Cost-Conscious Tenants Scooping Up Class-B Offices.

Over the past two years, as the office real estate market recovered from the recession of the 1990s, many second-tier buildings in the San Fernando Valley lagged behind.

But recently, as space becomes tighter and more expensive in luxury office buildings, interest in less prestigious, so-called class-B space has picked up dramatically.

Brokers representing class-B buildings report that vacancy rates have gone down to single digits from highs of 15 percent or more just a year ago. Some buildings are fully occupied for the first time since the 1980s.

"In the past, we were lucky to have occupancy rates of 75 percent or 85 percent in Van Nuys," said Mike Toth, a commercial developer who operates Toth Properties. "Now I have one vacancy in the whole building (that I manage in that area), and I'm down to 95 percent full in another building in Mission Hills."

Class-B offices are smaller buildings of 45,000 square feet or less, typically located in less desirable commercial districts or slightly off the main thoroughfare in prime business areas like Ventura Boulevard or Warner Center.

Space in such buildings went begging when the real estate recession raged through much of the 1990s because landlords were discounting rates on class-A space, bringing the prices on those buildings to levels comparable to less prestigious buildings.

But over the past year, class-A rents have increased by 15 percent or more, driving some cost-conscious tenants back into the market for second-tier properties as their leases come up for renewal.

"In the early '90s, for 10 cents or 20 cents (difference per square foot, monthly) you could have an A vs. a B," said Thomas Specker, senior managing director at Charles Dunn Co. Inc. "Now the difference can be 50 cents (a foot, monthly). A lot of tenants in class-A spaces are saying, 'What do I have to pay $2.50 for?'"

Statistics point to more interest

Recent leasing activity in the West San Fernando Valley illustrates the trend. According to a report by Marcus & Millichap, gross absorption topped 139,282 square feet for class-B space in the West Valley in the second quarter of 2000, more than twice the 60,705 square feet absorbed in the same period of 1999.

In the Woodland Hills and Warner Center area, a premier business district, gross absorption for class-B buildings reached 101,939 square feet in the second quarter, up from 67,394 square feet for the comparable period of 1999, Marcus & Millichap reported.

"I'm seeing two types of tenants (for class-B offices)," Toth said. "People starting to expand from a small office or a home office situation and tenants whose rents have been raised substantially, and they want to bring their rent down a bit."

Balter, Miller & McHugh LLP, a certified public accounting firm, is a case in point. Seven years ago the company located in Woodland Hills because three of its partners lived in the area and because rental rates compared favorably to less prestigious buildings elsewhere. But when it came time to renegotiate their lease this year, the partners were looking at a 15 percent increase in rental costs, said partner Brian King.

Officials realized they would not only save money by moving to Encino, but the location was also more convenient for many of the firm's clients, who are based on the Westside of Los Angeles.

"The building (in Encino) was remodeled, and they built it out to suit our needs, and it all went fairly smoothly," said King, who estimates that the current rent is about 20 percent under the price the firm would have paid to stay in Woodland Hills.

Bargain prices

Monthly rents for class-B properties in better locations can range as high as $1.85 or $2 per square foot. That compares with rents of $2.25 and $2.50 per square foot for class-A space in those locales. But on average, class-B properties are renting for about 20 percent less than luxury space, so in areas where luxury space rents for $1.85, class-B space has become even more affordable.

But it isn't just bargain rents driving tenants to these second-tier buildings. Brokers point out that even those who aren't looking for low rental rates have resorted to class-B properties because they can't find enough space to meet their needs in more expensive buildings.

"If a tenant is location-driven and they have to be in a certain spot, the lack of available space can force them into a B or C location," said Paulette Toumazos, vice president of office services for Daum Commercial Real Estate Services. She added that in some of these areas, tenants are renting class-B offices at rates approaching the cost in class-A space.

Daum, which manages all classes of properties, is seeing class-B vacancy rates fall into the 8-12 percent range, down from a 12-15 percent range a year ago, Toumazos said.

"It has been a long time since it's been a landlords' market like this, and it was probably when I first started (in the business) 12 or 15 years ago," she said.

Some tenants are also downgrading their spaces because they feel their business environment has grown more casual. "My experience has been that a lot of tenants want to have attractive space, but they neither need nor want for the showy (class-A) space because it sends the wrong message to clients," said Toumazos.

So far, most of the interest in class-B space has been in premier neighborhoods like Warner Center, but brokers believe that if the trend continues, even buildings in less prestigious commercial districts will reap the benefit of the space crunch.

That is already starting to happen in Van Nuys, where Toth manages a property that was nearly vacant three years ago despite fire-sale monthly rental rates of $1 per square foot. Today, the same building is renting at $1.25 to $1.35 per square foot, and it is 97 percent occupied. "I have a standard offer for 3,000 square feet, and I don't have the space," Toth said.