Downtown vacancies grow despite good absorption.

Banks' merger, new buildings help to soften the market

Downtown Los Angeles continued to absorb huge amounts of office space in the third quarter, but brokers said the market's vacancy rate is bound to remain high because of continuing business consolidations and the completion of new buildings adding even more space to the already oversupplied market.

The downtown market absorbed more than 500,000 square feet of space in the third quarter alone and by the end of the period had absorbed more space than it did during all of 1990, according to a report by Grubb & Ellis.

Ray Lepone, a senior marketing consultant with Grubb & Ellis' downtown office, said absorption for this year "should exceed 1990's total" of 976,000 square feet "by a wide margin." The downtown market had absorbed nearly 995,000 square feet by the end of the third quarter, Lepone noted.

The downtown vacancy rate was 18.6 percent at the end of the third quarter, according to Grubb & Ellis. The company said the rate was down from 19.3 percent in the second quarter but up from 12.9 percent at the end of 1990's third quarter. A big reason for the rising vacancy rate, it said, was the 3 million square feet of new space that came onto the market in the past year.

Brokers said the figures mean downtown is a tenants' market and will probably remain so for up to three years.

"Although leasing activity remained brisk during the quarter, the forecast for vacancy rates for the next year is decidedly grim," noted a report by Cushman & Wakefield of California Inc. "To add to an already overbuilt office market, three more projects totaling 2.24 million square feet are scheduled for delivery over the next three quarters."

Among the buildings scheduled for completion is the 801 Tower at 801 Figueroa St. The 24-story, 435,000-square-foot building is slated to open in April and will be about 60 percent pre-leased by then, said Gerald L. Eggleston, senior director of Cushman & Wakefield, which is handling leasing for the project.

Eggleston said there are "a lot of tenants signing leases" throughout the downtown market, but with the huge amount of space available, "there's no sense of urgency on the part of most tenants, so the deals drag on longer than most brokers normally would expect" before they are signed.

Eggleston also handles leasing for the 700 S. Flower building, a 32-story, 675,000-square-foot tower built in 1974. He said that building for years was 100 percent leased, but it fell to 76 percent occupancy after the building's fading luster and nearby Metro Rail construction prompted some tenants to move.

But occupancy is back up to 86 percent now that Metro Rail construction has moved on and the building has been spruced up in a renovation. Occupancy is expected to reach 94 percent by early 1992, Eggleston said.

Bert Dezzutti, senior associate with the downtown office of CB Commercial, said the downtown market this year is characterized by "strong leasing" in a "soft market."

Dezzutti said the average amount of spaced leased in a transaction has been declining downtown for the past several years, even though there have been some big recent leases like AT&T's renewal on 183,000 square feet at 611 Wilshire and accounting firm Coopers & Lybrand's signing a 15-year, $90 million lease for 174,000 square feet on six floors at Two California Plaza.

According to Dezzutti, tenants leased 2.5 million square feet of space in 294 transactions during 1990, compared with 2.4 million square feet in 245 transactions during 1989 and 3.5 million square feet in 214 transactions during 1988. He said the trend to smaller transactions is continuing this year, with more than 200 leases signed for the first three quarters of the year.

Most of the activity is in the best "Class A" buildings, Dezzutti said, with "Class B" and "Class C" structures fighting for what's left over.

He said some landlords are signing leases for rates up to 20 percent lower than the rents they need to meet their financing costs. But they have little choice other than to sign some deals to at least pay building operating costs.

"The landlords can only hope that the market will tighten and rental rates will go up so that they can break even," Dezzutti said.

According to Eggleston, the current downtown market is the most tenant-oriented he's ever seen.

"I've been doing this for 17 years, and in that 17 years there's never been a time like this, although if you go back to 1975 or 1976 I think some buildings were offering two years of free rent, so the market wasn't in the greatest shape then either," he said.

Eggleston said landlords "are dealing with the imbalance" in today's market by cutting rents and increasing concessions.

Brokers cite the cyclical nature of real estate, saying the market will eventually come back into a balance that doesn't overwhelmingly favor landlords or tenants. Most say that will take at least three years.

"If no construction commences, I'd say we could return to a healthy market with a 10-percent vacancy rate within three to four years," Dezzutti said. But the likelihood of a total construction halt is "almost impossible," he added.

Stuart Taylor, vice president of Cushman Realty Corp., said some construction is likely to continue downtown because that "is the designated building area" in Los Angeles.

Proposition U limits on building, down-zoning and other factors have "forced development into a few areas" of Los Angeles, and downtown is one of them, he said.

Taylor said the combination of unemployment, business consolidations like Security Pacific Bank's merger with Bank of America and the general economic slowdown have created the tenants' market.

But Taylor said the market is "a lot tighter than people think" for big tenants seeking large amounts of contiguous space.

"If you're a tenant looking for 150,000 square feet or more, you have literally a handful of options in new or to-be-built space where a top-of-the-line tenant would want to locate," he said.

But Taylor added that options abound for smaller tenants, especially with all of the sublease space on the market.

"There are terms on a lot of that sublease space that compete very favorably with the direct space that's left in new buildings," he explained. Taylor said the sublease space "is really dragging the market down and is making the landlords not only compete with each other, but with some of their own tenants."

Taylor said the market historically runs in cycles of three to seven years, indicating the current downturn has a few years remaining.

"We had almost a seven-year runup, and this downturn actually started in the second quarter of '89, so we're about two and a half years into a five- or six-year down-swing," he said. "I think we have two or three years to go in this cycle."