Office Vacancies Still Abundant In A Strong ‘Tenants’ Market

By Sean Belk
Staff Writer

While last year was purely a transitional period for the office space sector, all indicators show that this year continues to be a strong buyers’/tenants’ market with more landlord concessions, offering historically low or even free lease rates and renegotiated deals taking the lead.

Jeff Coburn, senior vice president of office and industrial markets for Lee & Associates, which opened its Long Beach office last year, said at this point most building owners fully understand the need to retain tenants and compete for new renters.

“There are still fluctuations going on, but overall I think people are feeling a little bit more optimistic than in 2009,” he said. “I think everyone’s under the realization that landlords know that it’s going to take time before everything really rebounds.”

The amount of relatively high available square footage in buildings across the board remains an indication that there still is less of a demand for any new space or expansions in the immediate area. Companies, for the most part, are still scrimping and saving to adapt to a new business climate that involves cutting costs at every level.

The unwaveringly high unemployment rate in Long Beach, the state and the rest of the nation also undoubtedly remains an indication that any economic recovery will be slow moving for the rest of the year.

Robert Alperin, senior director for Cushman & Wakefield in Long Beach, said he believes the office space vacancies have actually worsened this year, although he expects negative inventories to eventually hit bottom either later this year or next.

“My gut tells me that year over year we’re down,” he said. “Until we see a significant change in the economy where . . . companies start to hire, we’re likely to see a continuation [of high vacancy rates]. I don’t think it’s going to be a dramatic one, but I think it’s going to be a slow ebb. Long Beach is one of those markets where it never has gone into hyper speed one way or the other.”

Alperin also noted that, for much of the “shadow space,” or subleased space that isn’t typically listed, former tenants are still paying down their rent on spaces that are no longer occupied due to their acquisition by large corporations or downsizing.

While Cushman and Wakefield’s first-quarter report this year showed a 16.5 percent vacancy rate on a direct basis, it didn’t account for the 126,195 square feet of sublet space which would make the vacancy even higher at about 19 percent, he said.

Becky Blair, owner of Blair Commercial Real Estate, declares a citywide vacancy rate for office space remaining at about 18 percent.

Even though this year has been fortunate to bring more small business lease transactions, averaging about two leases per week, there are still large empty buildings either listed on the market or subleasing with significant amounts that might not be accounted for in some second quarter reports.

One building on West Broadway has held vacant space of up to 134,000 square feet ever since the property owner purchased it several years ago.

However, some recent reports from mid-year findings have already ventured to say that the vacancy rate in Long Beach has begun to level off.

Tracey Seslen, assistant professor for the USC Marshall School of Business, said the rising availability of office buildings has already hit its peak.

A second quarter report by Grubb & Ellis shows that vacancy rates are down 1.85 percentage points for Downtown Long Beach, dropping from a rate of 16.8 percent last year to 14.95 percent this year. The suburban market shows much less improvements with a vacancy rate of 17.88, down from 18 percent last year.

“For Long Beach, in particular, it looks as though vacancies have bottomed out in both the suburban and downtown markets,” Seslen said.

Figures for the South Bay region of Los Angeles County as a whole are much bleaker, she added. The statistics actually show an overall increase in vacancies this quarter, jumping from a rate of 16.8 percent last year to 17.8 percent this year.

Additionally, Seslen said rental rates for Class A office space have pretty much held steady (at 90 percent occupancy) for the last three quarters in downtown after significant declines in the first part of 2009, while the suburban market has seen an increase from its low last year.

Steve Warshauer of First Team Commercial agrees that office markets appear to have “stabilized” and are headed toward a recovery.

“In the second quarter, office vacancy rates appear to have peaked and are no longer rising,” he said. “If the current absorption and delivery trends hold, office vacancy rates should fall over the next several months.”

Co-Star Group, a national real estate database, has figures showing vacant office properties in Long Beach has increased this year, anywhere from 5,000 to 10,000 square feet, for both downtown and suburban markets in the second quarter (which ends June 30) compared with 2009.

The database shows suburban Long Beach maintaining 406 properties for lease or sale on the market at an average lease rate of $1.88 per square foot at full service gross, while the downtown segment has about 257 available buildings with the average rental rate of $1.95 per square foot.

Still, whether or not the city’s office space vacancy index is a true indication of market conditions is debatable. Co-Star representatives even indicate that due to the rapidly changing and fluctuating markets, vacancy rates could be simply “irrelevant” in terms of forecasting market conditions.

Lower Rates To Weather Tough Times

Many landlords continue to drop rates, adding concessions to entice tenants, including absorbing the costs of moving expenses, space remodeling or reduced and sometimes free rents.

Shaun McCullough, a senior vice president for Lee & Associates, said tenants with capital have the best opportunities from landlords who must compete by throwing out big tenant improvement packages.

“Now is a great time to be a tenant,” he said. “Not as much for a buyer because it’s a little difficult still for bridging that gap in pricing, but if you are a buyer or investor in all cash, you’re in a good position.”

With business down from 25 to 50 percent in some cases, USC’s Seslen added that right now tenants have the upper hand, which has caused landlords to renegotiate their leasing terms. The market has typically been a landlord’s market for roughly five to seven years.

“In an economy such as this one, the tenants have a large amount for negotiation power because landlords are so desperate to fill space,” she said. “Landlords have mortgages that they need to make right now.”

Lily Nguyen, manager of client services for CB Richard Ellis, which manages Douglas Park near Lakewood Boulevard, said their development offers roughly 128,253 square feet for sale and lease.

With two buildings sold and one leased out, there remains about 11,706 square feet still up for lease and 116,547 square feet for sale, she said. Most recently, tenants that have signed on to the property include Overland, Pacific & Cutler Inc. and Living Opportunities Management.

Competition From

‘Creditworthy’ Tenants

Meanwhile, the move to renegotiate terms, particularly to retain existing business or to attract more “creditworthy” tenants and steering away from shabby investors, has created a bit of competition for both tenants and landlords.

McCullough said there have been a lot of sales right now in distressed properties, but there’s a big gap still remaining between sellers’ and buyers’ expectations.

“The availability of funds is a little difficult,” he said. “The underwriting for an investor is pretty difficult and the appraisal process is very difficult.”

Seslin added that a company with investment-grade corporate debt is probably going to be able to pay their rent, and an S&P or Moody’s credit rating is going to be more pleasing to a bank from an underwriting perspective. Alperin agrees that credit history and the availability of cash flow has a lot to do with the kind of transaction a landlord is willing to involve themselves in.

“Right now it’s harder for landlords to underwrite transactions with their lenders,” he said. “Their lenders are much more conservative in their underwriting. For instance, for tenant improvement loans or for that matter for equity purchases, they want to understand the credit that’s behind the deal. So obviously if you have a Microsoft or a Boeing on the lease there’s not much concern that that company is going to pay their bills.”

Coburn said interest rates right now hover at about 6.5 percent for Small Business Administration (SBA) loans, which tend to be the best loans on the market for investing in a new venture with 10 percent down. But since underwriting is so difficult, many businesses are trying to qualify for conventional loans, which are still hard to come by.

Alperin said some of the driving forces in whether or not there will be more demand for office space has to do with how long the lease is, how much the tenant has to spend to get into the space, the quality of the building and the credit of the tenant.

Adapting To A New Business Climate

As companies have experienced widespread layoffs in the market in the past year, and due to the unavailability in growth through lending, smaller businesses are still struggling. As a result, McCullough said very few firms are expanding and have become more cost efficient in operating their businesses.

“That’s completely different,” he said. “Now they’re pretty much lean and mean and they’re adapting to a different type of business style. I don’t think anybody’s rushing to go out and expand.”

McCullough does see some signs of hope on the horizon, with clients now starting to look at new office space, getting out in the market and making more inquiries to see what kind of deals are available. Some industries that appear to be showing market growth include medical marijuana dispensaries as well as nursing schools.