Survey Sorts Out Myth, Reality of Office Markets By SHELLY GARCIA Senior Reporter A just released study of real estate trends suggests that while the broader economy has begun to see signs of an uptick, the market for office space is not likely to experience a strong recovery anytime soon. The survey, by Grubb & Ellis and PNC Real Estate Finance, examined office market trends nationally, but with few exceptions, the conclusions are equally applicable to the greater San Fernando Valley market as well, say the authors and local brokers. And even though the local market has, in many ways, fared better than a number of cities around the country, the general outlook is not much different for the Valley than it is for other parts of the city and country. “In some markets the vacancy rate may have a little further to fall,” said Robert Bach, national director for market analysis at Grubb & Ellis. “Other markets will see a bit of a recovery, and I would count L.A. in that. But it’s not going to be a robust economy. It’s not really going to feel that good.” The survey, which attempted to make sense of the many, often conflicting economic signals that have made headlines in recent months, identified some of the commonly held beliefs about the current office real estate market and sought to determine whether they were myth or reality. The survey revealed that, contrary to much of the current thinking among brokers: – Rental rates have not hit bottom, and will continue to fall further, albeit at a slower pace, perhaps for a number of years to come. – Tenants are not signing on for longer lease terms in order to take advantage of lower rates, but rather are continuing to make shorter term decisions until they see significant improvements in the economy. – There has been no measurable migration of Class B tenants to Class A space as happened during the last recession when rents came down. Although the survey conclusions supported several positive signs brokers often point to an economic recovery is underway as is a pickup in real estate activity it did so with caveats. For instance, the survey authors said that while real estate activity has picked up, it is chiefly characterized by more meetings and phone calls, not new leasing activity. That, say local brokers, is equally true in the Valley. “The large deals aren’t really happening,” said Trevor Belden, a partner with Lee & Associates North Los Angeles, who focuses most of his activity on the east Valley office market. “There’s the monster deal that happened in Burbank, but other than that, we haven’t seen any 5,000 or 10,000 square foot tenants running through the market. And we haven’t seen it for 18 months.” Grubb & Ellis statistics put the vacancy rate for the Valley overall at 12.8 percent as of the third quarter ended Sept. 30. The West Valley saw the highest rates, 14.5 percent for the quarter, according to Grubb & Ellis statistics. But when sublease space is factored in, the rates are much higher. According to a just-issued report by Studley, another brokerage company, overall vacancies in the Valley reached 15.8 percent in the third quarter, with Burbank registering the highest rates at 26.2 percent Lagging indicator The problem is that although most signs point to an economic recovery underway, office real estate is a lagging indicator. Not until the recovery begins to generate considerable job growth will tenants return to the leasing market for more space. That lack of activity will continue to exert downward pressure on rental rates, the survey concludes. “I don’t think we’ll see a real increase in rental rates on a national basis for years,” said Bach. Bach reasons that rents won’t start to rise again until the market hits what economists call “equilibrium,” at 10 percent. During the last recession, Bach said, vacancy rates declined an average of one percent a year. Even if this recovery is more robust, and rates decline by 2 percent a year, it will be several years before that point of equilibrium is reached. Brokers point out that landlords have initiated a number of tactics that amount to rent decreases without actually lowering their rental rates. For example, many property owners now offer several months of free rent or “beneficial occupancy,” which means the tenant moves in but doesn’t start paying rent for several months or more. Lee’s Belden disagrees, in part, he said, because dropping rental rates can hurt landlords who are attempting to refinance. But he concedes that some of the larger, publicly held landlords, may well be keeping asking rates stable while dropping effective rents. “What happens is the REITs and pension funds typically have to show a higher rental rate for their shareholders and for Wall Street, but they don’t actually have to show what types of lease rates they’re plugging deals at,” Belden said. Cautious companies One thing is certain: “With very few exceptions, rents are not increasing,” said Paul Stockwell, managing director at Studley. “Rent increases when the demand is starting to outstrip the supply, and that isn’t happening yet.” Most companies in the current recession are moving or expanding only because they absolutely have to, not because they want to take advantage of lucrative lease deals. According to Bach, a fiscally conservative attitude on the part of managers has resulted both in more sublease space and less interest in upgrading office space. During the last recession, many companies held onto space as they downsized and a number of companies moved to more prestigious addresses because they could do so at rents that weren’t much higher than those they were paying for Class B properties. But this time around, many companies unloaded additional space as soon as it became available, and others are staying put no matter the deals out there. “Companies are much more conscious of their bottom line these days and are not willing to trade status for cash flow,” said Bach. “That’s kind of a change in corporate America in all facets of their business.”