Demand Media and Google, who, in turn, attract smaller companies.

“Santa Monica is still a hot place,” Starr said. “Those vacancies will fill up.”

The atmosphere in Downtown appeals to the young talent in the Internet industry, he said.

“The entertainment and Internet businesses see it as a very positive place to be,” Warfel said.

Easy walking distance to a variety of restaurants, stores and personal services appeals to employees.

A lot will depend on how much tenants are willing and able to pay to enjoy this environment.

SANTA MONICA HOTELS posted small increases in occupancy and room rates in June, according to a report by PKF Consulting.

The occupancy rate increased 0.7 percent from a year earlier to 84.9 percent, while the average room rate rose 3.7 percent to $281.74 from June 2007 to June 2008.

For the first half of 2008, the occupancy rate had dipped 0.3 percent to 82 percent, but Santa Monica had the highest occupancy rate among submarkets in Los Angeles County tracked by PKF.

The first half of this year also saw the average room rate rise 5.6 percent to $275.79.

 

“Boy has the market changed.” Eric S. Broida

 

“The market is definitely shifting into a tenant’s market again.” Randy Starr

 

 

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