Rents on the Westside are climbing.  Landlords and their brokers have declared good times,  yet both CBRE and Newmark report vacancies at 12.7%for  the Westside and 15% for Los Angeles at the end of the first quarter.   Ten percent used to demarcate a landlord from tenant market.  Only once vacancies dipped below 10%–landlords declared good times.  The Westside’s occupancy has increased now for 4 straight years.   After the dot com bust in the early 2000’s, with only three years of rising occupancy, the Westside hit a peak of 93.6% occupancy and a low of a 6.4% vacancy. San Francisco has a vacancy rate of 5% at the end of the first quarter 2015.   In the 90’s,  Westside office vacancies dipped to 7%.  Only in the 1980s did vacancy not break below the magic 10% due to massive new construction.

So why are we so bullish with vacancies still over 10% The answer may involve the distribution of  vacancies.  Some areas of much hotter than areas.  For examples, rents in West Los Angeles are still under or near $3 per square foot while rents in Santa  Monica are over $4 per square foot. Creative office is now much hotter than conventional offices.   Industry Partners reports the vacancy for creative office at only 8.4%  Large blocks of space are much harder to come by than small spaces.  Offices with 4 per 1000 parking are much more dear than those with only 2 per 1000 parking in today’s world of 5 employees per 1000 square feet. .    As with the rest of the economy,  this expansion is not shared equally.

So far the answer is no; we have not had too much apartment construction.  Last year we hit 10,000 multifamily permits in the City of Los Angeles. It will take one to two years for this supply to come online. These units will not constitute a significant amount of historical supply. It has not reached the level of the mid 2000s, and it is nowhere near the levels reached during the mid 1980s.

Marcus and Millichap forecasts a 50 basis point increase in the LA County vacancy rate in 2015. They attribute this to the completion of 10,000 units representing a 0.9% increase in the stock. Therefore, Marcus forecasts an absorption of only 4,444 units. In 2014, vacancy declined 40 basis points although 9,300 units came on line. This decline indicates an absorption of 13,700 multifamily units in 2014. So it appears Marcus is forecasting a reduction in absorption in 2015.

The supply of new multifamily units is concentrated in Downtown Los Angeles, Hollywood, and Marina/Playa Vista.  These areas may experience some temporary rise in vacancy and competition.

The new supply can influence the severity of the downturn during a recession.  Multifamily rentals experienced a more significant downturn during the 1990 recession due to the large supply overhang of units built from 1984 to 1989.  Los Angeles rents fell from their peak in 1990 and did not recover until the end of the decade.   During the 1990s, there was little multifamily construction, and, as a result, apartments did not experience much in the way of rent reductions during the 2000 recession. A greater supply was built during the mid 2000s–although many units were probably for sale and not for rent. In any case, rents  fell by 10% to 20% during the 2009 recession.

We see many cranes and read many announcements of apartment projects. Unlike other times, owners intend to rent most of these multifamily units versus offering them for sale.  Even though the recent permit numbers do not indicate a supply above historical norms–many planned projects may turn into reality.  The first quarter 2015 permit results would imply a rate of over 13,000 units.  Successive years above 15,000 to 20,000 permits may indicate a supply reminiscent of the late 1980s when supply did impact rents negatively.  The above statistics can provide a context to current rental housing permitting, and some guide to supply levels which may influence the severity of another downturn.

On Tuesday, May 12, Jeffrey Palmer spoke on Bisnow’s Panel on Creative Office in Los Angeles.  Representatives of Bixby Land Company, Tishman, and Clarion Partners joined Jeff on the panel. These developers who joined Jeff on the panel not only build Creative Office buildings but also build and redevelop large scale creative office campuses.

Creative office is no longer the purview of just the small boutique developer.  Creative office is now mainstream.  The moderator for the event, Pete Roth of Allen Matkins, agreed with this sentiment and made the argument that creative office has gone global.

Pete Roth posed the question to the panel about opportunities for others to take advantage of the creative synergy that now exists in Playa Vista after many major creative company behemoths have moved there like Google, Yahoo, Sony Playstation, Verizon, and 72 and Sunny.  The large developers argued that the opportunities have now passed because the large tracts of land in Playa Vista are gone.  However, Jeffrey Palmer disagreed.  Jeff now predicts a wave of smaller developers coming to Playa Vista to redevelop the retail and industrial properties in and around the area.  Jeff also distinguishes creative offices, which describe an aesthetic, from collaborative team based offices, which describe office layouts and furniture.

Clarion Partners hired Gensler to redesign and re-brand a conventional 300,000 square foot Playa Vista office building into a creative office campus.  Gensler successful accomplished this feat by adding an exterior stairway, painted designs, and roll up doors on the ground floor.  The most successful feature of all included using the grounds to create an interesting “boutique hotel rooftop” like outdoor space for creative workers with fire pits, work bars, and conversational seating.

New Outdoor Furniture and Landscaping at I/O Playa Vista

Tishman is building a 300,000 square foot creative office park in Playa Vista from the ground up.  The campus will include over 15 different outdoor furnished spaces.  The new buildings will resemble modern versions of a bow truss warehouse.

Under Construction Playa Vista Office Building designed to resemble a bow truss warehouse.

You can read more about the conference below.

Why Price Doesn’t Matter for Creative Office | Bisnow

Jeffrey Partner, a partner and Chief Space Technology Officer at PMI, will participate on a panel this Wednesday at Bisnow’s The Office Revolution at 8:00 am May 12, 2015 in Playa Vista. To register go to www.bisnow.com 

The panel, which also includes representatives from Tishman, Hulu, Riot Games, Clarion Partners–will discuss what creative tenants are looking for in office space today.  We will get into trends in the workplace in these areas and what owners are doing to attract these tenants.

A preview of the speakers is included in the article below:

How LA’s Top Developers Attract Tenants Like Yahoo and Facebook – Other.

he divergent case: each new outcome is successively further from the intersection of supply and demand

The San Francisco office market may face a very extreme downturn during the next recession, especially one which involves a sharp reduction in startup valuations and funding.  The San Francisco office market is now dominated by technology companies and does not have the same diversity of tenants as other office markets. Colliers reports that tech firms represent 55% of San Francisco’s office leasing activity. The demand from tech tenants for space swings wildly with credit cycles.  Further, developers have plans for a level of new office construction not seen in decades.  This volatile demand combined with a lag in supply is similar to the hog or cobweb cycle.

In the cobweb or hog cycle, when prices are high, more investments are made in hog breeding. Their effect, however, is delayed due to the breeding time.  It takes three  to four years to breed hogs.  Nobody realizes how many hogs are being produced. Then the market becomes saturated   At the same time, demand shifts downward due to external economic events (like recessions). Prices plunge.  Production is reduced  but not immediately due to the hogs in the pipeline.  Finally, after several years, hogs production percipitously declines.  Just as demand and supply reach a new equilibrium at lower prices, demand shifts again upward due to external economic cyclical events.  Demand surges and prices spike.This procedure repeats itself cyclically. The resulting supply-demand graph resembles a cobweb. A permanent equilibrium is never reached.  Instead, prices swing wildly.

Does this describe the San Francisco office market?

San Francisco has averaged absorption of approximately 400,000 square feet per year over the last 24 years and 627,000 square feet per year over the last ten years.  During the dot com boom, absorption clocked in at 1 million square feet in 1999 and 1,258,000 square feet in 2000.  Occupancies reached 97% in 1999, and class A rents reached $78 per square foot.   Developers responded with  2.5 million square feet under construction in 2000 and 2.8 million square feet in 2001. However, in 2001 just as this supply was coming online,  absorption declined to a -6.9 million square feet.  The absorption declined again in 2002 by a negative1.2 million square feet.  Occupancies declined to 77% in 2002 (over 40% vacancy in SOMA), and class A rents fell to $28 by 2003.

Between 2004 to 2007, the market staged a comeback with average annual absorption of 1.4 million square feet.  Developers constructed only 375,000 square feet between 2003 and 2005.  This lack of supply resulted in occupancies climbing to 89% in 2007, and class A rents climbing to $48 per square foot.  Developers had 1.3 million under construction in 2006 and 1.7 million in 2007.

Alas, during the recessions  in 2009 and 2010, absorption fell to -1 million and -700,000, respectively.  Class A occupancies fell to 83% in 2010, and class A rents fell to $33 in 2009.  Between 2008 and 2012–office footage under construction fell to an average of   197,000 square feet.

A recovery started in 2011, and absorption has averaged a remarkable 1.7 million square feet between 2011 and 2014.  Occupancies rose to close to 96% at the end of 2014, and class A rents reached $65 per square foot.

The Volatile San Francisco Office Market

Yet,office space under construction has averaged 3.2 million square feet over the last two years. In their first quarter 2015 report, Colliers claims over 5 million square feet of new office space is under construction and another 10.8  million is in planning.  Socksite claims that San Francisco has the largest pipeline in 30 years.  So far, very little of this new supply has  been completed: see: http://www.socketsite.com/archives/2014/12/san-franciscos-largest-office-space-pipeline-30-years.html.  The low occupancies and increasing rents are encouraging developers to construct office space far in excess of the historical averages.

In the next downtown–given the nature of venture funding–absorption could turn significantly negative just as the tsunami of new supply hits the  market, just like the classic hog cycle.  Much of tech demand comes from start ups who are highly dependent on new funds for their survival: see http://www.globalupside.com/silicon-valley-vaporization-are-startups-burning-too-much-cash/.  If funding freezes up as it did in the last two recessions, many of these companies, as Marc Andreessen says, will vaporize:  http://www.businessinsider.com/marc-andreessen-on-startup-burn-rates-worry-2014-9 .

Maybe this time is different.

During the dotcom boom, many tech firms leased space they did not need and quickly abandoned during the bust. This time around, tech firms are only leasing what they need.  However, San Francisco developers have produced and plan to produce a much larger supply of new office space  than that supplied during the dot com boom.  Further, during the dotcom boom, tech firms gave landlords mega letter of credits as security–from 12 to 24 months  Today, tech firms are loath to give more than 6 months security.

Some would argue that the demand has permanently shifted as more businesses move back into the City to follow their employees lifestyle. San Francisco and technology are ground zero for this movement.   In the long run and over the next fifteen years, this argument will be true. San Francisco  will continue to prosper.  However,  a good part of what is happening in the short run can be just a classic hog cycle, a cobweb.  One must be prepared for extreme volatility.

PMI Expands Its Echo Park Portfolio Again!

251 Rosement Exterior

We are pleased to announce our acquisition of 251 North Rosemont Ave, a ten unit apartment building in the new Echo Park neighborhood of Los Angeles. The purchase price was $1,575,000 with a GRM of 14.55.

Just south of Temple Street and the 101 Freeway, the defacto boundaries of Echo Park have expanded as new retail, upgraded housing, and millennials in the creative industries push into the adjacent neighborhoods. We are actively expanding our portfolio to include properties in these neighborhoods, providing modern creative housing unlike anything else in these locations.

We intend to reinvent and extensively renovate this stereotypical 1929 building into a contemporary modern complex to fit the taste of the Creatives moving into and near Echo Park.  We will fix some of the building’s shortcomings, starting by constructing brand new interiors. On the outside, we will maintain and enhance the original property’s character while including a twist of hip.

251 N Rosemont is PMI’s 21st acquisition in Northeast Los Angeles.