L.A.'s office overflow Spurs South Bay revival.

South of Century Boulevard near Los Angeles International airport, a giant sinkhole stretches all the way to Long Beach.

Though it doesn't exist geographically, the great catch basin has been around for nearly three decades--at least from the perspective of the Los Angeles County office market.

Office buildings in the South Bay area often don't attract interest until markets to the north, notably the Westside, overflow with tenants who face a lack of space and a rising tide of rents.

And that's exactly what's happening today.

"There's practically no new construction and lot of job growth," said Kevin Shannon, a vice chairman at CB Richard Ellis Group Inc. who specializes in the region. "The South Bay always begins to fill up when markets start to overflow."

Despite seeming lackluster in comparison to the county's glitzier regions, the South Bay is rapidly improving in its own right, attracting a wave of investment and giving the area's landlords far better returns than projected.

Today, about 18 percent of South Bay office buildings are vacant--still high compared to the county average of 11 percent, but not bad for the region, which has historically posted vacancy rates around 16 percent.

There are signs that it may heat Up even more.

Private investor Dr. David Lee, who made a fortune buying buildings in downtrodden Koreatown before a leasing boom, has snatched up more than $100 million in properties. Lee's company, Jamison Properties Inc., now owns more than one-third of the office buildings near the airport.

And Kilroy Realty Corp., one of the largest South Bay landlords, has a portfolio that's 98 percent leased and commands monthly rents well north of $2.50 a foot. A real estate investment trust, Kilroy has been a darling of Wall Street for the last several years as the firm consistently out-performed similar real estate companies nationwide.

Conan Cotrell, a Kilroy vice president in charge of leasing and marketing L.A. County properties, said the area has finally developed a diverse economy and the region is bound for a sustained recovery.

In the early 1990s, the South Bay was crippled following the end of the Cold War, which was followed by a rash of aerospace mergers and slashed military spending. Five years ago, the region was devastated when the Internet tech bubble burst, wiping out an economy that had come to depend largely on dot-com start-ups.

These days, while the South Bay economy " still contains large aerospace and defense industry stalwarts, it's also home to a growing number of entertainment, media and advertising firms. "The marketplace is far more diverse now," Cotrell said. "It's far more mature."

Perils remain

Still, not everything is going the South Bay's way. Seemingly every time the market begins to catch on, a large corporate merger or market correction knocks the wind from its sails. The most recent up-cycle hasn't been immune, and now it faces perhaps its most daunting challenge.

In August, oil giant Chevron Corp. paid $18 billion for El Segundo-based Unocal Corp., which may significantly decrease the firm's South Bay presence. And in November, Nissan Motor Co. Ltd. announced it's moving the company's Carson-based North American headquarters to a suburb of Nashville, Tenn. The move will dump 400,000 square feet on the market.

"Just about every time a good chunk of space is leased, some corporate merger ends up putting a large sublease on the market," Studley's David Kluth, who has represented South Bay tenants, wrote in an e-mail.

The added space could jack up the South Bay's vacancy rate--which in turn could put a lid on rising rents or, in the worst case, force landlords to offer up concessions along with slashing rates.

Growth spurt 

However, companies are moving into the South Bay and expanding with increasing frequency.

Teledyne Technologies Inc. is departing its long-time West L.A. locale for a 125,000-square-foot headquarters in El Segundo on Continental Boulevard--a building formerly occupied by defense industry giant Raytheon Co.

Northrop Grumman Corp. recently inked a $23 million deal for 192,000 square feet on Sixth Street in San Pedro. The company has been expanding its operations in other areas of the South Bay, too. Last June, Northrop leased 216,600 square feet on North Douglas Street in El Segundo.

"As those leases come up for renewal, the companies will most likely renew," said JC Casillas, a Grubb & Ellis Co. researcher. "And when they renew they'll sign much longer agreements."

With nearly 32 million square feet of office building space, the South Bay is nearly on par with downtown Los Angeles in size. Only the Westside--with nearly 42 million square feet--is larger.

As in previous cycles, when the Westside and other markets improved Significantly, the South Bay has begun gaining momentum. Over the past four quarters, the market's landlords have filled almost 1.1 million square feet of vacant office space.

That pace could quicken in coming quarters as most brokerage firms have predicted that the overall L.A. County office market will go through a prolonged period of tightening and rent spikes. As the county's markets fill up, the overflow is expected to first settle in areas at the north of the South Bay market, such as the airport's Century Boulevard and El Segundo, and then spread southward.

Meanwhile, as Long Beach buildings fill up and rents rise, tenants will begin to be pushed out and are expected to move further north into Carson and Torrance.

"We're always the last to recover," Casillas said, "but over the long haul, the market is positioned to capture growing tenants."

Betting big

Partly due to its sheer size--and also because its buildings are older and harder to adapt to new users--the South Bay has typically had higher vacancy rates and lower asking rents than the county average.

Even in the roaring real estate days of the 1980s, when the South Bay was filled with aerospace and defense firms thriving on Cold War military spending, the region still had a 16-percent vacancy rate.

Then, following a decade-long downturn after the collapse of the Soviet Union, the South Bay began to heat up as dot-com startups filled the area's office buildings, which had plenty of cheap space.

By the height of the frenzy, the area's vacancy in early 2000 slipped to a historically low 10 percent vacancy rate and rents climbed above $2 a foot. But when the tech bubble burst--and most of the Internet firms went bust--the South Bay's vacancy rates shot up to nearly 25 percent and rents plummeted as landlords scrambled to attract bargain-hunting tenants from outside markets.

This time it looks different.

The build up to a stronger market has been quicker and the length of the upside could potentially be much longer, Casillas said. "The dot-coms were all based on perceived growth. These new companies are established. It's real growth," he said.

Some office-building investors are banking heavily that the good times are just around the corner.

Companies such as Jamison are snapping up office properties in areas poised to feel the benefits of a sharp rebound first. And others like Kilroy and Thomas Properties Inc. have even suggested building South Bay projects before inking major tenants, a risky venture for even the most reliable of markets.

Kilroy Realty's 1 million-square-foot development near Long Beach Airport, the Kilroy Airport Center, has been one of the market's best performing properties in the last two years. Now the company is moving forward with the project's final phase, which would represent a 220,000-square-foot expansion.

"We're looking to start the fourth phase of the project," Kilroy's Cotrell said. "The last phase would probably be some sort of build to-suit deal or even done on a spec basis."

Earlier last year, Thomas Properties Group exercised an option to buy a 46-acre El Segundo site from Federal Express Corp., where the company already has clearance to a build a 2.2 million-square-foot mixed-use office campus. Thomas is offering the first 14 acres of the site to a developer or to a user for a build-to-suit campus. The parcel is being offered at $27.5 million and already there are several interested parties, according to a Colliers International market report on the South Bay.

The report states that Thomas is being extremely selective as to who the parcel goes to, as it will set the tone for their future development to be completed on the remainder of the site.

Rosy outlook

As for Jamison, the company spent $71 million on three office buildings in the Airport Center Complex, near LAX that contain 700,000 square feet. Along with Jamison's nearby Herbalife building, the firm controls 27 percent of the office space near LAX. In that regard, the LAX acquisitions follow a common pattern for Jamison. The company controls large segments of office space in downtown Los Angeles and along Wilshire Boulevard in Wilshire Center.

"It's easier to manage things that way," said Lee, Jamison's president, who said that strategy works in areas where there's scant competition to buy office buildings. "There's less competition for tenants that way."

And earlier this month, Jamison plunked down $34 million for a 230,800-square-foot Long Beach portfolio, which consisted of a nine-story downtown Long Beach office building and a Signal Hill business park. Lee believes an influx of housing and retail construction will make downtown Long Beach one of the South Bay's prized office markets.

"We like the long-term fundamentals of the Long Beach market," Lee said.