L.A. Market Report

Hard Hit by Health Crisis, Los Angeles County Enters Transitional Period for Commercial Real Estate; Attractiveness of Suburban Investment Grows

Span of strong commercial performance interrupted by wave of job losses. Shelter-in-place orders and nonessential business closures that extended through the second quarter had a profound impact on Los Angeles County’s economy and commercial real estate sectors. During the three-month window, nearly 470,000 jobs were lost in the metro, raising the local unemployment rate to a national high of 19.4 percent in June. The leisure and hospitality, and retail trade sectors were hardest hit during this span, accounting for nearly half of the slashed positions. The number of traditional office jobs in the county also plummeted by nearly 120,000 in the second quarter. Together, the combination of prolonged stay-at-home mandates and widespread layoffs disrupted demand across property types, reversing recent vacancy and rent trends while also creating uncertainty surrounding the metro’s sizable construction pipeline.

Development pipeline gauges demand across all sectors. The initial months of the health crisis coincided with an influx of new apartments as quarterly delivery volume reached a 20-year high. In other real estate segments, supply additions were historically below average on a quarterly basis, with retail and office deliveries sparse and industrial completions totaling less than 1 million square feet. This lull in development, however, is temporary and potentially the result of nonessential construction shutdowns recorded at the onset of the pandemic. Entering the second half of 2020, construction was underway on approximately 15 million square feet of retail, industrial or office space, with at least 19,000 rentals being built.

Quarterly vacancy fluctuations blur some sectors’ outlooks. Vacancy rose across all Los Angeles’ primary real estate segments on a quarterly basis. The retail sector recorded the least fluctuation; however, the impacts of indoor dining bans, store closures and shifting consumer behavior were yet to be fully realized during the second quarter. The metro’s industrial market remains the nation’s tightest among major markets, buoyed by dual ports and a sizable population. In contrast, the apartment and office sectors are in a state of transition. An influx of new rentals and temporary office closures combined with widespread job losses translated to vacancies in both segments rising above the U.S. average. As apartment deliveries continue and office tenants reevaluate their long-term space needs, demand will be further tested in both sectors.

Suburban investment supports deal flow. Economic volatility and the inability to physically tour properties motivated some investors to take a wait-and-see approach during the second quarter. As a result, sales activity across the metro’s primary commercial real estate sectors slowed, with multifamily assets accounting for roughly half the transactions closed. Warehouse and medical office-related trades also supported deal flow, driven by investor demand for suburban properties. While more investors gain clarity on property performance and pricing in the second half, proposed statewide changes to commercial property assessments and apartment owners’ abilities to raise rents may cause investors to pause until the outcomes of Propositions 15 and 21 are determined in November.

OFFICE

Tenants Reevaluate Future Office Needs, Lifting Vacancy; Medical Office Sales Account for Larger Slice of Deal Flow

After completing 2.1 million square feet of office space during the previous nine months, developers finalized less than 100,000 square feet in the second quarter.

The metro’s vacant stock rose by 3.8 million square feet in the second quarter, lifting vacancy 100 basis points to a three-year high of 14.1 percent. In both Westside Cities and Greater Downtown Los Angeles, the volume of available space increased by more than 1 million square feet during the three-month window.

Despite a sharp quarterly increase in vacancy, the county’s average asking rent adjusted minimally, inching up to $40.14 per square foot in June. A 1.0 percent uptick in the Class B/C marketed rate drove the slight improvement in overall asking rent.

Average asset values in the office sector rose 3 percent to $458 per square foot over the past year ending in June. During the same 12-month span, the average cap rate climbed 10 basis points to 5.3 percent. Since 2018, the metro’s average return has hovered in the low-5 percent range.

Transactions involving low-rise medical office properties drove sales velocity from April to June, with deals most frequently closed in the San Gabriel Valley and Tri-Cities/San Fernando Valley region.

INDUSTRIAL

Los Angeles Remains Nation’s Tightest Industrial Market; Close-In

Suburbs Attract Buyers

Following the finalization of nearly 2.6 million square feet of space in the first quarter of 2020, developers completed an additional 826,000 square feet from April to June. Deliveries were centered in the Santa Clarita and San Gabriel valleys.

The county’s vacant stock increased by nearly 8.4 million square feet from January to June, lifting vacancy 110 basis points to 3.4 percent.

The average asking rent fell 2.7 percent during the second quarter, reaching $12.48 per square foot in June. In contrast to most submarkets, the average marketed rate in Santa Clarita Valley rose 2.5 percent, driven by recent supply additions.

The average pricing in the metro rose 5.3 percent to $280 per square foot over the past 12 months ending in June, with most second quarter transactions closing below this asset value threshold. The average cap rate climbed 30 basis points to 5.3 percent during the past year.

Buyer demand for closer-in suburban properties near major freeways supported overall sales activity during the second quarter. Deal flow was strongest in the San Fernando and San Gabriel valleys, where trades involving sub-20,000-square-foot warehouses translated to a compilation of $1 million to $5 million transactions.