Q2 2015 San Fernando Valley Office and Industrial Market Report

Office Market Recovery Strengthens for Leasing as Sale Prices Near Pre-Recession Levels

If the numbers for the second quarter are any indication, the Los Angeles office market recovery appears to be right on schedule. Fundamentals improved across the board in the quarter, and just as important, the data shows a consistent upward trend unbroken over more than four quarters.

Vacancies fell to 13.9 percent versus an adjusted 14.1 percent in the prior quarter and a 90 basis point (bps) improvement from the year ago period. The current quarter marks the first time vacancies, which have trended downward consistently since 2010, fell below 14 percent since Q4 2008.

On a net basis, 193,000 sf of space was leased in the quarter, a 135 percent improvement over the Q1 when 82,226 sf of office space was leased on a net basis.

Strong leasing activity is driving these improvements. In Q2, 1,238,378 sf of office space was leased, up from 976,350 sf of leasing in Q1 and bringing leasing volume for the first half of the year to 2,214,728 sf. With the exception of the first quarter of 2015 and the fourth quarter of 2014, leasing activity has exceeded 1 million sf in every quarter since Q1 2012.

As might be expected, the strong fundamentals have driven up lease rates, which in the current quarter rose by $0.03 to $2.28 per sf vs. $2.25 per sf in Q1.

Sales activity has been equally strong, and the median price of office buildings sold to date in 2015 reached $244 per sf, the highest since 2008 when the median price was $256 per sf.

There were 22 office building sales in Q2 achieving a median sale price of $235 per sf, somewhat less than the $245 per sf sale price in Q1 but an increase of 30 percent over the year-ago period when the median price of buildings sold was $181 per sf.

More office square footage is under construction than at any time in recent memory, thanks largely to 285,000 square feet of office space that has come out of the ground at The Village at Westfield Topanga and a 118,000-square-foot medical office building underway in Tarzana.

Industrial Lease Rates Now Just $0.04 PSF Off Pre- Recession Highs as Market Remains Exceedingly Tight

Lease rates continued to climb in the sec­ond quarter amidst strong leasing activity and exceedingly low vacancy rates.

The average asking lease rate for industrial properties rose another penny to $0.70 per square foot compared to Q1 and $0.06 per square foot compared to the year-ago pe­riod. Average lease rates are now as high as the market has seen since Q4 2008 and just $0.04 off the pre-recession high of $0.74 reached in Q3 2007.

The upswing in lease rates is no surprise considering that we have now seen sub- 3 percent vacancy levels for the past five quarters. In the current quarter, the vacancy rate measured 2.4 percent, 10 basis points (bps) above the 2.3 percent vacancy rate in Q1 and 50 bps below vacancy levels in the year-ago period. The slight uptick in no way indicates a change in the headwinds for the industrial sector as evidenced by continued strong leasing activity.

For the current quarter, 1,377,822 square feet of industrial space was leased in the region, 330,000 square feet more than the prior quarter. While the current level of leas­ing activity is below the 1,837,454 square feet leased in the year-ago period, the de­cline is understandably attributable to the sheer scarcity of available space.

Admittedly, absorption fell off in the quarter, but as with leasing activity, absorption can be expected to slow as the market tightens.

A total of 95 industrial building sales took place in the first half of the year, just 11 fewer sales than occurred in all of 2014. With the second half of the year traditionally seeing the larger portion of annual sales ac­tivity, this year promises to set a record for industrial sales in the region.

Median sale prices are already hitting new highs. The median price of buildings sold in Q2 was $142 per square foot, a dollar per square foot off the median in Q1 and an increase of 19 percent over the year-ago period.

The last time the median sale price ex­ceeded $140 was 2009 and only six sales were transacted at that time. Institutional investors continued to show interest in the submarket: Prologis acquired two buildings in the quarter.

Q2 2014 Office and Industrial Report San Fernando Valley

A Surge in Leasing Activity and Marked Improvement in Employment Drives Vacancies Down and Lease Rates Up

Another surge of leasing activity and marked improvement in employment levels drove office vacancy rates down to 15.5 percent in the second quarter compared to 15.8 percent in the prior period. Vacancy has improved by 150 basis points (bps) compared to the year-ago period.

There were 1,355,898 square feet leased in the quarter, up nearly 20 percent over the prior quarter although 365,762 square feet less than the space leased in the year-ago period. Velocity declined 18 percent from the first half of 2013 as well. A total of 2,492,863 square feet was leased in the first half of 2014 versus 3,039,301 square feet leased in the first half of 2013.

But the modest slowdown comes as lease rates show increasing strength. The average lease rate in Q2 was $2.27 per square foot, up $0.03 per square foot from the prior quarter and $0.05 per square foot compared to the year-ago period. Indeed, much of the pressure landlords were feeling to lease their buildings last year has subsided, and the average asking rate in the current quarter is the highest we have seen in the market since the fourth quarter of 2010.

It should be noted however, that average asking rates are still16.5 percent off their highs of $2.72 per square foot in Q2 2008

Absorption has been positive for the past four quarters with another 210,100 square feet absorbed on a net basis in Q2. This follows a Q1 absorption rate of just 59,131 square feet and a significant improvement from the year ago period when 179,715 fewer square feet were leased than were vacated.

Median sale prices for office buildings have been trending upward for the past three quarters and registered $196 per square foot in Q2 with a total of 10 buildings sold. Including distressed sales and those for which no sale price was reported, the median price was $230 per square foot with a total of 12 building sales.

Year to date the median price of buildings sold in the region was $190 per square foot. There were 22 office buildings sold in the period. Prices have risen 6 percent compared to 2013 when the median price of buildings sold was $179 per square foot.

 Industrial Vacancies Continue to Fall and Sales Momentum Builds

 Vacancy levels in the Los Angeles North in­dustrial market fell even further and the steady pace of absorption continued in the second quarter.

Vacancies declined to 3.4 percent in the quarter, down 20 basis points (bps) from the prior period and 110 bps compared to the year-ago period. Nine of the area’s 13 sub­markets are now showing vacancy levels be­low 3 percent leaving few options for tenants looking for industrial space.

Absorption has been very strong, and in Q2 2014 354,300 square feet was leased on a net basis. By comparison, 423,752 fewer square feet were leased than were vacated in the second quarter of 2013. For the year to date, 1,034,000 square feet of space was absorbed versus 233,723 square feet of ab­sorption in the first half of 2013.

With the steady pace of improvement, land­lords are beginning to increase rents. After more than two years with little change in lease rates, the average rate rose by $0.02 per square foot compared to the prior three quarters to $0.64 per square foot and by $0.03 per square foot versus the year ago period. The last time average lease rates were $0.64 was the third quarter of 2009.

While rock-bottom vacancy levels and expec­tations that lease rates will continue to rise are fueling investment activity, the shortage of suitable buildings is spurring more busi­ness owners to opt for purchasing rather than leasing their space. In the year-to-date period 42 industrial buildings were sold at a median price of $128 per square foot, an in­crease of 17 percent in the price of buildings sold compared to 2013. Sale prices have risen 28 percent over the past two years.

For the most recent quarter, 19 buildings were sold at a median price of $120 per square foot. Including distressed properties and those for which no sale price was report­ed, 25 buildings were sold at a median price of $119.

Much has been written recently about the constrained supply for industrial buildings, and nowhere is that more true than in the Los Angeles North market. The conversion of much of the area’s manufacturing real estate to multifamily or retail space and scarcity of raw land has left few opportunities for the development of new inventory, and a mere 59,000 square feet of new industrial con­struction is currently underway.