Impact of Downturn Varies by Sector, Market

LOS ANGELES-Rents have not fallen as far in the Downtown Los Angeles office market as they have in some other parts of the L.A. Basin, the industrial market continues to weaken in part because of declining port activity and investment sales are stalled in both of those sectors, according to new research and analysis by Cushman & Wakefield. Executive vice president Carl Muhlstein and senior managing director/branch manager Dwight Hotchkiss outlined those points and others Wednesday in an overview of what happened in Southern California’s office and industrial markets during the first half of this year and where those markets are heading.

Muhlstein noted that one of the misconceptions about the L.A. office market today is that Downtown Los Angeles is facing the same drop in rents as other parts of the L.A. Basin. “So far, it continues to be a very stable market,” Muhlstein said of the Downtown submarket. He explained that rents did not spike as high in Downtown as in some other submarkets, so they have not fallen as far.

The new Cushman & Wakefield research provides statistics on more than 290 million square feet of office space in Los Angeles and Orange counties and the Inland Empire, as well as more than 1.7 billion square feet of industrial space in those same markets. In general, the research shows vacancies rising while rents and absorption are falling, but with the impact of the downturn varying within different submarkets.

For example, Muhlstein pointed out that office vacancies could reach 25% to 35% by the middle of next year in the Northwest San Fernando Valley, where failed Washington Mutual Bank and companies connected to the subprime mortgage industry meltdown, like Countrywide, are vacating huge blocks of space. Overall vacancy is already at 23.8% in 2.5-million-square-foot Canoga Park/Chatsworth submarket, one of those cited by Muhlstein. The 23.8% figure includes 14.7% direct and 9.1% indirect space.

The vacancies will deal a sharp blow to building owners but will create opportunities for tenants who are looking to lease space, Muhlstein pointed out. Another submarket where tenants will find leasing opportunities is the Westside, where approximately a million square feet of sublease, new construction and direct space will be available over the next 24 months, Muhlstein noted.

Hotchkiss, in his overview of the industrial sector, cited rising unemployment and declining port activity as two of the primary factors driving vacancies up and rents down in the region. With job growth not expected until 2011, Cushman & Wakefield expects the industrial market to continue weakening this year and possibly flattening next year. Rental rates across the region have dropped about 17% to 20% year over year, Hotchkiss noted, and the volume of leasing is down by 40% or more in most markets. A major reason for the decline in leasing is that industrial users are either renewing leases and not expanding or, in some cases, going out of business, he explained.

Sales of industrial buildings have declined steeply, both in number of transactions and prices paid per square foot, with some buildings selling at or below replacement costs, Hotchkiss said. He said that SBA-financed sales to owner-users might pick up if the bid-ask gap narrows, especially since the SBA is being aggressive in trying to boost business.

But Hotchkiss added that investment sales, for the most part, will probably be distressed asset deals and probably won’t gain momentum until some time next year when owners with loans coming due will have difficulty finding financing. Muhlstein noted that office investment sales, too, have dropped sharply, but he noted that, coincidentally, more than a million square feet of office buildings are available for sale in Beverly Hills.

Muhlstein said that one of the big questions that Cushman & Wakefield is looking at now is “What will be the next big thing?” He explained that the run-up of rents and building prices that accompanied the housing boom followed an earlier technology boom in the dot.com era, which later collapsed. The next big driving force could be the new green economy, or possibly the expansion of biotech and biomed, or the continued expansion of the healthcare industy. “We just aren’t sure right now” what that next big thing will be, Muhlstein said.