What tenants can expect from the Los Angeles real estate market Featured

9:01pm EDT August 31, 2011
What tenants can expect from the Los Angeles real estate market

As the founder and CEO of Guardian Commercial Realty, Robert Chavez is frequently asked his opinion about the condition of the Los Angeles commercial real estate market.

“My response often surprises those who are not in the real estate industry,” he says. “They expect the health of office, retail and industrial markets will run parallel to the general economy. Accordingly, they are expecting my response to be one of doom-and-gloom during such a volatile financial climate. The answer, however, is a bit more complicated than that.”

Smart Business spoke to Chavez to get further insight into the current Los Angeles commercial real estate markets, and maybe even predict what the future has in store.

How can you explain the ups and downs of the Los Angeles real estate market in recent years?

Current Los Angeles rents are certainly much lower than they were during the 2007-2008 landlord market. That market was fueled by an artificial skyrocketing economy and East Coast investors buying large real estate portfolios and pushing exorbitant rental rates. For example, West Los Angeles and Century City rents rose from an average of $2.50/$3 per square foot in 2002-2005 to $5/$7 in some of the trophy buildings. Even micro markets like Sawtelle Boulevard, the domain of bargain West Side rents, rose from $1.50/$1.75 per square foot to more than $3 per square foot.

This spike was short-lived, however, and once the recession took hold rates dropped. Surprisingly, rates in most Los Angeles markets have not settled to their prior levels. The landlords that overpaid for their portfolios have fought desperately to maintain value and save face with their investment partners. Downtown Los Angeles in particular has become a much more expensive place to have an office.

Downtown landlords have successfully shifted from full-service gross leases to net leases with extremely high operating and tax expenses. This shift has helped camouflage a tenant’s true occupancy cost and, once the high parking costs are added, downtown is no bargain.

How has this impacted the current state of the market?

Ironically, the uncertainty of the financial markets has created inflated commercial property values in some markets. Large pension funds and private equity entities with billions of dollars to invest must place their capital. Reluctant to invest too heavily in the stock market, there has been a very high volume of bidders driving up sales prices. It is getting to the point of astonishing many industry experts. There are numerous reports of sales at prices well above what is supported by current rents. The large investors have the financial strength and ability to wait for markets to turn. They understand there has been virtually no new speculative commercial construction in the past five years and that any new construction will be extremely expensive given the high cost of labor, materials and government fees. They believe that once the economy finally recovers that tenant demand will quickly fill the existing supply of vacant space and landlords will be in the cat-bird’s seat to aggressively raise rents, reduce concessions and make big profits. It will be interesting to see just how far the speculation continues.

What can tenants do to better position themselves given their situation?

In the meantime, tenants still have a wide variety of attractive options. The market has been fairly stagnant for a few years and it is anyone’s guess as to when there will be a material shift. Many tenants with businesses in good standing and a favorable long-term outlook are committing to long-term leases as a hedge against escalating rents. This could result in tremendous cost savings and a real advantage against competitors that may be forced to sign leases in an expensive landlord market.

Tenants with real savvy are signing long-term leases with an option to terminate mid-term. Such forethought and flexibility could provide well-timed savings to the tenants who are patient and aggressive enough to secure such a lease.

What does the future hold?

Most real estate experts believe that higher rents will be the eventual outcome. Before the debt ceiling debacle, they were predicting a real estate turnaround in the next two or three years. Given what Wall Street has recently shown us, they may be extending their predictions.

Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardianusa.net or (310) 882-2060.