2014 NAIOP Commercial Real Estate Roundtable
The Los Angeles Business Journal invited NAIOP to assemble a roundtable of some of the most knowledgeable experts in the field of commercial real estate in Southern California. The roundtable included Cox, Castle & Nicholson Partner, David Wensley.
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How would you describe the office market in SoCal today?
Wensley: It is mixed, dependent on location (Downtown LA - West Side - Orange County), product type (Class A high rise – midrise – low rise) and product quality. Class A office in West LA and Orange County, for example, has very low vacancy with the Irvine Company, the dominant landlord in the OC high rise office market, reporting as low as 6% vacancy in their Orange County office portfolio, with two new class A office towers under construction in Fashion Island and one new Class A office tower planned for the Irvine Spectrum area of Orange County. In contrast, downtown Los Angeles is reported to have Class A office vacancy as high 18%, with some very prominent Class A high rise towers in downtown Los Angeles enduring vacancies as high as 30% or more. There has been an influx of some technology industries into the West Los Angeles market and retention of some traditional urban high rise office tenant users (law firms, financial services, etc.), but some offset to absorption due to flight of some companies from the market and California, such as Occidental Petroleum’s recently announced move from Los Angeles to Houston.
Can you comment on how the office space is changing in SoCal? What are tenants seeking today in terms of space? Layout? How are they accommodating/planning for employee attraction and retention? How is the trend toward creative space impacting decisions and growth?
Wensley: The footprint per person is definitely shrinking as companies seek to maximize efficiency and collaboration in the workplace. The trend has dramatically transitioned from “downsizing” as principally a cost-saving agenda due to the recession of 2007/08-2012, to a more focused “right sizing” agenda – blending technology with smaller personal space per employee, more collaborative and community space and higher levels of amenities for all. Many companies are implementing open-floor plans and furniture systems in lieu of private offices, even for executives. Companies are also focused on reducing paper production and storage; i.e., striving to be more “green” and “paper-less” which allows for reduced floor area devoted to filing and document storage. To address the perceived loss of personal space and/or personal privacy in the workplace in terms of employee attraction and retention, many companies are devoting a far greater percentage of their overall office space to private conference rooms, smaller “chat rooms,” collaborative work spaces, expanded kitchen and dining facilities which encourage more “lingering” and workplace interaction and collaboration. This is being supplemented with upgraded technology such as video conferencing, interactive phone systems and inter-office interface and other technological advances which allow for more open-floor work layouts and more working from outside the traditional confines of a dedicated office, such as from home, from conference rooms within the company space or from community space provided by the building landlord in the building interior and exterior common-area spaces. As landlords adapt to more “creative” office designs, which depart from traditional hard wall-window line offices, companies are allowed more flexibility in design, which allows for more adaptation to growth (i.e., less investment in fixed-wall configurations that do not allow for low-cost alterations to address growth needs). One adverse impact of the overall downsizing of space per employee is an increase in overall density of occupancy which strains available parking and building services such as elevators and power.
What other issues, such as technology and cost for example, are most impacting tenant decisions, and in what way?
Wensley: Lower fixed-wall window line space requirements and higher technology implementation result in traditional tenant improvement allowance funds from landlords being shifted to furniture, fixtures and equipment (including technology), which often results in less retained value in the leased space upon expiration of the lease term and tenant departure. Landlords are being forced to balance their investment in tenant space and potential reusability (or lack thereof) for less traditional tenant improvement configurations; however, as the trend continues and the demand for hard wall window line private office space reduces, creative space configurations will become more accepted in both the tenant user community and the landlord pool.
Are tenants trending toward longer or shorter renewals? What is impacting some of these decisions? Is there any difference for office or industrial tenants?
Wensley: The trend in the past two years has been a return to normalcy. From 2008-2012 there was a trend on both the tenant user side and the landlord side of the equation towards shorter renewal terms – tenants being uncertain as to the future and therefore unwilling to commit to longer initial terms and longer renewal terms, and landlords being equally unwilling to commit to longer initial lease terms and renewal terms at perceived below traditional market rent rates. Of late, the trend seems to be back to more traditional 5- and 10-year initial terms with 5-year renewals, often in multiple renewal term packages. There is a bit of a lingering trend for tenant users to insist upon some kind of early termination right prior to expiration of the initial fixed term, upon payment of some kind of termination compensation to the landlord. This trend continues due to some continued lack of confidence in the future overall and to more rapidly changing business climate, trends and technologies which, for some industries, can mean unexpected dramatic changes to business sand office space needs.
How are the trends in office space impacting lease transactions and their structure?
Wensley: There is simply a far greater emphasis on flexibility in virtually all aspects of the lease structure to accommodate more rapid changes in markets and technology. Rights to expand, contract and terminate early are typical. More flexibility on initial tenant improvement build-out and less restriction to “building standard” specifications has become more accepted in the landlord community. More latitude in future alterations and less restriction on “typical” office standard alterations and build-outs are becoming more acceptable. But with that is an increased emphasis on removal and restoration obligations of tenants upon lease expirations; i.e., a tenant may be allowed more leeway to build what they want, but there may be an obligation for the tenant to remove what they build at lease expiration vs. leaving it behind for the landlord (as reusability becomes less and less predictable with greater office layout creativity and rapidly changing user demands).
Who are the buyers in this market?
Wensley: Lots of buyers. Lots of money available. Not enough product and highly competitive at all levels, particularly in Class A office and net leased industrial.
Are there any “mixed-use” trends that are driving the market?
Wensley: There have been significant shifts in both the retail and office sectors over the past 10 years, which has resulted in blurred lines as to mixed-use trends. Non-traditional retail uses such as health clubs, movie theaters and restaurants have become more prevalent and even desired co-tenants in traditional and mixed use retail projects and also in traditional office buildings and office projects. We have seen the introduction of a health club into an office building project dramatically increase office leasing activity and desirability of a formerly office-only project. We have seen health clubs (historically prohibited in traditional retail centers) become desired co-tenants in retail centers, often replacing other traditional “big box” retailers that have succumbed to online retail pressures and other market change (such as former Circuit City, Mervyn’s and Home Depot Expo stores). Available multiple price point food sources have become more desired and demanded in the office market arena as tenant users seek to meet employee attraction and retention demands by insisting on or requiring landlords to provide more amenities on-site to address employee demands and expectations for a better, more energetic and collaborative workplace.
How would you describe today’s development sector? And the role of the public agency / city agencies in encouraging development today?
Wensley: Development in Southern California (and California generally) continues to be challenging from a government regulation and processing perspective. Even the most “pro-development” community agencies are saddled with our California regulatory scheme, approval processes, public comment and challenge rights and appeal periods. Regardless of local agency support, development in California is more challenging, time-consuming and costly than many other states. That’s a big reason why we see so many companies relocating portions or all of their business branches to other states such as Utah and Texas of late. A client recently advised me that they were able to permit and construct a manufacturing facility out of state in one-third of the time it took to permit and construct interior office improvements in one of their Orange County office building spaces.
What are the silver linings that you see?
Wensley: One of the greatest silver linings I see is that our Southern California real estate community is comprised of extremely bright, ambitious, creative and resilient people. It is an extremely relationship-oriented business community. The 8-year +/- recession we recently endured strained our real estate community to a degree not seen in the past 30 years; and yet many, many people in our business endured, adapted and are thriving again, many in completely different capacities than before. In NAIOP SoCal, we have seen a dramatic improvement in the overall mood and optimism of our members over the past two years, but even in the darkest hours of 2009-2010 people banded together, stayed connected and sought ways to help each other out whether with a job, a referral to a job, a supporting recommendation or some other encouragement. I’d like to think membership in NAIOP SoCal and attendance and participation in various NAIOP events provided (and continues to provide) a lot of people in our business an avenue to stay connected and in touch with emerging trends and opportunities in our industry. It was nice to see and be a part of.