Latest conversion plans take more space off submarket.

DOWNTOWN'S office vacancy remained historically low in the first quarter, putting added pressure on asking rates that were already on the rise.

"Vacancy is 15 percent, which has not been the case since the 1980s," said J.C. Casillas, regional research services manager for Grubb & Ellis Co.

Downtown's vacancy dipped under 20 percent in late 2002 and has been on the decline since. It closed 2005 at 14.9 percent with net absorption of 28,202 square feet, according to figures from Grubb & Ellis.

That boosted the average asking rate considerably. Class A space was offered at $2.83 per square foot and Class B at $2.06. That's an increase from the previous quarter of 13 and 7-cents, respectively. Rates for top-tier buildings have increased 42 cents since the first quarter of 2003, and Class B rents are above $2 for the first time since the 1980s.

Some of the overall vacancy drop is attributable to the large number of office-to-residential conversions that began last year.

In the latest in a run of conversions, the owners of the Aon Center at 707 Wilshire Boulevard plan to turn the top 10 floors of the 62-story office building into residential. "That's 160,000 square feet of prime office space gone in one fell swoop," says Chris Runyen, senior managing director of Charles Dunn Co. Inc.

The conversion didn't dampen leasing in the building. Aon renewed its 113,000-square-foot space there, and Transwestern Commercial Services expanded from 4,000 square feet to 8,000 square feet in a five-year deal.

In another conversion, developer Barry Shy bought Spring Street Plaza, an 800,000-square-foot, three-building property for $75 million from L & R Investment Co. He plans to redevelop the site, which is comprised of two office buildings and one manufacturing facility, into 1,000 housing units and 60,000 square feet of retail space.

With a number of under-performing buildings flipped to residential, the rush may be nearing its end. The structures with the best infrastructure, location and fundamentals have mostly been snapped up. Plus, key economic factors are changing.

"With interest rates rising and construction costs going up, it's the wrong time to think about major construction," Runyen said. "In fact, I think we're seeing the last of the conversion deals taking place right now."

Still, the conversions will have a lasting impact on the downtown office market.

"The workforce could grow even more as the inevitable happens and people who bought condos as investments want to rent them out," said Mark Robinson, corporate managing director for Studley. "With so much residential development, there are enough reasons for people to start taking downtown seriously. As a result, some firms are taking hard looks at downtown because it has more space, less cost and better proximity to the workforce."

Higher rents

Conversions are only one factor in the rental increases. Debt service is prompting many new landlords to jack up rents in an attempt to recoup the high purchase prices they paid, Grubb & Ellis' Casillas noted. "Each sale brings higher investor expectations and prices that are passed on to the tenant. It's the same for Class B."

Another factor is the tight surrounding markets. Low vacancies in nearby cities are causing tenants to look elsewhere when searching for large blocks of space or lowering operating budgets. Some downtown building owners upped asking rates hoping to cash in on a hoped-for in-migration.

But Clay Hammerstein, executive vice president of CB Richard Ellis, says there's no evidence that's happening yet. "Many experts thought that Downtown would benefit as the surrounding submarkets continued to tighten." But despite single-digit vacancy rates along the Wilshire Corridor, in Tri-Cities and on the Westside, he notes: "We are not seeing explosive growth in the tenant base downtown."

Stronger lease velocity

This year started with a bang.

"First quarter leasing activity is higher than the fourth quarter last year, which was higher the first quarter of 2005," said Scot McBeath, president of Scot McBeath Realty. "The trend is up and reflects a continuing increase in business confidence."

Law firms were a big driver. Forgey & Hurrell LLP will relocate next year to 15,764 square feet at 660 S. Figueroa Street in a four-year sublease from Law Firm Manning & Marder Kass Ellrod Ramirez LLP. Attorneys Lightfoot Vandevelde Sadowsky & Levine LLP relocated from 655 S. Hope St. to 800 Wilshire Blvd. in a 12-year, 10,150-square-foot deal worth $4.4 million.

Law firm Mayer Brown Rowe & Maw renewed its 77,282-square-foot space at California Plaza (350 S. Grand Ave.). The firm has rented in the building, which is 94 percent leased, since 1992. Also renewing, attorneys Sidley Austin LLP signed a 185,726-square-foot lease amendment at the Gas Co. Tower (555 W. Fifth St.). The deal extends the firm's lease through 2023 and increases its square footage by approximately 27,780 square feet.

Major Events:

* Developer Barry Shy bought Spring Street Plaza for $75 million from L & R Investment Co.

* Alliance Commercial Partners purchased the Pacific Center for about $65 million from Holualoa Cos.

* Law firm Mayer Brown Rowe & Maw renewed its 77,282-square-foot space at California Plaza.

* City National will expand its lease at City National Plaza by 75,000 square feet.

* The law firm Sidley Austin LLP signed a 185,726-square-foot lease amendment at Gas Co. Tower.