Downtown Los Angeles Rises Up

By Maura Webber Sadovi | Wall Street Journal

Office investors are beginning to trickle back into downtown Los Angeles as a rising number of residents, restaurants and glitzy entertainment options bring new zest to the city's once-overlooked core.

But the rebound in the office market downtown remains weak compared with the growth of the area's night life and residential population. The rise in office property values continues to lag behind the region's prime office markets in places like West Los Angeles, Santa Monica and Beverly Hills that still are favored by tenants and big investors.

Consider the deal that is in the works for 400 South Hope St., a 1980s-vintage tower a few blocks from the Frank Gehry-designed Walt Disney Concert Hall. CBRE Global Investors has agreed to pay about $236 million to buy the 26-story tower from a venture of Tishman Speyer Properties and asset manager BlackRock Inc., according to people familiar with the matter.

That price, which equates to about $337 a square foot, is still shy of the roughly $351 a square foot that Tishman Speyer and BlackRock paid in 2005. Downtown Los Angeles office buildings sold for as much as $450 a square foot at the peak in 2007, according to Real Capital Analytics, a real-estate research firm. By comparison, prices for the best buildings in the strongest markets in the Los Angeles region as well as the rest of the country are approaching record highs.

"If any central business district is lagging, it's Los Angeles," says Dan Fasulo, a Real Capital managing director.

The downtown Los Angeles market has long suffered higher vacancy rates than other office markets in the region. Its office towers were home to a vibrant international banking center in the late 1970s and early 1980s, but downtown was hurt by overbuilding, the recession of the early 1990s and consolidation in the financial-services industry.

The downtown market strengthened during the boom years leading up to the latest recession, but it got blasted again with the financial crisis, according to Steve Marcussen,executive director with Cushman & Wakefield in Los Angeles. Downtown Los Angeles's first-quarter office vacancy rate stood at 15.5%, above the 13.2% rate in West Los Angeles, 10.3% in Santa Monica and 8.7% in Beverly Hills, according to Reis Inc., a real-estate research firm.

The 700,000-square-foot building at 400 South Hope, which formerly was named the Mellon Bank Center, is 80% leased, according to people familiar with the property.

The good news downtown continues to be the rebirth of entertainment and other uses dating back to the Staples Center's opening in 1999. Developers since then have converted older office buildings into residential properties, and downtown's residential population more than doubled to nearly 50,000, according to Carol Schatz, president of the Central City Association. Meanwhile, arts and entertainment oriented buildings have opened downtown such as the Walt Disney Concert Hall and the sprawling LA Live entertainment complex.

More recently, a push is under way to build a National Football League stadium downtown. "Now…downtown's dominated by entertainment and tourism," says Mr. Marcussen. "We have a purpose again."

While office investors haven't flocked back to the city, they certainly are taking notice. During the depths of the downturn, downtown office deal activity ground to a halt with no large office building transactions in 2009 and only $211 million in 2010, according to Real Capital Analytics.

By comparison, this year is off to a decent start with $254 million in deals in the first quarter, although it still is well off the pace of the $3.4 billion in sales rung up in 2007 overall at the peak of the market.

Other parts of the city are enjoying more demand from technology, entertainment and other office tenants. But the declining availability of space and increasing rents in these markets work to downtown Los Angeles's benefit. Last year, the Gensler architectural firm relocated into about 53,000 square feet of downtown space from Santa Monica.

CBRE Global Investors is the investment-management unit of CBRE Group Inc. CBRE's brokerage arm represented the seller in the sale of 400 South Hope. The company keeps the two operations separate to prevent conflicts of interest.

Other sales downtown this year include the purchase of the PacMutual building by a venture of veteran developer Nelson Rising for $60 million. That property is nearly 40% vacant, and Mr. Rising is betting that downtown's continuing redevelopment will drive demand for office space.

But the former chief executive of MPG Office Trust Inc. also is cautious about the price he will pay given the uncertainty about when the area's rents will recover. "I'm investing at $140 a square foot," says Mr. Rising. "You make your money in the buy."