As the financial market wavers and business growth remains uncertain, occupancies for commercial buildings continue to ebb, leading to the lowest lease rates in Southern California in years.

Vacancy rates increased across the board in the three major Southern California commercial markets: the greater Los Angeles area, Orange County and the Inland Empire. Along with greater vacancies in commercial rental properties comes the attendant drop in lease rates.

Downtown Los Angeles, arguably being the most stable and established of the three areas, sustained the least amount of loss with vacancies currently ranking at 17%-just a 1 percentage point increase over one year’s time. Rents in downtown Los Angeles slipped from $2.97 per square foot to $2.83. This nominal price decrease can be attributed to the majority of downtown properties being owned by an elite group of landlords who are staunchly maintaining their prices.

Commercial property owners in other areas of Southern California do not have this luxury. Orange County now has a 22% vacancy rate. Coming in at a whopping 25%, one quarter of the commercial properties in the Inland Empire are now empty. Both of these markets are suffering from the glut of commercial property development during the Millennium Boom. Los Angeles has not endured as many vacancies due to the fact that even in boom times the downtown area was slow to develop.

The well-qualified renter is in an excellent position to negotiate, with property owners eager to find new tenants and making substantial concessions to keep good ones. However, the approach to signing long-term lease agreements is split. Some renters are seeking to lock in what they consider to be the best deal for as long as they can, while others are holding out until the market reaches the always-elusive and difficult-to-forecast low-point.

first tuesday take: Holdouts well into 2013 may be rewarded for their obstinacy. Several market factors point to a continued increase in vacancy rates and thus a greater decline in rents for at least the next year.

One aspect of the current commercial property market not often considered is the amount of rental spaces currently under lease that are not being occupied, known in the commercial real estate industry as shadow space. A troublesome lag will exist in absorbing space now on the market while existing tenants fill out the shadow spaces.

Job growth is extremely slow in California and small businesses have not yet stopped downsizing and thus need less space to operate. Further, tenant psychology is adversely affected by a flagging market. Those looking to occupy commercial space are now looking for property that will satisfy only their basic needs.  A deficit in demand for larger, more comfortable office space will continue to affect the overall value of not only these properties but the surrounding ones as well. Less seems to be more at the moment.

Vacancy rates in commercial rental properties are directly related to job growth and the gross annual income of the population in the surrounding area.  When business owners begin to lease more space and lease rates increase in turn, the sales volume of single family residences (SFRs) in the surrounding community will pick up. Until then, prepare to bump along for a couple of years on the flat line of the aborted checkmark recovery. [For more on the checkmark-shaped recovery, see the December, 2009 first tuesday article, The flat line recovery: a side-effect of sticky housing prices.]

Re: “Office vacancies rise, rents drop in southland again” from the Los Angeles Times