Exec: Renters Avoiding Buildout Costs In California Office Market
The imposition of energy efficiency standards for new and altered commercial buildings in California is helping to stoke the fires of a hot landlord’s market in offices, says one Los Angeles-based property exec.
At issue is the 1978 California law called Title 24, which aims to decrease the environmental impact of buildings. The law’s requirements impose costs on buildout and tenant improvement plans to the point that, according to Jim Proel, EVP of PM Realty Group, office tenants facing sub-10% vacancy rates are increasingly going the other way — toward longer lease terms with somewhat stiffer annual rent escalations than would be popular in a different market.
GlobeSt.com: Which barriers do you see worsening?
Proehl: The cost to build out tenant improvements will continue to escalate, which makes lease deals more expensive and requires higher rental rates and longer terms. Parking barriers will worsen as tenants go to more open space plans where the per-square-foot per employee continues to decrease.
GlobeSt.com: Are tenants continuing to shift their space needs down, or do you expect this trend to reverse itself at all in 2016?
Proehl: Most tenants do not want to take a step down since their largest operating cost is the cost of their staff. Tenants will try to get more creative with more open space to reduce their square feet while still maintaining the same quality of office space in the same quality location. There will be some tenants in low-margin businesses that will need to move down a class of building or relocation to a cheaper submarket to stay in the same quality of building. For tenants who signed their leases five years ago, they can expect a 50% increase in their rent, which is very significant.
GlobeSt.com: How optimistic are landlords about the office sector for this year?
Proehl: Landlords have not been this optimistic since 2006-07. Vacancy should drop below 10% in 2016, and rental rates will achieve double-digit increases. Landlords now have multiple tenants vying for good suites. Due to Title 24 raising the cost to build out suites, tenants are now signing five-to-seven-year leases with 3% to 3.5% annual bumps. 2016 will be a banner year for office landlords.