Office market struggling while industrial space booms.

DESPITE the South Bay's historically underwhelming office market, it's a different tale for the region's industrial market. The area's proximity to thriving ports is fueling sizzling demand for warehouses and manufacturing facilities.

Boosted by increasing freight traffic at the Los Angeles and Long Beach ports and cargo at Los Angeles International Airport, the South Bay's industrial properties are jam-packed and command some of the county's highest rents.

The juxtaposition of the South Bay's still struggling office market with its red-hot demand for industrial space couldn't be more stark. While office landlords are offering concessions to attract and retain tenants, industrial building owners are raising rents.

"Demand is off the charts," said Jeffrey S. Morgan, a senior vice president with CB Richard Ellis Group Inc. who has specialized in the South Bay industrial market for more than 25 years.

The industrial vacancy rate in South Bay stood at 2.5 percent, down from 2.8 percent in the fourth-quarter of 2005 and unchanged from a year ago, according to data from Grubb & Ellis Co. Meanwhile, asking rents in the region have jumped to 65 cents from 53 cents a square foot in the last 12 months. The region's average vacancy rate is near the county average and rents are significantly higher.

As for the office market, vacancy rates at the end of March had shrunk significantly to an average of 16.1 percent but were still high compared to the L.A. County office average of 11 percent vacancy rate. South Bay office rents, hovering at $2 a foot, were fiat--and nearly 63 cents below the county average.

So why the disconnect? Unlike some industrial markets across the state and country, the South Bay industrial market is heavily dependent on freight forwarders and handlers. Those types of operations don't spur a large amount of office leasing.

"This isn't like Silicon Valley, where a company might have their offices and a nearby production facility or warehouse," Morgan said. "Out industrial market operates completely independently of the office and commercial markets."

While the port complex and operations at Los Angeles International Airport fuel demand for warehouses and serve as a vital economic engine for the entire region, neither center has an impact on the office market in the same way it does with industrial properties.

But with the total number of containers entering the ports of L.A. and Long Beach through the first two months of this year exceeding last year by 2 percent, tenants are taking even more vacant office space off the market.

During the three-month period ending March 31, available space in the South Bay industrial market shrunk by about 2.2 million square feet--a 17 percent reduction.

"Increase in traffic through the ports is filling up all the warehouse space to near capacity," Morgan said.

Hurdles remain

Still, the industrial market could face some serious setbacks.

It's unclear whether Boeing Co. will continue producing C-17 cargo jets at its Long Beach facility--since federal funding for the program has been halted. There's also the possibility that one day the federal government could move or eliminate the Los Angeles Air Force Base in El Segundo.

An end to either program would have serious ramifications on both the industrial and commercial office markets.

Even so, one key reason that Los Angeles Air Force Base may continue to avoid being included on the Pentagon's base closure list is due to a complex deal that has completed new offices for the military and will result in homes for the South Bay.

Developers have finished a $115-million office complex and day care center at the El Segundo military facility: in exchange, the developers get 59 acres of base land and other parcels on which more than 900 condominiums will eventually be built.

When the offices were completed earlier this year by partners Catellus Development Corp., Kearney Real Estate Co. and Morgan Stanley, the Air Force moved its Space and Missile Systems Center to the new facility. The original base offices, built in the 1950s, will be razed to make way for condos.

Developers also have been busy tearing down obsolete warehouse and building modern facilities, which are increasingly including a substantial portion of office space. However, that office space will never be available for lease and therefore won't affect the region's office market. The new facilities are being snapped up quickly by owner-user firms looking to buy their facilities to take advantage of tax and other benefits.

"This market is unprecedented," said David A. Drummond, a senior vice president at Colliers International, who's been working in the South Bay for 35 years. "It's the most active, highly competitive market that I have ever witnessed."