L.A. Office Market Will Be "Challenged" in 2021

The Los Angeles office market is headed for a prolonged office recovery. A new report from Marcus & Millichap forecasts that office vacancy will grown 160 basis points this year to 18.5%, and office rents will fall 1.4% to $37.50 per square foot.

However, the stars are aligning for recovery. Los Angeles has done well in its vaccine distribution efforts and COVID-19 restrictions are waning across the market. As a result, the market can start down the long road to recovery; however, the pandemic has damaged the market. Many tenants have paused any expansion plans, and for tenants that had lease negotiations, many reduced their foot print, according to the report. The first quarter leasing was improved compared to the previous quarter, but most lease agreements were 10,000 square feet or less, showing a trend favoring smaller spaces.

New construction is also putting downward pressure on the office market. 4.2 million square feet of new office space will deliver to the market this year, increasing the total office inventory by 1.1%. The number is on par with deliveries from the prior two years. More than half of the new construction projects are located in the South Bay and West L.A. areas, and many are large speculative builds. The report predicts that the latter will be challenging to lease up, thanks to increased availability and sublease supply.

However, the South Bay is already showing signs of outperformance. In the first quarter, the vacancy rate in the submarket actually declined with 311,000 square feet of absorption. Beyond Meat took a large portion, signing a 280,000-square-foot lease in El Segundo. L’Oreal absorbed the remaining 70,000 square feet, signing a lease at the same property in El Segundo.

While leasing activity will be slow to return to pre-pandemic levels, investment already has. The first quarter investment volume returned to mid-2019 levels and pricing increased 3% to $470 per square foot. However, the average cap rate increased to 10 basis points to 5.2%. Investors are targeting low-rise suburban properties, and returns were above average in San Gabriel Valley, South Bay and San Fernando Valley. Medical office was also a favorite. Sales were up 9% in the first quarter—thanks to the sector’s sub-10% vacancy rate and limited new construction—with sub-5% vacancy rate.

While specific markets are sure to see a slow office recovery, the national office market is showing improvement. The national VTS Office Demand Index posted significant gains in January and February and is now 38% lower than it was just before the pandemic. By comparison, it was 85% below pre-pandemic levels last May.