Office, Industrial Hold Up Amid Slowing Economy

Office

The Los Angeles market still has the market fundamentals of an attractive investment.

Though there has been upward pressure on capitalization rates of roughly 50 to 70 basis points and downward pressure on pricing—which has fallen between 10% and 15%—the Los Angeles market continues to have a low vacancy rate with rising lease rates.

The declining values in office buildings should be met next year by an influx of foreign investment that continues to be fed by the weak dollar. While significant projects and buildings, such as Union Bank Plaza in Downtown Los Angeles, have been taken off the market due to falling prices, it is expected that investment activity will pick up in the coming year as timidity subsides to an increase in bargain shoppers.

It should be noted that these buyers will be much more conservative in their purchasing as underwriting has become an arduous task—though nowhere near as difficult as other markets.

Less leveraged investment entities remain active players in the market. CalPERS, the largest U.S. pension fund, increased its real estate holdings this past month to an unprecedented 10% of total assets as bargains become ever more present.

There is no doubt that the pace of leasing activity decreased in the fourth quarter with a noticeable decrease in demand. The vacancy rate in greater Los Angeles has increased by nearly a half of a percentage point, which has resulted in a substantial negative net absorption of nearly 500,000 square feet. Despite this, lease rates in the region have increased to a record of $2.84 per square foot.

Due to recent changes in the economy and capital markets, tenants are becoming increasingly diligent and cautious about space requirements and more creative with space usage. This creativity has stifled the significant organic growth that has drastically reduced the vacancy rates over previous quarters.

Industrial

Although facing considerable challenges to the economy and the greater Los Angeles industrial market, positive attributes of the current conditions are strong rents (69 cents per square foot), healthy tenancy (1.6% vacancy) and positive growth (557,055 square feet of net absorption).

However, investors and users alike seek signs of sustained stability and this cautionary behavior is causing activity to slow from levels experienced year over year since 2004. Yet, market slowdowns are the catalyst for more serious and opportunistic buyers, local and foreign, often flush with cash and banking on continued strong global economic activity to drive demand for industrial space.

With demand trending toward smaller spaces, buildings with more than 100,000 square feet are sitting for longer periods of time while investor and user interest turn to blocks of space as low as 2,000 square feet.

On the trade front, a key driver of the industrial market, the total number of containers handled at the ports of Los Angeles and Long Beach in November fell by 3.8% from a year earlier. According to the Los Angeles Economic Development Corp., this was the fourth month in a row of year-over-year declines.

Data and analysis provided by CB Richard Ellis Group Inc. Research.